What is Event Risk?
The term “event risk” refers to the possibility that an unexpected event will adversely impact an asset, organization, sector, etc., resulting in a loss that has to be borne by the investors and other stakeholders. Although these events are very much unpredictable in nature, it is still possible to reduce the impact of these events by setting up suitable risk assessment and management process. One of the most common tools employed for hedging any kind of event risk is insurance.
Sometimes businesses face unforeseen events that significantly impact their operational or financial risk profile. The vulnerability of the businesses to any unexpected event is known as the event risk. The source of an event risk may be specific to a company or industry or something completely unrelated, such as a natural disaster. Some of the examples of event risk pertaining to corporate actions include leveraged buyout, hostile takeover, corporate restructuring, merger &acquisition, etc.
Example of Event Risk
Now, let us look at some of the events that happened in the past and see what their economic impact was.
The disaster of Chernobyl that took place on April 26, 1986, is considered to be one of the worst nuclear disasters in human history. It left a long-lasting impact on the entire world, both in terms of social and economic. The disaster resulted in the contamination of as much as 150,000 square miles of area spread across Ukraine, Russia and Belarus, while its economic impact breached $700 billion over the next three decades.
Source: University of South California
The terrorist attack that took place on September 11, 2001, was another colossal external event that shook businesses across the world, especially the airline industry, which incurred huge losses. According to Air Transport Association, the 4-day shutdown immediately after the 9/11 attack resulted in revenue losses to the tune of $1.4 billion for the airline industry. Even after resuming services, the industry continued to incur losses as a large number of travellers avoided flying.
Types of Event Risk
The event risks can be broadly categorized into the following four types:
- Opportunity Risk: This type of risk refers to the possibility of losing an opportunity while pursuing a different available option. For instance, when a company opts for an option from two or more mutually exclusive choices, it basically let goes the remaining opportunities. There is a likelihood that the best option was one among the options that were not pursued, and this is what is known as opportunity risk.
- Risk of Uncertainty: This type of risk pertains to the risk of uncertain events that can potentially influence the smooth operations of a company. These risks usually originate out of nowhere, and thus they can’t be controlled due, but the damages done by them can be reduced through insurance. Examples of uncertain events include fire outbreaks, natural calamities, market downfall, terrorist attacks, political unrest, etc.
- Risk of Hazards: This type of risk occurs due to poor workplace management or improper handling of harmful material, which eventually results in hazardous events that may severely injure some of the workforces. Some of the sources of the hazardous events are biological/ chemical hazards or inappropriate allocation of responsibilities.
- Operational Risk: This type of risk refers to the risk that is associated with day-to-day business activities. These risks usually take place due to the failure of processes, policies, or systems. It is considered to be one of the direct risks as it arises out of the daily operations, which are typically critical for the smooth functioning of the business.
How to Minimize Event Risk?
The minimization of the impact of event risk is one of the steps of the risk management strategies. Organizations can reduce the adverse economic impacts of some of the event risks (such as fire outbreak, theft, etc.) by insuring themselves. Further, various financial products are available, such as Act of God bonds, options, swaps, collateralized debt obligations, that can also help hedge the event risks. Investors use credit default swaps to protect themselves from the risk of credit default or use stop-limit orders to arrest potential losses during trading hours. However, there are certain event risks that are beyond the purview of these financial indemnities, such as terrorist attacks, and no insurance companies offer any coverage against these devastating risks.
Event Risk Assessment
The process of assessment of event risk can be broken down into the following three steps:
- Identification of the potential hazards
- Determination of the probability of its occurrence
- Thorough evaluation of its severity
The assimilation of the above three steps helps in determining the probable consequences of an event if it occurs. Although it might seem simple, all the steps are very complicated and require extensive practical knowledge alongside extravagantly long computing hours. Hence, it is very important to have a team of professionals who are well experienced in the field of event risk management.
Event Risk Management
Event risk management is the outcome of the process of event risk assessment. Here, all the required actions, measures, and protocols are decided, such as eliminating, reducing, and mitigating the risks. Under risk management, the hazardous process might be removed entirely, replaced with a safer option, contained or placed in a protected area, etc. In some cases, the key individuals associated with the process are trained to circumvent the hazardous event. There are many more event risk management strategies available that can be employed case-to-cases basis.
So, an event risk can cause economic or reputational damage to a company, an industry or even to the entire world. In most cases, these event risks result in huge financial losses for businesses. However, the companies can reduce the adverse impact of some of these events by employing adequate and proper event risk management professionals.
This is a guide to Event Risk. Here we also discuss the introduction and how to minimize event risk? Along with types and example. you may also have a look at the following articles to learn more –