Risk Management

 

CONCEPTS OF RISK MANAGEMENT 

TOPIC-1. INTRODUCTION REALITY OF RISK

Any process, by definition, involves a change or a series of changes over time. A process can be natural or man-made. The degree of change from the beginning to the end of a process is dependent on many factors. In the case of man-made processes, such as those characteristic of manufacturing industries, the end is almost certainly predictable, but for the processes of nature there are many factors which make the end unpredictable.

pg. 1

 

CONCEPTS OF RISK MANAGEMENT 

TOPIC-2. CONCEPT OF RISK MANAGEMENT  Risk management is the identification, assessment, and prioritization of risks followed by

coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or to maximize the realization of opportunities.  

A high risk industry is not necessarily one which must be avoided by investors. Invariably high risk Industries provide significant opportunities for high and/or rapid returns on investment. But it is obvious that the investment has to be carefully researched first, and the risks of the venture carefully weighed. Thereafter, the venture must be watched with constant vigilance. A technique for constantly monitoring and evaluating an investment, and its risks, is called "risk management". There is another group of risks which also can be identified but which can be excluded from consideration, either because their incidence is beyond any reasonable human effort (or expense) to control, or because the chances of their occurrence are too statistically insignificant to consider. The process of managing risk is based on the individual analyses of  three fundamental activities, which are taken in sequence, and subsequent synthesis of the results into a programme of management action. The three activities are: - Identification of risk, or discovering the source(s) from which a potential risk may arise, pg. 2

 

CONCEPTS OF RISK MANAGEMENT 

- Measuring risk, or evaluating the impact on an individual or an organization in the event of a potential risk occurring, and - Managing and controlling risk, or selecting the most effective method(s) to deal with a potential risk. These three components have, in turn, many sub-components. These all must be reviewed and analyzed when a risk management exercise is undertaken. Guiding the farmer in making a review and analysis, and formulating a risk management strategy, are the subjects of the following sections.

TOPIC-3. RISK MANEGEMENT PROCESS:

According to the standard ISO 31000 "Risk management -- Principles and guidelines on implementation," the process of risk management consists of several steps as follows:  

 

1. Identification of risk in a selected domain of interest pg. 3

 

CONCEPTS OF RISK MANAGEMENT 

2. Planning the remainder of the process. 3. Mapping out the following:   the social scope of risk management   the identity and objectives of stakeholders   the basis upon which risks will be evaluated, constraints. 4. Defining a framework for the activity and an agenda for identification. 5. Developing an analysis of risks involved in the process. 6. Mitigation or Solution of risks using available technological, human and organizational resources.

TOPIC-4. IDENTIFICATION OF RISK:

In addition, the exposure to different types of risk can change during the life cycle of a species. These differences may be subtle if the species has a simple life cycle, or they may be dramatic if the species has a complex life cycle with major metamorphoses. The pre-smolt production of young salmon in the freshwater hatchery stage, for example, has risks greatly different to those during grow-out in offshore marine cages. Consequently there is a range of differences in terms of risk between one species and another, and each with its own sub-set of associated risks.  

Finally, equally common to all production systems and practices, and which have no relationship to species or life history, are the pure risks, such as the climatic perils of high winds, unusual wave forces, floods, pg. 4

 

CONCEPTS OF RISK MANAGEMENT 

drought, abnormal temperature conditions, and natural hazards of  earthquakes and volcanic activity. The following framework summarizes the principal areas of risk faced by the farmer in the pursuit of profitability in the aquaculture industry. They are separated into (i) business risks, that is, risks directly related to the business of producing aquatic animals and plants; and (ii) pure risks, that is, the risks of life and business in general. Business risks 1. Production risks (i) Operational risk

Risks which interrupt the production cycle, such as mechanical failure, failure of technical processes, services

late

delivery

of

supplies

and

(ii)Technological risks

Risks associated with lack of adequate technology, such as hatchery propagation, or lack of technical information and expertise

(iii) Financial risks

Risks due to government financial policies, use and dependence on government policy instruments, terms of credit, changes in operational costs

(iv) Social risks

Risks due to actions of special interest groups, such as environmentalists and conservationists

2.Market-related risks

Risks due to loss of product quality, lack of  market information, actions of third party (the marketing middleman)

3.Consumer-related risks

Risks due to loss of consumer appeal, health regulations, actions of third party (the consumer)

pg. 5

 

CONCEPTS OF RISK MANAGEMENT 

Pure risks (i)Physical risks of nature

Risks due to extreme climatic and meteorological conditions (wind, flood, drought, earthquake, volcanic action)

(ii) Social and political risks

Risks due to theft, malicious damage, and fraud

(iii) Liability

Risks due to legal actions against the farm

The examples are far from exhaustive but they indicate the principal types of risk for each process which are important for farmers in the aquaculture industry to consider. In their own right, each area is worthy of identification and should be given appropriate thought in the context of the particular operations of each individual farm, its location, the market system, and the target consumers of the product. To neglect this exercise possibly creates a third risk category, namely management risks, which would identify elements of poor planning and poor business control. 1. Business Risks

The business risks are those directly related to the production of  aquatic animals and plants, and the associated commercial business of  the industry. The risks are conveniently sub-grouped into three activities or process described earlier, namely production on the farm, marketing, and preparation for consumption.

  Production risks



Production risks are the principal concern in the daily routine of the farmer, as the production process is his sole responsibility. There are many and varied risks in the production process which can reduce profitability, compared with those which may occur in the subsequent processes of marketing and consumption. pg. 6

 

CONCEPTS OF RISK MANAGEMENT 

Production risks can be conveniently categorized into (i) operational, (ii) technological, (iii) financial, and (iv) social risks. (i) Operational risks

A large number of farms have failed to attain profitability in one or more years because of accidents or major disruptions in the production process. A principal cause of disruption in daily operations is often mechanical failure of plant and equipment. Mechanical failure is an area of weakness which requires expert engineering assistance. A number of farming practices are not dependent on regular water delivery but function on water treatment and recirculation. A life support system is even more at risk of failure when there are a number of mechanical components. For example, recirculation systems are often constructed as "package" units, with all mechanical components having back-up components and safety systems. However, these only add to the mechanical complexity of the system and increase the risk of  equipment failure almost exponentially. There are a number of routine activities in the daily operation of any farm which may be described as "hazardous" to the stock, and create risk. Typical hazards are those which expose the stock to a new environment, albeit temporary; for example, all handling activities required for such things as injection of veterinary medicines to treat pathogenic organisms, counting, weighing, measuring, or transferring stock around the farm, and also the use of chemical baths. Risks to lost production through disruption in the production process can be alleviated by livestock insurance. Insurance is a proven technique for the farmer to divert risk (see Section 4.3). However, as production risks are so diverse some underwriters will often only agree to share the risk, and often restrict the cover in various ways. The stock mortality insurance market which exists at the present time is relatively pg. 7

 

CONCEPTS OF RISK MANAGEMENT 

sophisticated, both at underwriting the risks to stock and applying the technique of risk management. (ii) Technological risks

Aquaculture is a new technology, and the industry is still emerging. It cannot be assumed that the risks associated with aquaculture production are the same as other advanced and established businesses, such as agriculture, horticulture, or fishing. Comparisons are meaningless. However, it is interesting to compare man's level of  knowledge of the natural history and biology of a few key aquatic species produced by aquaculture with those of certain domesticated land animals, cereals, or vegetables. For example, if it is assumed in relative terms that about 75% of the biology of the human is known, then probably about 50-60% of the biology of the major domestic land animals, poultry, and crops is known. But the knowledge of the biology of the aquatic animals and plants probably ranges from 20% (for such as the salmonids, and carps), down to 5%. (iii) Financial risks

Many financial risks are common to all business enterprises and therefore might be considered "pure risks" However, there are always some conditions which make them peculiar to the aquaculture industry, and therefore they must be considered by the farmer as factors which can influence the profitability of the enterprise. Aquaculture farmers, like agricultural farmers, invariably require repeated loans. In addition to loans for capital construction, the farmer usually requires initial operational loans. These may be followed by short-term loans for annual supplies of seed, feed, new equipment, or expansion. Thus the government monetary policy is important. For example, government measures to control inflation or high interest rates on loans obviously have a bearing on the farm's profitability. pg. 8

 

CONCEPTS OF RISK MANAGEMENT 

The government's policy toward a new industry, such as aquaculture, may include a number of non-fiscal incentives for the farmer. These may include grants for development, development infrastructure (such as industrial zones), government equity shareholding, government insurance, leasing of facilities, and even compensation schemes. There may also be subsidies for construction, equipment, and supplies, labour and manpower schemes, and price support. Finally there may be credit on advantageous terms through quasi-government credit schemes, special loans with deferred repayment schedules, and loan guarantees. One or all of these non-fiscal incentives may be available to the farmer and, where economically sensible, they should be b e used. It is important for the farmer to determine continuously the extent to which these non-fiscal and fiscal incentives are making the farm operations profitable, as government incentives are usually removed once the industry is established. The profitability of any farm is closely tied to the farmer's management of capital and cash flow, but also to his overall financial awareness of  other changes going on about him which have a direct or indirect effect on the profitability of the enterprise. The farmer will continue to need short-term credit to maintain the operation, and the lending institutions must make certain that credit is always available. (iv) Social risks

National goals for the aquaculture sector in many countries, and the individual profitability of many farms, are invariably programmed through a series of development phases. This projected expansion, when considered in its entirety, is making considerable demands on natural resources. As a result, many other industries, equally important to the economies of countries and local areas, now compete openly and vigorously for the same resources.

pg. 9

 

CONCEPTS OF RISK MANAGEMENT 

For the individual farmer social problems may result in the non-renewal of a lease (if he does not own the property), or limit important expansion plans. They may also lead to the loss of rights to take water for the farm, or to install costly water treatment to purify farm effluents. These are all risks to his business. Social behaviour may also effect the individual farmer in other ways. For example, again mostly in the developed world, a zealous group of  "animal rights" activists have caused damage by illegal actions, including the release of fish from cages. They have also been responsible for the release of minks from farms, for the release of  dolphins from aquariums, and animals from zoos and medical research centres. Potentially such a group is local, and a small risk to farmers as a whole, but a risk none the less, particularly if there is an organized and concerted effort against, say, salmon farmers.  Market-related

risks

In theory, once the production process has ended, and the healthy live animal has left the farm gate (or the on-farm processing plant), and payment has been made, the product is no longer the responsibility of  the farmer. This, under normal circumstances, would be the end of his risk. In practice, unfortunately, this is not the case. The farmer is still exposed risks may change the quality of histhen product purchasedtoby thewhich consumer. If the quality changes, both until the consumer and the marketing middleman will not make future purchases, and this obviously will have an influence on the profitability of the enterprise. These risks the farmer now shares with the marketing middleman, as the middleman is also dependent on a satisfied consumer. Therefore, to avoid the risks of loss of quality of his product, and the loss of future consumers, it is important that the farmer works with a marketing system and middleman whom he can trust to handle his product pg. 10

 

CONCEPTS OF RISK MANAGEMENT 

correctly. Some farmers, of course, choose not to take this risk, and process and retail their product to the consumer directly, either at the farm gate or in local urban markets.   Consumer-related

risks

Again, in theory, once the consumer has purchased the product in the market place, the responsibilities for the quality of the product by the farmer and the marketing middleman have ended. This, under normal circumstances, should be the end of their exposure to risks. Again, in practice, this is not the case. The farmer and the middleman are dependent for their individual profitabilities on repeated purchases by the consumer. Consequently the risks continue until the product has been consumed, and a verdict of approval has been given. The risks, however, are now shared by the farmer, the middleman, and the individual consumer. 2. PURE RISK:

Pure risks describe a group of risks common to life and business in general, and are not specific to the aquaculture industry. Their occurrences are not selective, but the consequences of some of them have a prior relevance to the aquaculture industry compared with many other industries.  industries. 

  Physical risks of nature



Many pure risks are due to the uncontrollable physical forces of nature. Typical risks are damage to the farm through wind storms, floods, droughts, earthquakes, and even volcanic actions. Unfortunately many farm investors do not research the background meteorological conditions of the site of the farm, and only learn of the extremes of  nature once the farm has been built and an incident has occurred.

pg. 11

 

CONCEPTS OF RISK MANAGEMENT 

Of all these risks, those which have specific relevance to the industry of  aquaculture are those which concern water. All farms are obviously entirely dependent on water. Many are constructed in natural water bodies, such as cage farms in the sea or inland lakes, or net pen farms, or coastal enclosures; others are pond farms or tank farms on land adjacent to the coast or inland water bodies which rely on pumped water. Therefore the prime pure risks are flooding, drought, changes in salinity, and depositions of silts. Drought is equally serious. Water provides the aquatic animals and plants with oxygen for life, and the volume of water passing through the farm regulates the carrying capacity (or the biomass of life which the farm can support). As the water resources decline through drought, the carrying capacity drops below profitable levels, the growth rate decreases below optimum, and finally all the stock may die.  Social

and political risks

The second sub-group of pure risks includes a number of common social risks and less common political risks. Of the former, these are typically theft, malicious damage, fraud, and of the latter riot, sabotage, and possibly war. The social risks are obviously the most immediate concern to the farmer. Poaching, in particular, has been a major risk to farmers. Poaching is likely to continue and probably pr obably increase as such practices as cage farming increase, with large numbers of high-value species held in a compact and convenient enclosure. Similarly, some large farms may be 200-400 hectares in area, and almost impossible to patrol.   Liability

Any business, not only that of aquaculture, is always at risk from the legal actions of employees, clients, and the general public. The origins pg. 12

 

CONCEPTS OF RISK MANAGEMENT 

of the actions are not always obvious. For example, the purposeful treatment of nets with a toxic TBT-based anti-fouling paint have resulted in a number of liability claims from the th e general public. Similarly the risks to public health from the production of aquatic animals and plants in polluted waters, or the poor handling of molluscs, have both resulted in bad publicity for the industry, and sometimes legal actions.

TOPIC-5. MEASURING RISK

Quantifying risks is as important to the farmer and his enterprise as identifying risks. This is an important activity as it assists in placing risks in some order of priority and highlights decisions to be made.  

There are two elements of each risk which need to be quantified before any assessment can be made of the cost and economics of controlling it reliably. These are: - the frequency of the risk occurring, and - the cost and economic consequences of it occurring. The principal decisions facing the farmer, the investor, can be subdivided into three categories, namely: - Commercial decisions. These are the basic decisions about business, and are made through financial comparison of the anticipated return on investment with the cost of any risk if it occurs. In the worst case, of  course, it may be decided that the risks and uncertainty of doing business in the way proposed are too great, and the investment is not made. pg. 13

 

CONCEPTS OF RISK MANAGEMENT 

- Mitigation and control decisions. These are the decisions specific for each risk which must be made if its impact is to be reduced or eliminated altogether. If the risk is only to be reduced, then it is important to decide to what acceptable level, and at what w hat cost. - Financing decisions. These are the decisions which deal with ways of  financing the risk (for example, by insurance), in surance), and their acceptability. However, in spite of all the difficulties at the present time, quantification of the risks can be estimated intelligently if the appropriate information is assembled. A simple check-list of the type of information which must be assembled includes the following: (i) Environmental data - Climatology

Basic weather data, and incidences of extremes

- Hydrology

Basic physical data of water bodies (range of tides, wave direction, pitch, etc.), water chemistry, and all seasonal changes

- Geology

Topography, soil composition, and chemistry

(ii) Biological data - Species data Life history cycle, basic physiology, reproduction -Species pathology Specific diseases, incidences, treatment, efficacy of  treatment, known epidemics, regulations regarding diseases - Aquatic biology

Plankton profile and seasonal blooms

(iii) Production data - Carrying capacity capacity Stock densities, handling pg. 14

 

CONCEPTS OF RISK MANAGEMENT 

- Feeding

Feeding rates, feeding behavior

- Harvest

Size, methods, handling

(iv) Engineering data - Site works

Standards and ccodes odes of practice for facility construction (tanks, cages, rafts), water systems, moorages

- Operations

Alarm systems

(v) Social data - Employees

Regulations for health and safety, working conditions

- Nonemployees

Local conditions, level of unemployment

(iv) Economic data Costs of design services and construction, operating costs, marketing data, production profiles, internal rates of return The list is not exhaustive, but it describes the principal areas of concern, and the type of information required.

pg. 15

 

CONCEPTS OF RISK MANAGEMENT 

TOPIC-6. MANAGING & CONTROLLING RISK:

The third activity in the risk management process, after identification and quantification of the business and pure risks, is managing and controlling the risks.  

There are three main techniques for managing and controlling risk. These are: - finance the farm and its operations to cater for risk, and absorb the consequences and cost of risk in its profitability, - organize the farm and its operations in such a way as to eliminate risk as much as possible; and - divert or spread the risk, for example, through insurance.   Absorb

the Risk

Absorbing a risk is one management technique appropriate to certain types of risks. The financial investment behind a farming enterprise should therefore be sufficient to withstand the occurrence and financial consequences of most risks. Typical pure risks which fall into this category are the normal fluctuations in market prices of products, changes in international currency rates, and increases in labour costs, etc. There are also a number of business risks, such as increases in the price of feed due to (say) sudden shortages of fish meal, and breakdown of machinery.

pg. 16

 

CONCEPTS OF RISK MANAGEMENT 

However, absorbing risks requires positive action on the part of  management and not simply acceptance that the enterprise can withstand the loss should it occur. This may require a certain level of  financial liquidity by reserving a fixed percentage of the profits in a sinking fund, or strict regard to specific practices. Investors in the industry, and more by default than planned strategy, continue to absorb potential risks without maintaining the required liquidity, and pay the consequences. Others, so far, have been lucky.  Organization,

Industrial Standards, and Codes of Practice

Managing and controlling risks are the responsibility of the industry as a whole. This is brought about by individuals recognizing the specific responsibilities within their own particular branch of the industry, and by professional associations and groups of individuals working together to improve organization, to set appropriate standards, and to adopt codes of practice. The following examples illustrate only some of the issues currently of  concern to the industry which can alleviate some of the high risks. (i) Selection of the site

The basic organization of the farm and its subsequent operations begin with the selection of the site. Unfortunately there is considerable misconception about the site selection process, which is clearly very important. With almost certain probability, no site is perfect. The prospective farmer is not able to select a site which meets all the criteria which he or others might have assembled. The farmer has to compromise different criteria and, in practice, the farm site selects itself. The location of the majority of farms is determined by the principal factors which govern the availability of appropriate land and access to pg. 17

 

CONCEPTS OF RISK MANAGEMENT 

suitable water. Land ownership or water rights are therefore the two main criteria. Consequently most farms are sited by Individuals who already own potentially suitable land, or have access to potentially suitable water; or, alternatively, are the only locations for which a sale or lease can be made. (ii) Pilot scale projects

A procedure important to the development of a particular farm or enterprise, but not necessarily considered a standard procedure, is the pilot-scale project. If the investment is in a farming practice which has been well established and proven in the area, then a pilot-scale project is probably not economically justified as a number of the risks have been identified, reduced, or eliminated. On the other hand, if the investment is in a new technology, with little or no prior practice in the area, then the pilot project should be used to assist in identification of  unknown risks, and to provide the real quantification of those risks. Expansion of the pilot-scale project does not take place until the risks are manageable and controlled economically, and farm operations are trouble-free to the trained employees. (iii) Engineering standards

Professional engineers have been slow in entering the business of  aquaculture. Civil and mechanical engineers have rightly been used by many farmers for the design of facilities, but agricultural and marine engineers have not recognized the aquaculture field as one to which their backgrounds can readily be applied to the research and development needs of the industry. Consequently the industry has been slow in producing the fundamental engineering information from which standards and codes of practice are set.

pg. 18

 

CONCEPTS OF RISK MANAGEMENT 

(iv) Professional standards

For many reasons, a farmer has inevitably to seek professional assistance either to plan the farm, or throughout its subsequent operations. Although not readily recognized as such, expert consultation is a risk to the farmer, and it is essential that this risk is managed like any more obvious one. (v) The treatment of disease

Disease of the stock is one of the main risks to the profitability of the farm. Diseased animals and plants are often unsaleable. Invariably they require costly treatment, and the costs are not always recoverable once the disease is eliminated. Moreover, the stock may still not be marketable until all residual chemicals have been cleaned from the body. (vi) Workers' health and safety

Aquaculture is an industry which has attracted the participation of a large number of individuals, the majority of whom have never received any basic education or training in its systems or practices. Only in the last five years has there been a steady stream of trained individuals entering the industry to join those whose training was received "on the  job". However, both groups are quite clearly dedicated to the emerging industry. The majority of the work force in the industry is comparatively young.

  Divert the Risk



Most of the risks identified and analyzed by a farmer for his enterprise can be reduced by varying degrees, yet few can be entirely eliminated. Thus they have the option to absorb these risks themselves (see 4.1) or to divert them. pg. 19

 

CONCEPTS OF RISK MANAGEMENT 

There are a few risks, and parts of certain risks, which are not worth insuring. These are important for the farmer to know as it is not necessary to reduce the farm's profitability by paying premiums to an Insurance underwriter to cover risks which will Inevitably and frequently occur. Insurance underwriters level their premiums to cover the cost of ordinary losses, allowing also for a profit, and an "uncertainty" margin to enable them to establish a reserve for disasters and catastrophes which occur from time to time. The role of insurance, as the principal method for diverting or sharing the farmer's risk exposure of his enterprise, is an important one which merits examination and explanation. Insurance is already the established mechanism for managing the risks of many existing enterprises. The presence of an active insurance industry in the aquaculture industry provides the lending institutions with the confidence to make loans to farmers, and it is important to the future of the industry that both continue. However, because of the high risk of  the industry, and plenty of evidence that the industry lacks all the right technology, many underwriters are being extremely circumspect about providing insurance, or are severely restricting their cover. Unfortunately this is coincidental with a time of great need for capital investment in the industry, both privately and by lending institutions. The confidence of the insurance companies in the industry at this time is vital, as their role is important.

pg. 20

 

CONCEPTS OF RISK MANAGEMENT 

TOPIC-7. THE ROLE OF GOVERNMENT IN RISK MANAGEMENT  

The policy and legislative actions of any government, at national, state, and local levels, have significant impacts on the management and control of risk in the aquaculture industry. Some of  these impacts do not arise through actions directed toward the aquaculture industry itself, but through actions directed toward associated or competing industries, such as agriculture, tourism, or recreation. Unfortunately few governments at the present time consider or coordinate multi-sectoral development.  

  Government

Policy

A national policy toward aquaculture development is important for the industry. This may be no more than including statements about the sector in a five-year economic development plan, or it may be a detailed development plan for aquaculture alone. With recognition the aquaculture in any development plan, the there invariablyoffollows a number sector of policy instruments for government administrators to manage the sector and control individual private investments. The range and use of these policy instruments are usually in direct relationship to the status and strength of the sector. For example, in countries where investment in the sector is being encouraged, the government will stress incentives, such as grants, loans, and subsidies, and even fiscal incentives, such as exemptions from tax. In countries where the sector is well developed the government will invariably impose duties, taxes, and quotas. pg. 21

 

CONCEPTS OF RISK MANAGEMENT 

 Legislation

A government manages and controls the aquaculture sector through legislation. The type and degree of legislation obviously have a direct and significant impact on the sector as a whole, and on the individual enterprise and farmer, and therefore constitute risks to all of them. Legislation is sub-divided into two areas, namely legislation dealing with resource utilization and resource management, and legislation dealing with farm management.

pg. 22

 

CONCEPTS OF RISK MANAGEMENT 

CONCLUSION

Lastly I would like to conclude that risk management is the critical activity or process that is used to identify, control and finding out proper

steps

to

minimize

the

risk.

Risk

management is

the

identification, assessment, and prioritization of risks followed by coordinated and economical application of resources to minimize, monitor, and control the probability and/or impact of unfortunate events or

to

maximize

the

realization

of

opportunities.

Risk

management also faces difficulties in allocating resources. This is the idea of opportunity cost. Resources spent on risk management could have been spent on more profitable activities. Again, ideal risk management minimizes spending (or manpower or other resources) and also minimizes the negative effects of risks. Hence it is said that those who implement risk management tools in their business has a key of success/profitability in business.

pg. 23