A common misconception about risk management is that the goal of risk management is to completely eliminate risk from the organization. This is not the case in practice, since it is practically impossible to exclude risks. In practice, this is not the case as the risks cannot be practically eliminated.
Approaches to Risk Management
The approaches commonly followed in the risk management process have been detailed below:
Risk Avoidance:
The simplest strategy is called risk prevention. In this approach, the company avoids taking risks as much as possible. However, this strategy is not viable for many companies. In fact, most businesses carry some degree of risk. Thus, if the company is simply trying to avoid risk, it should significantly reduce the scope of its activities. The end result of this approach is that there is little incentive for activity to occur.
Diversification:
Diversification is one of the oldest and most fundamental strategies of risk management. With this approach, the company consciously tries to engage in very different business activities. Because the activities are so different from each other, adverse economic events generally do not occur simultaneously.
Risk Transfer:
Another way to manage risk is to transfer it to outside parties. There are many outside parties, such as insurance companies, willing to take the risk for a fee. However, there is no insurance for all risks.
Risk Retention:
Risk retention is a strategy by which a company decides to keep risk on its books. This policy may be due to a high conversion cost. Or it may be because the company has too much confidence in its internal controls. Companies with good operational risk management processes tend to retain risk.
Importantly, the same risk can be addressed in different ways, depending on the company's standard policies. It is important to create policies based on the different approaches above.
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