[MUSIC] So one characteristic that virtually all human beings share is that we do not like risk and we do not like uncertainty. However, one of the realities that we have to face as human beings is that none of us can necessarily control every single thing that's going to happen to us in the future and there are some very natural risks that each one of us faces. So in this lecture topic we're going to introduce the topic of risk management. Talk about some of the sources of risk that each one of us faces in our daily lives. And then talk about the risk management process and try to relate that specifically to how it affects our financial plans and planning for our financial futures. So on this slide I have three different broad categories of risk defined, personal risks, property risks and risks associated with liabilities or liability risks. Now any risk that we face in our daily life can fall in one or more of these categories. So just to provide some examples of personal risk these include the risk of injury that we may face, poor health that we may have in the future or maybe the risk of losing our job and be unemployed for a specific period of time. Property risks are going to include anything that is going to be a associated with the loss of any assets that we own. So not necessarily ourselves personally but any assets that we own or the loss of value of any assets that we own. And in terms of the category of liability risk, that refers to damages to other people's well-being or other people's property. So not necessarily our own health or our own injuries to ourselves or damages to our own assets but damages that we're somehow involved with through negligent behavior that affects other people's health or well being or other people's assets or asset value. So just to talk about some examples here. Again, we might be worried about health risks or the risk of getting some type of illness that's going to affect our ability to complete our job or perform our job duties in the future. That would fall under a single category of personal risk. But again there might be risks that fall across multiple categories that I have listed here. For instance, if we get into a car accident, we might have some personal risks associated with injuries from the accident. Our car, an asset that we own may also be damaged. And there may also be liability risks associated with that accident if the accident was our fault. The other thing that I'd kind of like to just provide some context on and things to think about as we work through this section on risk management is thinking about whether risks fall in the category of avoidable or risks that we can define as being avoidable. Things that we can change maybe with different behaviors or altering our actions. Versus risks that are unavoidable or things that are completely out of our control. Again, risks may fall in one of the three different categories that I've listed at the top here. And they may also fall in the two categories of avoidable and unavoidable. The way that we approach these risks and manage these risks is going to depend on which category that they fall in. So what exactly is risk management? Well risk management is typically talked about as a process that individuals go through that involves basically two key steps. First of all we're going to go through and identify and assess the various risks that we face, again, across all three of those categories, personal properties and liability risks. We're going to assess what the danger is or what the potential negative outcomes that we might face from each one of those risks might be. Second, once we have a good understanding of the risk profile that we face, the different risks that we face each day. How are we going to use the available tools and resources and strategies that we have available to us to manage those risks? The whole point of a risk management plan is to, again, identify those risks and then come up with a plan to change the amount of risk that we face or bring the risk level down to a level that is acceptable to you as the individual. And this is a very key point that we need to understand throughout this risk management section of the course. We all differ as individuals we all differ in terms of the amount of risk tolerance that we have or the amount of risk that we are willing to take on or bear. So there are no absolute right or wrong answers in terms of the strategies that we implement, or the management plans that we implement to help manage those risks. Right now we're going to talk a little bit about some of the tools that we have available to us within those risk management plans. First, I'm going to, again, provide some categories for the different tools just like we categorized our risk in the first section of the lecture. And first, I want to talk a little bit about risk avoidance and risk reduction. Now specifically here, we're talking about strategies or actions that an individual may take on that are going to directly change either the likelihood of a risk occurring or if that risk does occur it's going to impact the severity of that risk. Okay, so again, these are behaviors or actions that you can take on as an individual that could be part of your risk management plan that are going to directly impact the risk itself. All right, so some very common examples that we might think of here diversifying your investment portfolio. We touched down this a little bit in the long-term investment section of the course. But here we might be combining multiple assets to reduce the likelihood of a loss or the size of a loss if it occurs with the investments that we've selected to include in our portfolio. Some other more personal examples might be from a driving perspective, we can think about using our seat belt. That maybe will reduce the likelihood that you're in an accident. But it most likely is going to reduce the severity of any injuries that you might face. If you do get into a car accident, we can think about changing our driving behavior or maybe slowing down a little bit. Driving at or below the speed limit to reduce the likelihood of a car accident. Or we can think about our behaviors like just simply not texting while we're driving, that's also going to reduce the likelihood of an accident and helped to avoid or reduced some of the risks that we face. Finally, I've also listed up here from a health perspective, we might think longer term about implementing regular exercise routines or a balanced diet into our everyday life. And long term, that should reduce the likelihood and the severity of some of the health related risks that we face as individuals. Right now I'm going to talk a little about a different kind of topic, specifically risk sharing or risk transfer. So here we're talking about the use of tools or the use of strategies that don't necessarily change the risk itself. But it's going to help to change the outcomes if that risk does occur or some sort of loss occurs because of a risk. Okay, so here we're not talking about changing our behavior and having an impact on the risk itself. We are talking about using resources to change the outcomes if those risks occur. So again, some examples here, that we might be able to relate to ourselves as individuals. From a business perspective, if we were worried about losing the money that we've invested in a business, we might think about taking on additional business partners to spread that risk or share that risk across multiple individuals or taking on additional investors. Or just from a financing perspective, we might think of using a combination of debt and equity financing just so the business isn't financed completely by our own financial resources. We're also using a lending institution that's going to share in some of that business risk. Again, on a more personal level, and something we're going to get into in more detail as we continue to move on. Another way to share or transfer risks to other parties is through the use of insurance contracts. And we're going to see a number of examples here of very common insurance contracts that are used to transfer burst business or personal risks or losses from the individual to the insurance company that's going to take those on as part of the insurance policy. All right, and then finally I want to talk a little bit about and differentiate between what people often call self insurance versus an explicit or formal insurance contract. So first of all self-insurance against something that we've covered in other areas in the class. Self insurance refers to designating savings to be used if a risk occurs in that cause sort of a loss. So again example that we've talk about before, establishing an emergency savings fund. So we have some money valuable to cover things if they come out. Things that are good for emergency savings, maybe some unexpected damages to our car or repairs that we need to our car over time. We don't necessarily know when they're going to occur, or even if they definitely will occur but they're pretty common and things that we can plan for by setting aside some savings in an emergency fund. Now in contrast, formal insurance policies refer to things where an actual insurer, another party is involved and they agree to bear the cost if something occurs that causes a financial loss. And the individual or the insured for that service pays that insurer a premium, all right? And again, we're going to talk about some specific examples of formal insurance contracts. That's a very common types that a lot of us are familiar with all ready are auto insurance, health insurance and life insurance. Again, another point I want to make here distinguish between the two. Self insurance is typically going to be effective and used more often when risks that were thinking about covering are more predictable and are going to generate kind of smaller or more manageable losses. So again, the example that I mention about putting some emergency savings aside for car repairs. That's something that maybe we can all wrap our heads around and put an amount of money away that will effectively cover those losses. Insurance contracts are really more effective for some of those less predictable and highly severe losses that may be incurred for things like severe auto accidents, severe health problems, losing our job for a significant period of time. So those are the cases when formal insurance contracts are often more effective and more commonly used in practice. Okay, to summarize this lecture segment again we talked about risk management and provided a definition. Again, that risk management process involves identifying and assessing the risk that an individual faces. And then coming up with a strategy to use the tools and the resources and the methods that are available to us to manage that risk and bring it down to a better acceptable level. Again, that acceptable level it's very important to understand that that differs across individuals. So again there are no right or wrong answers in terms of how much insurance you should have or how big your emergency fund might need to be. And there are a wide range of management methods available to us. So we talked about methods that fall in that category of avoidance and reduction where we're actually changing the risk that we face and the likelihood of it happening and the severity of it if it does occur. And we also talked about sharing and transfer methods where we're taking that risk and we're transferring it or sharing it with another party. Again, the key thing to understand here is that a comprehensive risk management plan is something that takes all the risks that an individual faces, assesses those, and then determines the best course of action, the best combination of approaches to bring the overall risk that that individual faces down to that acceptable level. [MUSIC]
