Academic journal article Risk Management and Insurance Review

Risk Management: History, Definition, and Critique

Academic journal article Risk Management and Insurance Review

Risk Management: History, Definition, and Critique

Article excerpt

Abstract

The study of risk management began after World War II. Risk management has long been associated with the use of market insurance to protect individuals and companies from various losses associated with accidents. Other forms of risk management, alternatives to market insurance, surfaced during the 1950s when market insurance was perceived as very costly and incomplete for protection against pure risk. The use of derivatives as risk management instruments arose during the 1970s, and expanded rapidly during the 1980s, as companies intensified their financial risk management. International risk regulation began in the 1980s, and financial firms developed internal risk management models and capital calculation formulas to hedge against unanticipated risks and reduce regulatory capital. Concomitantly, governance of risk management became essential, integrated risk management was introduced, and the chief risk officer positions were created. Nonetheless, these regulations, governance rules, and risk management methods failed to prevent the financial crisis that began in 2007.

Introduction

Risk management began to be studied after World War II. Several sources (Crockford, 1982; Williams and Heins, 1995; Harrington and Niehaus, 2003) date the origin of modern risk management to 1955-1964. Snider (1956) observed that there were no books on risk management at the time, and no universities offered courses in the subject. The first two academic books were published by Mehr and Hedges (1963) and Williams and Heins (1964). Their content covered pure risk management, which excluded corporate financial risk. In parallel, engineers developed technological risk management models. Operational risk partly covers technological losses; today, operational risk has to be managed by firms and is regulated for banks and insurance companies. Engineers also consider the political risk of projects.

Risk management has long been associated with the use of market insurance to protect individuals and companies from various losses associated with accidents (Harrington and Niehaus, 2003). In 1982, Crockford wrote: "Operational convenience continues to dictate that pure and speculative risks should be handled by different functions within a company, even though theory may argue for them being managed as one. For practical purposes, therefore, the emphasis of risk management continues to be on pure risks." In this remark, speculative risks were more related to financial risks than to the current definition of speculative risks.

New forms of pure risk management emerged during the mid-1950s as alternatives to market insurance when different types of insurance coverage became very costly and incomplete. Several business risks were costly or impossible to insure. During the 1960s, contingent planning activities were developed, and various risk prevention or self-protection activities and self-insurance instruments against some losses were put in place. Protection activities and coverage for work-related illnesses and accidents also arose at companies during this period.

The use of derivatives as instruments to manage insurable and uninsurable risk began in the 1970s and developed very quickly during the 1980s.1 It was also in the 1980s that companies began to consider financial management or portfolio management. Financial risk management has become complementary to pure risk management for many companies. Financial institutions, including banks and insurance companies, intensified their market risk and credit risk management activities during the 1980s. Operational risk and liquidity risk management emerged in the 1990s.

International regulation of risk also began in the 1980s. Financial institutions developed internal risk management models and capital calculation formulas to protect themselves from unanticipated risks and reduce regulatory capital. At the same time, governance of risk management became essential, integrated risk management was introduced, and the chief risk manager (CRO) position was created. …

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