Risk Assessment

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Since no one is omniscient or omnipotent, everything in life carries a risk-either in terms of associated probabilities of failure, unacceptable costs or catastrophes; or in terms of the magnitude of those outcomes. A risk assessment is somewhat like a cost-benefit analysis, except that it focuses on the probabilities of unwelcome costs, rather than on offsetting benefits. As part of the comprehensive overview of options and possible outcomes, a risk assessment is an important-and in many cases-an indispensable tool for completing a reliable cost-benefit analysis, but can also serve the sole purpose of estimating the risk and preparing for an unwelcome event that has absolutely no compensating benefits, e.g., a gigantic meteor impact with the Earth.

In decision making and strategizing, a risk assessment can provide invaluable input regarding not only the risk of failure, but also the risk of events or outcomes not defined in terms of "mission success". For example, in tossing a coin and betting on it, the risk of failure is 50% in terms of probability and $X, in terms of the bet. However, there can be other real risks that need to be factored into the decision to bet or not, e.g., the risk that the coin will be lost (if tossed on a bridge or over a drain grating).

Risk assessment is the process of identifying things that could go wrong and developing solutions that can prevent them or at least minimize the damage. The risks could be physical, such as accidents, or financial, such as loss of funds. Normally, the process results in a risk evaluation in the form of a report or advisory.

All members of an organization should participate in decreasing risks. Financial departments should try to minimize financial loss by choosing safe business practices. Employees in charge of safety should minimize risks that could cause injury. In truth, most individuals perform assessments on a continual basis. For example, most people would not place their scissors on their chair because someone might sit on them. That is an assessment that takes place with hardly any notice. Other risks may be much less obvious, yet potentially far more costly, should they be realized as incidents or situations.

A comprehensive and rational risk assessment should include at least two key dimensions: the probability of the adverse event and the cost (in terms of dollars, pain and suffering, lost opportunities, etc.). In mathematical terms, this is called "expected gain (or loss)". When both the probability and the costs are sufficiently high, the risk is rightly regarded as severe. However, even low probabilities can be considered "risky" if the potential losses are unacceptably high, e.g., the costs of severe birth deformities associated with use of a certain drug, when such outcomes are exceedingly rare.

So-called "risk averse" decision makers will be inclined to negatively evaluate actions that have an associated cost and/or probability they, but perhaps not others, find unacceptable, preferring to "err on the side of caution". Some may argue that if sub-prime mortgage lenders and some oil companies been more risk averse in recent years, perhaps catastrophic collapse of some housing markets and oil rigs may have been prevented.

In the real world, of course, very often risk cannot be eliminated. If a risk cannot be eliminated, its effects must be minimized. This means minimizing the probability and/or the costs of an event or incident. But before being minimized, they have to be estimated-both in terms of their likelihood and their costs (assuming that the latter costs are greater than the cost of a risk assessment).

Risk assessments range from the very simple to the very complex. Common sense dictates the elimination of many risks; for example, securing a ladder before climbing it does not require any special calculations. On the other hand, large projects require the working of formula to determine what the risk is, what the potential loss is, what the probability of an incident is, and what the best prevention is.
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