Curricular Concepts in Risk and Insurance
Teaching Risk Management As A Decision Process
—A Review of the New I.I.A. Program in Risk Management
George l. Head
The textbook literature in risk management is beginning to grow significantly beyond the pioneering work of Mehr and Hedges, and there are indications that more texts are germinating on campuses and in business offices throughout the United States. New, worthwhile articles, pamphlets, and other publications on risk management subjects are constantly appearing. Therefore, one criterion for a well-designed curriculum, or even a single course, in risk management is that new material can be easily and logically integrated into the program without disrupting its structure.
This criterion has been particularly important in the revision of the Insurance Institute of America's Program in Risk Management. Because this revision has been a major undertaking, involving creating of three new courses to replace the former six-course offering, the overall format of the new Program has had to be sufficiently flexible to incorporate new material without another major restructuring for several years. Achieving this flexibility within a relatively permanent overall framework required a general structure which, for permanence, could survive periodic revisions of any of the texts adopted in the new Program and which, for flexibility, would be logically consistent with future texts, articles, and other materials which should be included to keep the Program current.
A curriculum which appears to meet these requirements rests on the concept that risk management for a firm is fundamentally a process for deciding which methods of treating risk will best fulfill that firm's goals. Hence, the key to teaching risk management is to follow a structured decision-making process applicable to risk management problems.
Many authorities in business management have observed that there are certain common steps in the making of all rational business decisions. For example, one text identifies four essential phases of sound management choice: (1) diagnosing the problem, (2) finding alternative solutions, (3) analyzing and comparing alternatives, and (4) selecting the best alternative. Another source recognizes much the same process but adds a preliminary step of becoming aware of the problem and a concluding step of checking to be sure the alternative selected has solved the problem. A third text elaborates the same decision process (described as a "model for the management of change") into eight stages.
This generalized management decision process appears to be akin to the still more general process known as the "scientific method" of inductive reasoning. The scientific method is often described as involving (1) recognition and formulation of a problem, (2) collection of data relevant to the problem, (3) formulation of alternative hypotheses to explain the problem, and (4) testing these hypotheses. Inserting "alternative solutions" for "alternative hypotheses" in the steps of the scientific method yields a procedure very similar to management decision process.
Several recent texts present a risk management decision process which closely parallels both the general management decision process and the scientific method. For example, Elliott and Vaughan see the functions of a risk manager as (1) identifying pure risks, (2) evaluating these risks, (3) considering alternatives and deciding on risk treatment devices, (4) implementing this decision, and (5) reviewing the results of the decision. The major difference between these risk management functions and the general management decision process or the scientific method is the substitution of "pure risk" for "problem" and "risk treatment device" for "solution" or "hypothesis." Even this difference is not substantive; the listing of risk management functions is only a specific application of the generalized management decision process or the scientific method.
Therefore, the Institute has done very little that is new by using a five-step risk management decision process as the core of its Program. The steps in this decision process require the risk manager to (1) identify and analyze significant pure risk loss exposures, (2) develop alternative techniques for treating each exposure, (3) choose the best technique or combination of techniques for treating each exposure, (4) implement the chosen technique(s), and (5) monitor the results to control and coordinate the firm's total risk management effort.
The only innovation the Institute can claim here is perhaps the placing of greater emphasis on a structured risk management decision process than has been evident in the past. These five points are the major headings in the single outline which seeks to unite all three courses in the Program.
The first course, RM 54, covers the first two points in the outline by treating risk identification and analysis, the nature of risk management techniques, and how these techniques could be applied to various loss exposures. In addition, RM 54 lays the conceptual foundation for a decision rule by which to perform a third step of choosing the best technique(s) for treating each exposure.
The second course, RM 55, completes the third, fourth, and fifth steps in the decision process for some risk management techniques, and the third course, RM 56, does so for the remaining techniques. These courses use the decision rules from RM 54 to explore how each technique should be applied, and then describe procedures for administering and controlling each technique.
Which there is nothing magical about the particular five steps in the Institute's decision process, adhering to some decision sequence has at least three advantages in teaching and learning three advantages in teaching and learning risk management. First, a structured sequence helps to organize to material presented. So much of risk management literature presents only isolated bits of distilled wisdom that it is often difficult for the student to see how "it all fits together" and for the teacher to make an organized presentation of all relevant points. But, with a decision-making framework on which to build, it becomes easier to see how a given article, chapter, or paragraph relates to, say, recognizing liability exposures, and how another section of the assignment pertains to, for example, controlling the use of insurance for liability exposures. Relating separate assignments to a unifying decision framework permits easier comparison of what different authors say on the same subject.
A second advantages of teaching risk management as a decision sequence is that this format can discipline the student to approach risk management problems logically. All too often, students seem to want leap illogically from recognizing a risk a selecting a risk management technique such as insurance to cope with it. Insurance may be the right choice (or one of the right choices), but the student has unconsciously skipped the intermediate steps of analyzing potential loss frequency and severity of the risk and of considering how other risk management techniques could be used instead of, of in conjunction with, insurance to better handle the exposure. Dragging the student back from the conclusion to which he has leaped—forcing him to examine loss potentials and alternative techniques—can accustom him to following a problem-solving regimen when his inspired insight fails.
Third, making risk management decisions within a framework borrowed from general management helps show that risk management is only a specialized branch of general management rather than some completely foreign activity unrelated to the firm's goals. This link with general management also can be useful to the risk manager in explaining his decision to other managers, probably his superiors. For senior managers who reach decision through a recognition-analysis-choice implementation-control sequence, a risk management decision presented in "the language of management" probably will be more understandable and sympathetically received than a risk management decision explained in some "alien tongue".