Risk assessment in an enterprise: an example, approaches and models

2024 Author: Howard Calhoun | [email protected]. Last modified: 2023-12-17 10:16

One of the elementary functions performed in insurance companies is risk assessment (underwriting). Its importance is due to the fact that it is at this stage that the main parameters of insurance in the future are modelled. Thus, taking inappropriate risks or misclassifying them will lead to a deterioration in the financial results of insurance, as well as to the creation of an inadequate risk portfolio. This is especially important in the insurance sector, which is long-term in nature. Incorrectly concluded insurance contracts cannot be terminated unilaterally by the insurance company, which means that they can have a negative impact on its economic situation for a long period of time.

General view

Risk - the possible occurrence of an undesirable phenomenon associated with the work performed. This could result in loss, injury, or death to employees doing the work.

Under the risk assessment in the enterprise understand the identification of hazardsand threats to the company that exist in production, determining the extent of these threats in order to identify ways to prevent.

This is also a set of analytical activities that allow you to predict additional income opportunities or the expected amount of damage.

Risk assessment principles

Among the basic principles of risk assessment in an enterprise are:

• complexity of the approach, which is expressed in the need to assess all hazards and their sources at the enterprise;
• comparability of the level of risk with the level of return;
• risk-to-cost ratio means that the possible amount of loss should be equal to the share of capital that provides loss insurance;
• economic feasibility, when the risk management process should be more profitable than the cost of it.

Purpose and subject

Risk assessment in an enterprise on the example of insurance covers the following areas:

• medical;
• professional;
• non-commercial;
• financial.

Medical risk is related to the he alth of the insured and is determined by many factors: biological and genetic, age, lifestyle and behavior.

Occupational risk includes all elements that affect the likelihood of death associated with the place and type of work performed. Its occurrence is based on the assumption that the danger in the profession is not linear, but random.way distributed among different areas of labor activity. This type of risk includes factors that directly affect human safety (noise, dust, light, etc.) as well as indirect ones (tension, stress, excitement, etc.)

Non-commercial risk - this type consists of all non-commercial activities carried out by the insured in his spare time. The interests of the individual must be taken into account here. There are also interests that clearly do not increase the number of failures.

Financial risk is associated with the danger of some reinsurance, which is understood in two ways: as too expensive insurance in relation to disposable income, or as excessive in relation to insurable interest. The consequence of such a phenomenon may be the rapid liquidation of the enterprise.

Components

Insurance risk is assessed based on two components:

• choice;
• classification.

As part of the selection process, the insurance company evaluates individual claims in terms of the risk they pose to decide whether to accept or reject (postpone) insurance claims. Deferral is applied in a situation where it is impossible to correctly assess the risk at the moment in question and when such an opportunity may appear in the near future. Therefore, the main and immediate purpose of the selection process is to counter the process of adverse self-selection made by companies that want to insure themselves.

The second component of the process is classificationaccepted insurance claims for specific risk classes. This is directly reflected in the application of the premium rate. In the classification process, the insured is assigned to a group of clients representing a similar probability of risk. The immediate purpose of the classification is to achieve a situation in which insurance is included under conditions and at a premium level that reflects the degree of its risk.

The starting point for the classification of customers and the structure of premium rates is the division of the standard class (group). It will reflect the average risk for the entire insured portfolio, and nominees will be burdened with an average premium. The standard group should be large enough and include a sufficiently large percentage of the insured (about 90%). This reduces the likelihood of deviation from the average risk and reduces the cost of administering the insurance portfolio.

In addition to the standard class, it is necessary to create non-standard classes with an increased insurance risk, as well as with an increased insurance premium. It is important that the number of these classes guarantees a balance between the minimum requirements (due to technical needs) and their maximum number in order to avoid anti-selection risks and increase administrative costs.

Delphi Method and Nominal Group Method: Application Basics

In the process of risk identification, various developed methods for quantitative assessment of enterprise risks are used. Among the main methods, the following methods should be noted:checklist, heuristic, Delphi and holistic.

For example, the Delphi method is based on the opinion of experts invited to participate in the risk identification process. In this case, individuals do not meet and often do not know who else is involved in the risk identification process and what types of risks have already been identified.

The Delphi Method consists of three steps:

• Selection of a group of experts who carry out the assessment.
• Compiling an anonymous list of risks they think the company is exposed to.
• Providing all examiners with a comprehensive study that lists all types of risks identified by examiners involved in the identification process. Formation of requests for a new identification, taking into account the results contained in the presented study (this process can be repeated many times).

The Delphi method for assessing the risks of an enterprise's activities is similar to the nominal group method. It allows individual experts to be contacted without direct communication between them.

Enterprise risk assessment and an example of applying the nominal group method includes three steps:

• gathering a panel of experts and asking them to submit their identified risks in writing;
• compilation of a list of all types of hazards thus obtained and discussed by experts;
• give each expert a weight (importance of a given risk for the level of profitability of the company) and rank them.

VaR method forinvestment risk assessments

Today the VaR method is very popular among many investors and banks in the risk assessment system at the enterprise. Its task is to express the existing investment risk with a single number. In essence, VaR is the total loss that does not exceed the loss in the value of the portfolio over any period of time and takes into account current probabilities.

For an accurate calculation, you need to know the profit distribution function of the portfolio for a certain period of time. In most cases, the VaR values are completed within a period of one to ten days, in which the confidence level is very high - up to 99%.

In order to accurately calculate VaR, several basic parameters should be considered - a specific time period (for which calculations are made), as well as the composition and distribution function of the total value of the investment portfolio.

It would seem that the information is not difficult for the composition of the portfolio, but in practice there are problems, especially when it comes to large enterprises. In the arsenal of the past, there may be thousands of assets to track difficulties. Another important point is the determination of the value of these instruments.

The VaR enterprise risk assessment method has been developed to make it as easy as possible to assess the risks and needs of various categories of investors. There are three main methods of VaR-estimation. Each of them has its own characteristics:

• Historical method. It involves examining price changes generated by a portfolio over a certain period of time in the past to calculate historical data on the value of fixed assets (alreadypast). The advantage of this method is that it is possible to value a portfolio of assets, including derivatives (futures, options, etc.). Drawback: Huge effort to collect historical data.
• Analytical method. It involves identifying and recording when calculating market factors that affect the value of a portfolio. The advantage is that most of the required parameters are already there, so the VaR calculation is quite fast. Disadvantage: low quality and inaccurate calculations.
• Monte Carlo method. It involves modeling likely price changes based on a set of assumptions. It also takes into account market factors that may affect the price of a portfolio. The advantage of this method: the ability to easily reconfigure the calculation, taking into account economic forecasts. Disadvantage: it does not show the final price of the portfolio, but the only possible scenario of events, the complexity during calculations.

Bankruptcy risk assessment

The tables below show the characteristics of the main methods for assessing the risk of bankruptcy of an enterprise.

It is usually associated with the probability of financial losses of the company as a result of the influence of adverse factors.

Enterprise risk assessment and an example of the methodology are presented in the table below.

Model specifications	Indicators used in the model	Shape of the model function and classification criterion
In the process of creating a modelcompanies were considered bankrupt or threatened with bankruptcy. The sample consisted of 34 companies facing failure. He althy companies were selected in such a way that each of them corresponded to one of the bankrupt companies. Initially, 19 financial indicators were analyzed, six of them were used to build the model.	X1 - current assets / current liabilities; X2 - current assets - inventories - short-term receivables / payables; X3 - gross profit / sales revenue; X4 - average inventory value / sales revenue360 days; X5 - net profit / average asset value; X6 - total liabilities + provisions / operating results + depreciation;	Z=1, 286440X1 - 1, 305280X2 - 0, 226330X3 - 0, 005380X4 + 3, 015280X5 - 0, 009430X6 - 0, 66132 Z> 0 - no risk of bankruptcy

The following model is related to the calculation of ratios of assets and realized financial values.

Assessing the risk of bankruptcy of an enterprise through the model of J. Gaidk, D. Stos.

Model specifications	Indicators used in the model	Shape of the model function and classification criterion
The model was developed at 34 enterprises of two numerically equal classes: insolvent and bankrupt. Initially, 20 indicators were used, eventuallyin the end only four were taken into account.	· X1 - average cost of liabilities; short-term / cost of goods sold360 days; X2 - net profit / average asset value for the year; X3 - gross profit / net sales; X4 - total assets / total liabilities.	Z=- 0, 3342 - 0, 000500X1 + 2, 055200X2 + 1, 726000X3 + 0, 1115500X4 Z> 0 - no risk

Risk assessment at the enterprise and an example of model A. Holds is presented in the table below. Within the framework of this method, the ratio of various groups of assets, liabilities to the company's income is presented.

Model specifications	Indicators used in the model	Shape of the model function and classification criterion
The model was built on the basis of 40 bankrupt enterprises and 40 enterprises that continue their activities. The study covered 3 years (1993-1996). At the first stage of the analysis, 28 financial indicators were selected, the final form of the model was based on five of them.	X1 - current assets / current liabilities; X2 - total liabilities / total assets; X3 - income from total activity / average annual assets; X4 - net income / assets; X5 - current liabilities / cost of goods and materials sold360.	Z=0, 681000X1 - 0,019600X2 + 0, 157000X3 + 0, 009690X4 + 0, 000672X5 + 0, 605 Z> 0 - no risk of bankruptcy

The following model shows the calculation of the ratio of financial results to assets and liabilities of the company.

Enterprise risk assessment model by E. Michinska and M. Zawadzki (GINE PAN model)

Model specifications	Indicators used in the model	Shape of the model function and classification criterion
Evaluation of the model was based on a set of 80 companies in 40 risk-free and 40 non-threat banks. The analysis included reporting data for 1997-2001. 45 indicators were preselected. Four indicators were used to build the model.	X1 - operating result / average asset value for the year; X2 - equity / assets; X3 - net financial result + depreciation / total liabilities; X4 - current assets / current liabilities.	Z=9, 498X1 + 3, 566X2 + 2, 903X3 + 0, 452X4 - 1, 498 Z> 0 - no risk of bankruptcy

Economic risk assessment

Let's consider the methodology for assessing risks at the enterprise. There is a huge number of possible settlement options both in domestic and foreign practice.

Mostly qualitative methods are used to assess economic risk. The choice of one of them should be preceded by familiarity withcharacteristics of this group. Qualitative risk assessment methods can be divided into three groups: matrix methods, indicator methods, risk graphs.

Matrix - usually two-parameter methods. The assessment of the economic risks of an enterprise in this way is based on a matrix built from two parameters. Once analyzed, risk assessment is not difficult, but it should be remembered that the absence of parameters related to the working environment, such as exposure to risk, can prevent an accurate assessment of hazards.

The group of matrix methods includes the PHA method and the risk matrix method for non-measurable factors.

Indicator methods are multi-parameter and multi-level methods. In this case, the risk assessment is based on the calculation of the indicator value, which is the product of the parameter weights. The introduction of several levels of estimation of parameters and risk values makes the assessment more complete and more accurate than in the case of matrix methods. The use of indicator methods for risk assessment is facilitated by such parameters as exposure to risk, the ability to protect against threats. Enterprise risk assessment and an example of the indicator method is more commonly referred to as the Five Step method.

Graph-method is the most diverse way in terms of the number of levels for estimated parameters - there are from two to five levels for each parameter. It is worth remembering that although with a small number of levels it is easier to estimate the parameters, the risk assessment will not be accurate enough. This method evaluates four parameters, but also considers additional criteria such asexposure and ability to use protection against threats. This solution allows for a more complete assessment of economic risk.

Occupational risk assessment

Assessment of occupational risks in an enterprise is a process of constantly examining all possible aspects of the work performed by employees in order to identify hazards, determine the possibility of their elimination or the absence of such an opportunity to prevent their creation using the necessary measures and protective equipment.

There are many effective methods for assessing occupational risk. However, it is recommended to choose those that do not require special knowledge and that can be easily assessed by a group of specialists. However, it should be noted that the results obtained provide the necessary information to prevent the occurrence of hazards. There are three areas with different levels of risk:

• in area I, where the risk is unacceptably high and cannot be reduced with available resources, no work is allowed;
• area II, where the risk can be accepted if it is constantly controlled, but efforts must be made to reduce the possible danger, taking into account the economic condition;
• area III, where the risk is negligible and does not require control, as it is not expected to increase.

In the literature you can find information that it is necessary to carry out a risk assessment for all workplaces. This should be done for those positions for which the analysis has not been previously carried out, andalso in the event of a change in position that may change the level of danger.

A risk assessment should be carried out when:

• new jobs created;
• changes are made on workstations;
• requirements regarding the acceptable level of working environment factors, risk assessments have been changed;
• Changes related to the application of protective measures.

In addition to the above cases, periodic occupational risk assessments may also be required to be carried out in workplaces and for technologies and processes with a high probability of risk, the consequences of which can be very significant or catastrophic.

Conclusion

Thus, risk assessment is broadly understood as the process of determining the likelihood of an event occurring that is associated with a hazard. The evaluation process is considered as an element of the analysis. It also includes a set of tools and methods. The ultimate goal is to reduce risks and benefit from the current situation.