What actions can I take for a risk ?
There are four ways to react to risk : accept, avoid, mitigate or transfer. What does this mean ? and how do I put this in place ?
In a previous article, we stated that risk can be both a threat or an opportunity. When analyzing a risk and deciding how to react to it, one will keep this in mind.
To illustrate this article, let’s imagine you run a circus. Trapezists run an act every night. The risk in this performance is that one falls, get hurt and that the circus be sued in the process.
I Accept my risk
Accepting a risk is a straight forward notion. The risk is there and I accept to run the business with it, without doing nothing about it.
In our example, you simply do nothing to protect the trapezists from falling down. If one of them falls down the circus is probably up for some severe legal ations. On the contrary, you can apply a higher price to your entrance ticket because what they do is more dangerous.
I avoid my risk
Avoiding is a risk is simply not accepting to run the business with it. Another way of seing it is to modify the business as to by-pass the risk.
If we go back to our example, the best way to avoid the fall of the trapezists, is to not let them perform. But this attracts less people, reducing your income.
I transfer my risk
Transferring the risk means that you will transfer the consequences of it to another party. This basic idea is the one that built the initial derivative markets.
Practically speaking, transferring the risk means you will take some form of insurance that will transfer the results of the risks to another party, with, or without, a premium.
For our trapezists, you will insure the circus so that if something happens, the insurance company will cover for the legal actions and their consequences. You will pay a premium for this taking over but you can still charge a lot for seeing a dangerous act.
I mitigate my risk
The risk mitigation is the fact of taking actions that will reduce the risk that the company runs to an acceptable level. The risk will remain but with a reduced impact or probability.
This segment of the risk management is the one using most of the risk resources of a company. Indeed, the mitigation needs to impact the business day in, day out while some other risk responses are once in a while exercises.
When we go back to our trapezists, mitigating the risk of a fall would be installing a net that would catch them when they fall. The net will cost money in investment and maintenance, you will still able to run the performance and charge for it, even if a little bit less because the act is less perilous.
As we are in the risk responses, we will need to talk about the controls. But this is for our next article.
Co-Founder & Partner
After 13 years as CFO of The Bank of New York Mellon, I had several positions that allowed me to cover a wide range of topics: general management of entities, Risk and finance management, corporate taxes, supervision of IT and operations, accounting, budgeting, creation and restructuring of legal structures, regulatory reporting, acquisition of companies, operational statistics, and management accounting.
My strengths are in Finance and Risk Management