RISK MANAGEMENT I

STUDY GUIDE 1 (RMN111ZE)

Compiled by:

PROF RW VIVIAN

Revised by:

L BENNETT & DC HAASBROEK

Edited by:

HP NICHOLAS
 Unisa
PO Box 392, UNISA, 0003

Copyright Unisa 2006

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 RISK MANAGEMENT I

TABLE OF CONTENTS
PAGE

CHAPTER 1: INTRODUCTION TO RISK .................................................. 1

CHAPTER 2: HISTORY AND DEVELOPMENT OF THE RISK

MANAGEMENT FUNCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15

CHAPTER 3: FUNDAMENTAL PRINCIPLES OF RISK MANAGEMENT ........ 21

CHAPTER 4: RISK ASSESSMENT ....................................................... 41

CHAPTER 5: RISK CONTROL ............................................................. 73

CHAPTER 6: RISK FINANCING ........................................................... 99

CHAPTER 7: COMPENSATION FOR OCCUPATIONAL INJURIES AND

DISEASES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 125

CHAPTER 8: ROAD ACCIDENT FUND ................................................ 139

CHAPTER 9: EMPLOYEE BENEFITS .................................................. 153

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INTRODUCTION
The purpose of this course is to give you an overview of risk management as a subject.
It is no more than an introduction to this field.

Once you have completed the course, you should have a basic understanding of risk
management, and know who risk managers are, what they do and how risk management
fits into the corporate or organisational structure.

4th Edition January 2000

3rd Edition January 1997

2nd Edition September 1991

1st Edition June 1988

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KEY TO ICONS
The following icons are used throughout the study guide to indicate specific functions:
ACTIVITY

This icon indicates that you are required to complete certain

activities which will assist you with your studies.

DEFINITION

This icon indicates a clarification of a word/concept or the

nature of something.

EXAMPLE

Examples are given for further clarification and are indicated by

this icon.

NB/TAKE NOTE

Information of particular importance is indicated by this icon.

SELF-EVALUATION

If you answer the self-evaluation questions indicated by this

icon, you will be able to assess the degree of success you have
achieved in mastering the study material.

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CHAPTER 1

CHAPTER 1
INTRODUCTION TO RISK

CONTENTS PAGE

LEARNING OBJECTIVES ................................................................... 2

1.1 GLOSSARY OF TERMS AND DEFINITIONS ............................... 2

1.2 INTRODUCTION .................................................................... 5

1.3 RISK .................................................................................... 5

1.3.1 The two dimensions of risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

1.3.2 Risk and insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
1.3.3 Economists' view of risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
1.3.4 The risk management view of risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
1.3.5 Insurance and risk management classification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
1.3.6 General classification of risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
1.3.7 Early classifications of risk . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
1.3.8 Systematic and unsystematic risks . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
1.3.9 Moral hazard . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12

1.4 TYPES OF LOSSES ............................................................. 13

1.5 QUESTIONS FOR SELF-EVALUATION .................................... 14

1.6 REFERENCES .................................................................... 14

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LEARNING OBJECTIVES
After studying this chapter, you should understand:
the concept of risk
the types of risk
the classification of risk

1.1 GLOSSARY OF TERMS AND DEFINITIONS

The following list of terms and definitions have been taken from the Society of
Risk Managers (South Africa) practice statement number 1.

Risk management
Risk management is a management function whose objective is the protection of
people, assets and earnings by avoiding or minimising the potential for loss from
pure risk, and the provision of funds to recover from losses that do occur.

Risk
Risk is the presence of uncertainty and is measured as the variation from the
expected outcome of a given situation.

Pure risk
A pure risk is a risk which results only in loss, damage, disruption or injury with
no potential for gain, profit or other advantage. Pure risks are usually insurable.
Risk management is concerned primarily with pure risk.

Speculative risk
A speculative risk carries the potential of either loss or gain. These risks which
are also referred to as trading or entrepreneurial risks, are not normally
insurable.

Risk identification
Risk identification is the identification of the pure risks to which an organisation
is or could be exposed.

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Risk evaluation
Risk evaluation is the expression of identified pure risks in an organisation in

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financial/numerical terms to gauge the frequency of occurrence of these risks
and the potential severity to the organisation.

Risk control
Risk control is the provision of appropriate levels and standards of protection for
people, assets and earnings to avoid or minimise the pure risks which have
been identified and evaluated in an organisation.

Risk financing
Risk financing is the provision of funds to recover from losses that do occur.

Risk avoidance
Taking action so as not to incur the risk in the first place.

Risk elimination
Doing away with existing risks.

Risk transfer
Non-insurance contractual transfer of the consequences of risk.

Risk reduction
Reducing the risk by controlling its frequency and its severity.

Insurance
The process whereby the responsibility for financing insurable losses that occur
is transferred to a professional carrier or insurer by contract.

Maximum possible loss (MPL)

The maximum cost of a loss that could result from single event conditions
including failure of risk control measures.

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Normal loss expectancy (NLE)

The maximum cost of loss that could result from a single event given that all risk
control measures operate as expected.

Estimated maximum loss (EML)

The maximum cost of loss that could result from a single event when a critical
risk control measure fails but ancillary risk control measures operate as
expected.

Frequency
The number of times a loss producing event occurs in a given period of time.

Retention funding
When losses that occur are financed from internal resources either on a "pre-
funded" funding basis or on a day-to-day basis as an operating expense.

Severity
The amount or value of damage, consequential loss or injury resulting from each
event.

Captive/Dedicated insurance company

An insurance or reinsurance company established to insure primarily risks of its
parent, affiliates, subsidiaries and associates and occasionally selected third
party risks.

Peril
A peril is an event that may cause a loss, e.g. a fire, storm or theft. In modern
parlance, the term "risk" sometimes replaces peril, but unless it is clear from the
context exactly what is meant, it is suggested that "risk" may be qualified by
naming the peril concerned, e.g. a fire risk, a storm risk.

Hazard
A hazard is a condition or activity that creates, introduces or increases the
frequency and/or the severity of a loss from the given peril, or perils, e.g. the
storage of flammable liquids constitutes a fire hazard.

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Incident
An incident is an unplanned, unexpected and undesired event that may or may

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not downgrade the efficiency of the business operation. Incidents may occur
fortuitously or as a result of a deliberate action.

Accident
An accident is an unplanned, unexpected and undesired event that results in
physical harm to a person and/or damage to property. It is usually the result of a
fortuitous contact with a source of energy above the threshold of the body or
structure.

1.2 INTRODUCTION
In order to manage risk, you should have an understanding of what risk means.

1.3 RISK
In one of his speeches, Theodore Roosevelt said the following:

"This nation was built on risk risk in tackling the wilderness, risk in business
enterprise We will continue to take even bigger risks, but the consequence of
failure is becoming more and more unacceptable."

Risk is part of everyday life when, for example, you are driving your car and
want to pass the vehicle in front of you, you run the risk of colliding with a
vehicle travelling the opposite direction. In the road ahead you see a vehicle
coming towards you, and you have to decide if you are going to take the risk of
passing the vehicle in front of you. In order to make that decision, you have to
assess the risk of a potential head-on collision. You would consider the size of
the oncoming vehicle in essence evaluate the severity of the consequences if
a collision should occur. If the vehicle is a motorcycle you would be less
concerned than if it is a ten-ton truck. You would also attempt to judge the
speed at which the vehicle is travelling, its distance from you as well as the time
it would take you to overtake the vehicle in front of you you would, in essence,
evaluate the likelihood of a collision. After you have assessed the risk of a head-
on collision, you will, based on this assessment, decide whether the risk of a
collision is acceptable or not. Based on this risk assessment, you would then
decide whether or not to pass the vehicle in front of you.

Another example would be going to the casino to gamble. When gambling, you
run the risk of losing money (obviously you can also break even by having the
same amount of money that you started off with). Again you would consider the

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consequences gambling the amount of money you could lose or win as well as
the chances or likelihood of winning or losing.

We have to take risks in order to progress and to prosper in life. However, the
problem that we are facing is how much risk we should take. Too little risk will
get us nowhere and taking too big a risk could result in us losing everything
even our lives. We therefore have to understand the fundamental principles of
risk in order to manage it effectively.

1.3.1 The two dimensions of risk

As can be seen from the two scenarios above, risk has two dimensions:
Likelihood the chance or uncertainty of the event taking place (collision or
no collision; winning or losing money).
Consequences (positive or negative) that may result from the event (minor
damage or severe damage or even fatalities; winning or losing money).

Risk can therefore be defined as follows:

"Risk is a chance (likelihood) of loss or gain (consequences)."

There are different views or perspectives of risk, and these have a number of
fundamental differences as well as similarities. Three of these perspectives will
be discussed for the purpose of obtaining a clearer understanding of what risk
is. The following views will be discussed:
The insurance view
The economists' view
The risk assessors' view

1.3.2 Risk and insurance

(a) The meaning of risk in the insurance industry

Apart from its technical meaning, the word risk is used very loosely in the
insurance industry. The following are common uses of the word:
Risk as the subject of an insurance policy

Insurers use the word risk to refer to the subject of the insurance policy.

When insurers talk about risk in this sense, they have accepted the risk they
have insured. For example, an insurer may comment that his/her records
reveal that he/she covers 20 'risks' in close proximity to each other. The
insurer means that the insurance company has accepted 20 different
premises for insurance purposes. Likewise, an industrial risk means that

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the insured company is an industrial company while a commercial risk

refers to a commercial company.

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Risk denotes peril

The word risk is often used to denote the peril that is insured under the
policy. For example, the insurer says that 'this policy covers all risks to the
insured property except those arising from war'. In this sense the insurer is
using the word to indicate the particular type of peril which is covered.
Risk denotes the insured

The insurer uses the word risk as an indication of the person seeking
insurance. In this case the insurer may decline to renew an insurance
policy because he/she considers the person to be a high risk (because of
too many claims).

The three examples above show that the word risk means different things to
different people. The meaning of the term will therefore be determined by the
context in which it is used.

(b) Risk as a funding problem

The insurance industry's biggest concern about risk revolves around the funding
of its losses, as this is what their business is mainly about. They want to be as
accurate as possible in predicting the losses that can be expected, in order to
calculate realistic premiums to ensure a healthy/adequate fund and profits.
Statistics or so-called loss history has therefore dominated their view of and
evaluation of risk. The law of large numbers plays a very important role. As the
number of exposure units (number of losses) increases, so the average cost of
events becomes certain to the extent that they can be confident that the
premium income based on that average will not be exceeded by the claim
cost per unit. It could therefore be argued that their main focus is on the risk of
ending up with a bankrupt fund.

Indeed, some writers such as Doherty (1974:7.1-11) have successfully applied

the portfolio theory, which is so well developed and researched in the investment
field, to the financial risk field (economists' field), and it seems that the two fields
overlap at this point. We will look at the "economists' view" next, as it explains
the insurance view of risk to some extent.

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1.3.3 Economists' view of risk

(a) Risk, uncertainty and profit

In business finance, probably the most common classification of risk is that there
is a relationship between risk, uncertainty and profit. As risk increases, so does
profit. One may therefore question whether risk treated through insurance also
does away with profit. Indeed, the long-term insurance industry may find this
argument rather amusing. If the business community is no longer prepared to
carry any risk and opts to insure it all, does the insurance industry then become
not only the true bearer of risk, but also the reaper of all benefit? Ultimately the
whole industrial sector will work for the insurance industry. The strength of the
insurance industry in the community seems to indicate that this is a likely
outcome.

Under par.1.2.1 above, risk is explained as having two dimensions

consequence and likelihood. This view holds true for the economists' view of
risk, with the difference that the level of risk is increased only by the variability of
the consequences and not by the likelihood. Thus, the greater the uncertainty
that exists about the end results, the bigger the risk. This is, for example, what
distinguishes 'blue chip' companies on the stock exchange from other
companies they are a fairly 'safe' investment as their share price is very stable.
Should the price vary, the variation would be small and investors therefore stand
to lose only a limited amount of money and conversely only make a moderate
profit. 'High-risk' companies, on the other hand, differ from blue chip companies
in that their share price can vary dramatically. Investors therefore stand to make
a sizeable profit or possibly lose everything. This view can best be explained by
the normal distribution curve:

Figure 1.1 The normal distribution curve

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On the above normal distribution curve, A would represent a smaller risk than B
as the 'swing' of A is smaller than that of B. A would, for example, represent a
blue chip company and B the high-risk company.

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1.3.4 The risk management view of risk
The risk management view of risk differs from the economists' view in that any
increase in likelihood and/or consequence results in an increase in the level of
risk. Furthermore, risk management as a discipline refers to risk as those risks
that have only the potential for loss or no loss, but no potential for gain the
so-called 'pure risks', as explained in more detail later in this chapter.

The risk management definition of risk would therefore be as follows:

"Risk is the likelihood of a specified outcome or consequence within a given time

span."

1.3.5 Insurance and risk management classification

Classification of risks is fundamental to the study of insurance and risk
management. The four classifications discussed below pure vs. speculative
risk and fundamental vs. particular risks are the most important. A number of
other classifications are also referred to but are not dealt with in depth.

Classification of risks must not be seen as dividing all known risks into a number
of set categories. In other words, a risk may fit into more than one category. An
example in this regard is that war is classified as both a pure risk and a
fundamental risk. Each classification focuses on a different aspect of risks. In
this way the fundamental and particular risk classification is of particular
importance to the insurance industry, as fundamental risks fall outside the limits
of insurability because insurance is based on the principle of "the fortunate many
paying for the unfortunate few". In simple terms, this means that many people
put their money/premiums in a pot/fund and the unfortunate few who suffer
losses are paid from this pot/fund. It should be obvious that more money should
go into the pot/fund than is being claimed. In the case of fundamental risk, such
as war (where a total country may be affected) the system collapses.

(a) Pure and speculative risk

The most useful distinction from an insurance and risk management perspective,
is that between pure and speculative risk. This distinction is fundamental to the
study of insurance and risk management since the insurance industry seeks
only to deal with pure risk.

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This distinction is presented below.

Speculative risks are those that offer the firm a chance of gain or loss. Such
activities are usually undertaken in the hope of gain, although the range of
possible outcomes includes those that will register to the owner economic
losses. Investment in business activities are invariably risky in a speculative
sense; other examples of speculative risk arise with the holding of currency,
stocks, real estate, etc., where price fluctuations can either benefit or deprive the
owner.

Pure risk, on the other hand, refers to those risks that offer only the prospective
of loss. Thus the possible outcome from activities or events exhibiting pure risk
range from zero to negative.

This risk classification, although not watertight, forms the basis of the concept of
risk in insurance and risk management. There are cases in which it is not very
easy to determine whether the risk that we are dealing with is indeed a pure or
speculative risk. Nevertheless, the basic concept is that a pure risk is one that
results only in a loss. This is a useful concept and fundamental to our study.
Many writers have been able to identify borderline cases that are very difficult to
classify, for example a credit risk. Granting credit undoubtedly leads to the
possibility of greater profits. At the same time there is a risk that the person to
whom the credit is extended may not pay his/her debts. Generally credit risk
would be regarded as a business or speculative risk. However, it is possible to
insure credit risk. Another example is the prospect of a strike. As a general
rule, a strike could only result in a loss but is generally not regarded as a pure
risk. Although insurance may be arranged against a strike in isolated
circumstances, this is the exception rather than the norm.

One of the short-cut methods of dealing with the distinction between pure and
speculative risk, is to accept that pure risks are those risks that can be dealt with
through insurance, while most speculative risks generally are not dealt with
through commercial insurance. This definition or distinction does not really
assist us from a conceptual point of view, but has some practical value.

Risk management, as referred to in the context of this study guide, focuses on

managing pure risk. Speculative risks are usually the concern of financial
managers in an organisation, although it should once again be mentioned that
the boundaries are not set in concrete as there may be overlapping in some
areas.

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(b) Fundamental and particular risks

According to Hansell (1985:2) fundamental risks are those risks that tend to

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affect large sections of society or even the world, rather than only the individual.
Fundamental risks contain the element of catastrophe, for example war, famine,
earthquakes or pollution. Fundamental risks have a widespread disaster
potential and are generally regarded as uninsurable in the commercial market.
They are considered as problems of society as a whole to be dealt with at
governmental or international level. Clearly the type of risk that one would
classify as being fundamental risk would be risk of war, nuclear disaster,
unemployment, wear and tear, and old age.

Particular risks, on the other hand, are risks with comparatively restricted
consequences. Most insurable risks are therefore classified as particular risks,
which are likely to result in loss for individuals when they occur.

1.3.6 General classification of risk

Doherty (1985:2) mentions a number of risk classifications, including the
following: marketing risk, financial risk, resource management risk and
environmental risk.

Marketing risk: The demand for a firm's products depends on many factors
that may or may not be within the control of the firm. For example, influences
that combine to create uncertainty about future demand for the firm's product
include product design promotions, general income levels, price, price of
competing and complementary products, consumer tax and changes in
government regulation of trade in the firm's products.

Financial risk: The cost of providing and maintaining capital is subject to

capital market fluctuation. In recent years, both debt and equity costs have been
subject to considerable fluctuation. Financial risk may be modified by specific
corporate decisions. An example in this regard is that an increase in the
corporate debt will often increase the default risk on old debt and enhance the
variability of the shareholder's return. This type of financial risk is studied
extensively in the fields of investment analysis and business finance.

Resource management risk: In the production process, the firm brings

together specific resources. The provision of these resources is subject to
various risks, such as price changes that are withdrawn from the production
process, sudden physical impairment or destruction by fire.

Environmental risk: Risk may arise from incidental interactions between the
firm and the environment, for example, corporate decisions about ownership of
property and the operation of vehicles may expose the public to certain dangers
for which the firm has a statutory or common law liability. Also, government

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regulations other than those giving specific product or industry basis, such as
zoning laws, may impose a contingent cost on the firm or result in unexpected
benefits, etc.

Although the classification of risk is arbitrary, it should be managed correctly.

1.3.7 Early classifications of risk

One the earliest classifications includes the following items:
Risk of destruction of property through physical hazard
Uncertainties in the production process
Risk resulting from market processes such as price changes
Risk caused by abnormal social conduct
Risk arising from the failure to utilise available knowledge

1.3.8 Systematic and unsystematic risks

In the field of business finance, systematic and unsystematic risks are classified.
The classification of systematic and unsystematic risk is widely used in applying
business risk theory to the movement of shares on the capital market and hence
capital market theory. An example in this regard is that the price of a single
share may move because of an event such as a fire at the premises of the
company, and this is classified as an unsystematic or particular risk. On the
other hand, if all the shares across the entire market move, the move is due to
systematic or market forces.

1.3.9 Moral hazard

The term moral hazard is found in most insurance texts.

At the turn of the century, the insurance industry classified risks mainly as
having a physical and moral nature. The physical risk referred to the actual
physical details of the risk concerned. For example, the physical details of a fire
risk include facts such as the height of the building, the type of construction, the
presence of firewalls and sprinkler protection. These aspects would be
determined during a fire survey of the premises.

The insurance industry also realised that the exposure largely depended on the
type of person concerned. If the housekeeping on the premises for which
insurance was required were poor, the insurer would view this as an increased
risk. The tendency would be to say that it constituted a bad risk, as the attitude
of the person in charge of the premises is not conducive to reducing the risk of
fire. Such a person would be classified as a higher moral risk than one who
maintains high housekeeping standards.

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1.4 TYPES OF LOSSES

Looking at a few of the types of losses that can occur in an organisation that

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are relevant to risk management as referred to in this study guide one can
form some idea of what types of losses are included in the scope of risk
management. This classification of losses is also useful from an insurance point
of view, as these are mostly insurable:

1.4.1 Property loss Includes loss of and damage to property

such as vehicles, buildings, equipment,
etc.

1.4.2 Net income loss Net income loss can be subdivided into
two categories:

1.4.2.1 Increase in expenditure For example the renting of equipment due

to own equipment being damaged in an
incident.

1.4.2.2 Decrease in revenue Loss of revenue due to a major fire.

1.4.3 Legal liability loss/Claims (Against the company): For example false
arrest of a client.

1.4.4 Personnel loss Includes injury to personnel, etc.

The above classification can best be illustrated by means of an example.

If a motor car is involved in an accident, the following costs/losses may be

involved:

1. The cost of damage to the car itself (generally insured).

2. Indirect or consequential costs such as hiring another vehicle may be

involved (insurable). Because of the accident, the driver is unable to keep
an important appointment with a client, a major contract is lost and as a
result of the failure to secure the contract, the company loses several million
rand.

3. If third party property is damaged in the incident or persons are injured due
to the negligence of the driver, legal liability claims arise (generally
insurable).

4. If the driver was injured in the incident, medical costs have to be paid. If the
person is permanently disabled, it may involve payments from the pension
fund as well. (These costs may involve the Road Accident Fund [RAF],
Workmen's Compensation Fund, medical aid and pension fund.)

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1.5 QUESTIONS FOR SELF-EVALUATION

1.5.1 Risk is explained as consisting of two directions. Briefly discuss each
of these.

1.5.2 Briefly differentiate between pure and speculative risks.

1.5.3 List the four classes of risk.

1.6 REFERENCES
Doherty, N.A. & Carter, R.L. 1974. Handbook of Risk Management. London:
Kluwer-Harrap.

Greene, M.R. & Serbein, O.N. 1983. Risk Management: Text and Cases.
2nd edition. Reston: Reston Publishing Company.

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CHAPTER 2
HISTORY AND DEVELOPMENT OF RISK
MANAGEMENT

CONTENTS PAGE

LEARNING OBJECTIVES ................................................................. 16

2.1 INTRODUCTION .................................................................. 16

2.2 HISTORICAL DEVELOPMENT ............................................... 16

CHAPTER 2
2.2.1 The development of risk management in the USA . . . . . . . . . . . . . . . . . . . . . . . 16
2.2.2 The development of risk management in the United Kingdom/
Europe . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18
2.2.3 The development of risk management in South Africa . . . . . . . . . . . . . . . . . . 18

2.3 QUESTION FOR SELF-EVALUATION ...................................... 19

2.4 REFERENCES .................................................................... 19

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LEARNING OBJECTIVES
After studying this chapter, you should be able to:
describe the history and development of risk management

2.1 INTRODUCTION
The term 'risk management' was first introduced formally in the early 1950s.
However, risk management principles and philosophies are as old as humanity.
Early people practised risk management as a way of survival from the natural
and animal dangers that they encountered in their everyday life. If they had not
practised effective risk management, we would not be here today, as humanity
would have become extinct a long time ago, considering all the challenges they
faced daily in staying alive. Although the risks that threatened our ancestors
have been overcome to a large degree, modern people and modern business
itself are faced with many new risks that have accompanied our technological
advancement. As humans progress new risks will arise constantly. These
challenges necessitate a formal systematic approach in order to ensure our
survival not only as human beings but also in business.

However, over the years, risks have increased. Each time people are faced with
new risks, they put systems in place to overcome these or to minimise their
consequences.

The process of risk management has developed into a scientific approach of

dealing with risks facing both individuals and businesses daily. Risks are no
longer dealt with merely on an ad hoc basis. The methodology has become
more proactive and many firms now employ highly trained persons to deal with
such issues within the organisation. The process has evolved from the
insurance industry.

2.2 HISTORICAL DEVELOPMENT

2.2.1 The development of risk management in the USA

Risk management has its roots in the insurance industry. In the 1950s when risk
management came to the fore, the job was given to the company insurance
manager. The job of the insurance manager was traditionally to purchase
insurance cover and process claims. Risk management found its earliest
developments in the United States. One of the earliest references to the

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concept of risk management in literature appeared in the Harvard Business

Review in 1956. The article suggested that someone in the organisation should
look after the pure risks in a company. At that time, many large corporations
had a person appointed as the insurance manager. It therefore seemed logical
that the insurance buyer should be responsible for this portfolio as well and
would become known as the risk manager. For this reason, risk management is
said to have its roots in the insurance market.

During the initial development stages of risk management, the risk management
philosophy that prevailed was still dominated by the insurance approach. The
move from insurance management to risk management occurred over a period
of time, but even today the concept is not fully implemented as yet in some
organisations. However, as the process develops further, it is only a matter of
time before it becomes universally accepted as the preferred method of dealing

CHAPTER 2
with risks.

At the same time when risk management was being developed in the business
sector, the business colleges in the United States began rewriting their curricula
to include the latest developments in the field. Previously, managers were
trained in insurance as a method of dealing with risks. With the introduction of
total risk management they were trained to realise that there may be other more
cost-effective ways of dealings with risks, such as preventing losses from
happening in the first place.

The process of risk management involves dealing with the complete aspect of
pure risks in an organisation and is not limited to insurance buying only. This
covers the complete process of deciding how to deal with risk by adopting one
or more or a combination of the following techniques:
Risk avoidance
Risk reduction
Risk retention
Risk transfer
Risk sharing

The professional insurers' association known as the American Society of

Insurance Management, eventually changed its name to the Risk and Insurance
Management Society (RIMS) in 1975. The society now also publishes a regular
journal called Risk Management.

There is also a professional qualification for risk managers in the United States.
The qualification is a diploma in Risk Management and the professional
designation is Associate in Risk Management (ARM).

The United States of America is generally regarded as the forerunners of the

concept of risk management.

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2.2.2 The development of risk management in the United

Kingdom/Europe
The development of risk management in the United Kingdom came some years
after the USA. As with the USA, risk management in the United Kingdom was
closely linked to insurance. The City University of London and the University of
Nottingham introduced formal training courses covering insurance and risk
management in the early 70s. Following this, the Glasgow College of
Technology first introduced a degree programme in Risk Management in 1982.
The Association of Insurance Managers and Insurance Consultants (AIMIC) later
changed its name to the Association of Insurance and Risk Managers in Industry
and Commerce (AIRMIC).

2.2.3 The development of risk management in South Africa

The development of risk management in South Africa began in the early 70s.
Similar to the developments in the United States and the United Kingdom,
development originated within the insurance industry.

The South African Risk and Insurance Management Association (SARIMA) was
formed in 1986. Membership of this organisation is on a corporate basis. In
1990, the Society of Risk Managers was formed where membership is on an
individual basis. The aim of the society is the promotion of the professional
status of risk managers in South Africa.

There is no formal degree in Risk Management as yet in South Africa, but Risk
Management is included as part of a degree programme at the University of the
Witwatersrand and the University of Pretoria. Also, the University of
Stellenbosch offers Risk Management as an optional extra in its MBA-degree
programme. The University of South Africa (UNISA) offers Risk Management as
part of its B COM degree as well as a separate course presented by the Centre
for Business Economics.

From the discussion so far, you will have noticed that risk management is still a
growing concept. Life is full of uncertainties, and risks go along with these. The
challenge for risk managers is to help and assist individuals and organisations to
live with this uncertainty in a productive manner.

In subsequent chapters you will learn about the full scale and extent of the
practice of risk management and how the philosophies and principles applied
affect managing health and safety in the working environment.

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2.3 QUESTION FOR SELF-EVALUATION

2.3.1 Describe the origins and development of the concept of risk
management.

2.4 REFERENCES
Valsamakis, A.C., Vivian R.W. & Du Toit, G.S. 1992. The Theory and Principles
of Risk Management. 2nd edition. Johannesburg: Heinemann.

Vaughan, E.J. 1997. Risk Management. 1st edition. NY: Wiley.

CHAPTER 2

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NOTES

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CHAPTER 3
FUNDAMENTAL PRINCIPLES OF RISK
MANAGEMENT

CONTENTS PAGE

LEARNING OBJECTIVES ................................................................. 22

3.1 INTRODUCTION TO RISK MANAGEMENT ............................... 22

3.2 RISK MANAGEMENT DECISION CRITERIA ............................. 23

3.2.1. Cost benefit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23

3.2.2. Risk aversion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 23
3.2.3. Authoritative reasons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24
3.2.4. Policy-based decisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

3.3 THE RISK MANAGEMENT MODEL ......................................... 25

3.4 THE LOSS CAUSATION MODEL ............................................ 26

3.5 THE PROCESS OF MANAGING RISK ..................................... 32

3.6 COST OF RISK AS CONCEPT ............................................... 39

3.7 QUESTIONS FOR SELF-EVALUATION 40

CHAPTER 3
....................................

3.8 REFERENCES .................................................................... 40

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LEARNING OBJECTIVES
After you have studied this chapter, you should be able to explain:
the risk management model
the distinction between risk assessment, risk control and risk financing
the risk management process
the criteria applied to risk management decisions

3.1 INTRODUCTION TO RISK MANAGEMENT

Risk management is fast becoming one of the vital functions within
organisations. It encompasses occupational health and safety, fire protection
and prevention and a number of other disciplines. There is a growing
understanding and acceptance that there are principles common to all these
disciplines: managing risk and reducing losses. In fact, it has been said that
risk management is one of the few remaining areas of management with major
cost-reduction potential. There is a need for a structured approach towards
managing risk, as resources have been allocated in the past for the reduction of
injuries and other forms of loss, without always first establishing the level of risk
involved. This often resulted in either inadequate control measures or an
"overkill", and money was sometimes literally wasted on safety.

The biggest motivation for applying risk management lies in the financial
benefits: reducing losses in order to improve the profitability of the organisation.
In the process, a host of other benefits are gained for the organisation and its
employees. These include a reduction of the number of injuries, due to the fact
different types of losses are quite often caused by the same factors. For
example, if a transformer is not maintained properly and explodes due to a short
circuit, it can result in injuries to personnel, fire, damage to nearby equipment,
substandard quality of a product that may still be in the process, environmental
impact/oil pollution, etc. It can therefore be said that by taking better care of our
business we are taking better care of our employees. This explains why
organisations like General Electric Aircraft Engines in the USA have started
integrating their safety (covering not only occupational injuries and diseases, but
also damage to property, fire protection and prevention, etc.) and environmental
management systems. Integration of safety and quality assurance systems has
made good progress in other organisations.

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In terms of the above, risk management can be defined as follows:

"Risk management is a managerial function, aimed at protecting the

organisation, its resources and profits against the adverse consequences of
exposure to pure risk, by reducing the frequency and consequence of the
adverse consequences" (Valsamakis et al., 1992:56).

3.2 RISK MANAGEMENT DECISION CRITERIA

A critical question that always needs to be asked is, why should risk
management be implemented? In an organisation, resources are allocated
to the different departments such as marketing, production, engineering, etc.
Risk management and possibly a risk management department in an
organisation would similarly require resources, and one would have to be
able to justify these. There are basically four reasons why people and
organisations apply risk management:

1. The steps are cost-beneficial

2. People have an aversion to risk
3. Authoritative reasons exist to take the steps
4. Policy-based decisions are made

3.2.1 Cost benefit

As mentioned earlier, the biggest reason for applying risk management is to gain
financial benefits. The basic philosophy is that money should only be spent if

CHAPTER 3
the benefits outweigh the expenditure. In this context, the capital spent on
installing a sprinkler system is seen as an investment and it must produce a
return. The return on investment must be positive and preferably greater than
the value usually gained, otherwise the sprinkler system should not be installed.

Risk analysis plays a critical role in calculating cost benefit. The comparison is
basically between the risk involved and the money to be spent in order to reduce
the risk to an acceptable level. The section on risk assessment and value
judgement later in the study guide more clearly illustrates the dilemma that
cost-benefit analysis presents when it comes to preventing injuries and fatalities,
especially concerning the public.

Although important, it quite often happens that risk management is applied even
though it is not cost-effective, due to one or more of the reasons below.

3.2.2 Risk aversion

Another major reason for applying risk management is that people are averse to
risk. Even people who regard themselves as risk takers are, in fact, averse to

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risk. For example, bankers who operate in the private sector would regard
themselves as risk takers. They are not actually risk takers. Before lending
money, they will take every possible step to ensure that they have adequate
security for the loan.

Because of this natural aversion, people take steps to reduce risks, even if the
steps are not cost-effective. Imagine trying to convince the shareholders after a
R50m fire loss that you had decided not to purchase a sprinkler system because
you didn't regard it as cost-effective. After a major loss, no one is particularly
interested in cost-to-benefit calculations.

The decision to implement risk control measures based on risk aversion is

influenced by the magnitude of potential losses and the cost of the control
measures. The following factors usually influence the decision:
The magnitude of the possible loss
The size of the capital investment in relation to the risk control expenditure
The magnitude of the maintenance budget in relation to the risk control
expenditure

3.2.3 Authoritative reasons

Authoritative reasons play a major role in deciding to implement risk control
measures. Not many managers would argue against implementing a control
measure if they know that failure to do so could result in a jail sentence or being
charged with culpable homicide should an employee be killed.

The most common forms of authoritative reasons are:

legislation
acceptable codes of practice

Another "form" of authoritative reason is society or the community. Few people

realise the power that society has, and that society can and will close an
organisation down if it is not seen to be responsible enough. An excellent
example is the Richards Bay issue where an organisation was not permitted to
mine sand dunes in a particular area, because of the impact it may have had on
the environment. This was done despite the major benefits for the country in
terms of foreign exchange that would have been generated.

3.2.4 Policy-based decisions

In practice, many decisions are simply policy based. If the company's policy is
that its employees are important, it probably has an effective system for
prevention and treatment of occupational injuries and illness in place. Another
company may decide that they want to obtain ISO 9000 certification in order to

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enhance the quality and image of their product, and would therefore develop and
implement a quality assurance system. It often happens that chemical
companies, for example, want to improve their image among the general public
and spend large amounts of money on environmental issues. Although the
original motivation may not have been specific to risk management, risk
management would benefit.

3.3 THE RISK MANAGEMENT MODEL

The risk management model is depicted in figure 3.1.

RISK MANAGEMENT

RISK CONTROL RISK FINANCING

Fire
Security Retention External
Safety financing financing
Occupational health
Environmental management

CHAPTER 3
Maintenance
Quality management, etc.

Figure 3.1 The risk management model

In terms of this model, risk management consists of two components: risk

control and risk financing. Firstly, an attempt is made to control risk and
secondly, losses that result from the exposure to pure risks have to be financed.
It is not possible to prevent all losses and sometimes not even cost-effective to
control all risks and therefore adequate and appropriate funding is necessary
to pay for these losses.

In terms of risk control, different disciplines have been developed over the years
to manage specific risk exposures. These include:
the development of safety for the control of accidental loss such as injuries,
occupational diseases, damage to property, etc.;

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quality assurance/management to control the risk of producing a

substandard quality product or rendering of a substandard quality service;
maintenance systems to control the risk of premature failure of equipment,
extend the life expectancy of equipment, etc.;
human resources departments for the control of the risk of employing
incompetent personnel, and so forth.
Risk financing is vital to ensure that adequate and appropriate funds are
available to pay for losses. The funds can be from the company's own sources
or from outside sources such as insurance.
However, the model does not reflect the process of managing risk; for example,
no reference is made to risk assessment. The model is sometimes used to
structure the risk management department in an organisation.

3.4 THE LOSS CAUSATION MODEL

If the main focus of risk management is the reduction of losses, then it is vital to
understand what causes loss.
One of the simplest and yet most effective models to illustrate the loss producing
process, is known as the Loss Causation Model. A slightly modified version of
this model is widely known in South Africa as the 'Domino Sequence'. Although
fundamental to the principles of managing safety, it is understood by few and
rarely applied. Figure 3.2 shows this model, as formulated by Bird and Germain
(1992:22).

LOSS CAUSATION MODEL

Inadequate Basic causes Immediate Incident/ Loss/

control causes Accident
Injury/
Personal
factors Damage/
Inadequate: Substandard
System acts Environmental
Standards Job
Compliance factors Substandard impact, etc.
conditions

Measurement Measurement Measurement

of of of
control cause consequence

Figure 3.2 The loss causation model

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Following the brief discussion below, you should have a clear understanding of
the importance of this model for the management of risk.

Principle of multiple causes

The arrows in the diagram depicts the principle of multiple causes, which
states:

"Seldom, if ever, are problems and accidents the result of a single

cause."

Loss

As mentioned earlier, the major reason for applying risk management lies in
the financial benefits. Loss, or rather the reduction thereof, is the focus of
risk management. This includes all forms of loss resulting from exposure to
pure risk. These losses include, but are not limited to, the following:
Injuries
Occupational diseases
Damage to equipment
Substandard quality product
Loss of company property (theft)
Financial losses (e.g. fraud)
Production losses
Premature failure of equipment
Employee unrest/strikes

CHAPTER 3
Very few companies have effective loss recording systems, with the result
that little is known about how much money is lost through these types of
losses. (The recording and costing of losses will be discussed in more
depth in the cost of risk and management information systems sections of
this study guide.) It would suffice to say that these losses come off the
"bottom line" of the organisation's balance sheet, i.e. they have an
immediate and direct impact on the profits of the organisation. Risk
management can therefore never 'make money' it saves money. It is
critical to understand this principle, which is explained more effectively by
the table in figure 3.3.

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EFFECT OF LOSS ON THE ORGANISATION

Loss Profit margin
amount 5% 10% 15% 20%
R100 000 R2 000 000 R1 000 000 R750 000 R500 000

R1000 000 R20 000 000 R10 000 000 R7 500 000 R5 000 000

R10 000 000 R200 000 000 R100 000 000 R75 000 000 R50 000 000

R20 000 000 R400 000 000 R200 000 000 R150 000 000 R100 000 000

Value of turnover required to recover from/pay for the loss

Figure 3.3 Effect of loss on the organisation

From the table in figure 3.3 one can see that even a relatively insignificant
loss size of R100 000 requires a turnover of R1 000 000 at a profit margin
of 10% in order to recover from the losses or, put differently, the
organisation has to sell an additional R1 000 000 worth of products only to
be in the same position they were before the losses occurred. It is not
unrealistic to estimate the losses of a medium-sized manufacturing
company. With a turnover of approximately R1 billion (R1 000 000 000),
such a company would suffer losses in the order of R30 000 000 per
annum. This obviously depends on the type of operation.

To return to the loss causation model, loss is therefore the end result of the
sequence of events.

Incident/accident
Losses don't just happen they are caused. Bird (1992a:26) found in his
research that loss often results from a contact with a source of energy or a
substance. This information is valuable from both a risk assessment and a
risk control point of view. In terms of risk assessment, identifying sources of
energy, such as mechanical energy (rotating shaft and gears), electrical
energy, heat, etc., is an effective way of identifying hazards. From a risk
control point of view, one could, for example, develop control measures to
reduce the amount of energy transferred or strengthen the body or structure
that would be exposed to the energy in order for it to be able to absorb
more energy before damage or injury actually results.

The accident (or is it incident?) therefore immediately precedes the loss.

There has been much debate and confusion about the appropriate name for
and meaning of this. It can probably best be termed as a "loss-producing
event". Bird (1992a:18) defines an accident as:

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"... an undesired event that results in injury to people, damage to

property or loss to process; it involves contact with a source of energy
or substance above the threshold limit of the body."

This definition points more specifically at events that result in injuries,

occupational disease, some substandard quality product losses and
damage, including fire damage. However, in terms of other forms of loss,
there may not always be a contact with a source of energy or a substance.
The problem is not so much what to call this event, but rather how to define
it, as it is vital from a reporting point of view, i.e. how to define the events
that would need to be recorded in order to ensure that all loss-producing
events are recognised/identified and recorded and what the scope of risk
management is. Secondly, this event should be given an appropriate name,
and in terms of this, the term 'incident' is widely recognised as covering a
wider spectrum of losses than 'accident'. For the purpose of this study
guide, the term 'incident' will therefore be used. Incident, in this context, can
therefore be defined as follows:

"An incident is an inadequately controlled event that could or does

result in injury to personnel, damage to property or environment or loss
to process, or that downgrades the efficiency/effectiveness of the
organisation or that negatively effects the image of the organisation;
The event could involve contact with a source of energy or substance"
(Bird & Germain, 1992a:20).

In the above definition, 'injury' includes all effects on the victim, including
physiological and psychological effects; 'property' refers to all assets; and

CHAPTER 3
'process' includes product and service. A negative image could have a
dramatic effect on an organisation. An example in this regard is that the
share price of Union Carbide plummeted after the Bophal incident.

Immediate causes

The term 'immediate causes' refers to the things that go wrong directly
before an incident occurs. Immediate causes are visible deviations from
acceptable codes, standards and practices and could be either actions by
persons or conditions that exist in the workplace. Immediate causes can be
divided into two categories: substandard acts and substandard conditions.
Previously, substandard acts were referred to as 'unsafe acts' and
substandard conditions as 'unsafe conditions', but there are many acts and
conditions that are not unsafe yet still lead to losses. Furthermore, as Bird
(1992a:26) puts it, one needs to think broader and more professionally. This
line of thinking has distinct advantages:
It relates practices and conditions to a standard a basis for
measurement, evaluation and correction

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It minimises the finger-pointing stigma of "unsafe act" somewhat

It broadens the scope of interest from accident control to risk control,
encompassing safety, quality, production, cost control, etc.

Substandard acts and conditions can be identified for all forms of loss.
Typical examples include the following:

Substandard acts
Operating equipment without authority
Using defective equipment
Improper application of equipment
Improper position for the task

Substandard conditions
Defective tools, equipment or material
Fire and explosion hazards
Temperature extremes
Inadequate or excessive illumination

It should be clear that 'using defective equipment', for example an electric

carpet washer with damaged cord insulation, could result not only in the
person operating the equipment injuring himself/herself through
electrocution, but potentially also in damage to other equipment or fire. If
the equipment is used at a client's premises, it could result in substandard
quality service if the equipment fails or even a liability claim against the
company if the equipment was to damage the client's property or start a
fire.

Unfortunately, many organisations' safety/risk control systems are aimed at

treating the immediate causes. For example, during incident investigations,
often only immediate causes are identified and sometimes treated usually
with little effect and short-lived results. Immediate causes are only
'symptoms' of the actual problem. This principle can best be described by
comparing it with a disease:
You feel ill and decide a visit to your doctor is necessary. The doctor
asks you to explain your problem. In reply you say that have a
headache, run a fever, that your body aches, that you cough and that
your nose is running. After the examination he would probable say that
you are experiencing the symptoms of flu. The doctor can treat you
firstly by giving you a prescription to treat the symptoms pain pills for
your headache and aching body, a coughing mixture for the cough, etc.
thus treating only the symptoms. After taking the medicine you would

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feel better, but as soon as you run out of medicine or stop taking it, you
would feel ill again. That is because the doctor did not treat the basic
cause of your illness the flu virus. The doctor has to prescribe
antibiotics to fight the flu virus in order for you become well again, thus
treating or getting rid of the basic cause of the illness. Doctors would
usually do both: treat the virus and the symptoms so that you would
also feel better during your recovery.

The same principle applies in risk management. In order to be effective in

preventing losses, basic causes have to be eliminated. In incident
investigations all immediate causes have to be identified before the basic
causes leading to the immediate causes can be identified.

Basic causes

Basic or root causes are the fundamental causes of loss. Basic causes also
help explain why people perform substandard practices. Logically, a person
is not likely to follow a procedure if he/she has never been taught the
procedure; a person who is never told the importance of a job is unlikely to
be motivated to a high degree of pride in his or her work.

Similar to immediate causes, basic causes can be divided into two

categories: personal factors and job factors. Bird (1992a:28) identified
thirteen basic causes of loss:

Personal factors

CHAPTER 3
Inadequate capability
Physical/Physiological
Mental/Psychological
Lack of knowledge
Lack of skill
Stress
- Physical/Physiological
- Mental/Psychological
Improper motivation

Job factors
Inadequate leadership and/or supervision
Inadequate engineering
Inadequate purchasing
Inadequate maintenance
Inadequate tools, equipment, materials
Inadequate work standards
Wear and tear

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Abuse or misuse

Again it should be clear that if, for example, a person has a lack of
knowledge the person would not only have difficulty in performing his or her
job safely, but also have difficulty in producing a quality product or to be
productive. Through lack of knowledge, people make mistakes that could
lead to equipment being damaged, injuries to themselves or others,
environmental impact/pollution, etc.

Basic causes are therefore the "origins" of substandard practices and

conditions. However, they are not the beginning of the cause and effect
sequence it starts with "lack of control".

Lack of control (inadequate control)

Control is one of the four essentials of managing: planning, organising,

leading and controlling. There are three common reasons for inadequate or
lack of control:

Inadequate programme or system

The word system should be used rather than programme as a

programme has a start and an end, whereas a system is a never-
ending loop, or a continuous process of monitoring and improvement.
The risk management system may be inadequate because of too few
programme activities or systems.

Inadequate programme/system standards

With adequate systems in place to manage the risks facing the

organisation, the next possible reason for inadequate control could be
the lack of, or inadequate standards. Standards need to be in relation
to the level of risk it has to control.

Inadequate compliance with standards

Finally, systems are only adequate and standards appropriate if they

are complied with. If not, it would result in inadequate control that
would result in the existence of basic causes in the organisation.

3.5 THE PROCESS OF MANAGING RISK

Risk has two dimensions: consequence and likelihood, or "what would happen
if?" (consequence) and "how likely is it to happen?" (likelihood). It should be
clear that total safety is impossible (and unjustifiable) and that zero risk is
unachievable. It is so unlikely that the potential hazards, although truly

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horrendous, will occur that we have to live with that possibility. In other words,
the risk is tolerated. On the other hand, there are some smaller consequence
events that occur frequently that are controlled because they reduce the quality
of our lives and the profitability of our businesses. When thinking in this way, a
"paradigm shift" can occur; our view of reality changes.

Once we start to think in terms of risk, we automatically start to rank and

prioritise. This is another great virtue of risk assessment: it allows us to plan
and programme our investments, enabling us to become proactive, to break the
cycle of reaction, to control and manage our risks.

Risk management consists of a number of steps or activities:

1. Hazard identification
2. Risk analysis
3. Value judgement/Acceptability or tolerability
4. Risk control
5. Risk finance

The first three steps can be combined under the heading "risk assessment".
The steps/activities would therefore consist of:

1. Risk assessment
2. Risk control
3. Risk finance

Unfortunately these steps do not reflect the process that needs to be in place in
order to manage risk. This factor is the deficiency in most organisations' efforts

CHAPTER 3
to manage risk. We live in a changing world, with the rate of change increasing;
standards and conditions deteriorating, etc. Therefore a process of managing
risk needs to be in place, a process that would constantly review and update
information on risk and review and improve control measures as appropriate.

This process is explained in more detail below.

Identification of hazards

In order to manage risk, the first step is to identify hazards. Identification of

hazards will be discussed in more detail in the chapter on risk assessment.

Analysis of risk

Once hazards have been identified, the level of risk or the threat that it
poses to the organisation has to be analysed. Analysis of risk will be
discussed in more detail in the chapter on risk assessment.

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Value judgement of the risk

Once the extent of the risk is known, a decision has to be taken whether the
risk is acceptable or whether something needs to be done about it. Value
judgement of risk will be discussed in more detail in the chapter on risk
assessment.

Development of control and financing measures in order to reduce the

risk to an acceptable level

Should the level of risk be unacceptable, a decision has to be taken in

terms of what needs to be done in order to reduce the risk to a level that
would be acceptable in terms of either reducing the frequency or the
consequences of exposure to pure risk. These measures are risk control
and financing measures.

Before considering the factors involved in developing control measures, it is

important to emphasise that the extent of the control measures to be developed
should be in relation to level of risk it addresses. To this end, Bird published a
paper entitled "The control of catastrophic events and the big 10 goals in Safety
Management". Although referring to safety management, the principles have
universal value. Bird (1992b:21) wrote the following:

Principle of systematic action

The higher the risk, the more systematic the control action should be to
achieve required objectives or goals.

Principle of situation control

The higher the risk, the more that effort should be directed at building safety
and a quality-prone environment/situation.

Principle of stress control

The more critical the work, the more that effort should be directed at
recognising, evaluating and controlling stress-causation problems in the
total organisation.

Principle of checks and balances

The more critical the work, the more that effort should be directed at
building checks and balances into the activity to ensure that it will be done
the right way.

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Principle of forcing mechanisms

The more critical the work, the more that effort should be directed at
developing and applying management techniques, motivational and
mechanical devices that provide forcing mechanisms which increases the
likelihood of desired behaviour and error-free work.

Developing risk control measures involves the following:

Identifying the work to be done

"Work" refers to control measures, such as engineering design or revision,

procedures, maintenance of equipment, inspections, etc.

Setting standards for the work to be done

Again, in relation to the level of risk, standards have to be set for the work
necessary to reduce the level of risk to an acceptable standard. It is critical
to set standards in order to make the work measurable.

Implementing the system

With work identified and standards set, the control measures are
implemented.

Measurement

It is often found that control measures are implemented and never reviewed,

CHAPTER 3
unless something drastic, such as a major incident, occurs. Therefore, in
order to ensure that the control measures are indeed as effective as was
intended, these need to be monitored and measured.
This measurement can be in the form of regular measurement by sampling,
or by comprehensive measurements such as auditing on a periodic basis.

One would need to determine how well the work is being done in terms of
the assessed level of risk.

There are basically three types of measurement: measurement of

consequence, cause and control/performance. This can best be explained
by means of the Loss causation model (see figure 3.2).

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LOSS CAUSATION MODEL

Inadequate Basic causes Immediate Incident/ Loss/

control causes Accident
Injury/
Personal
factors Damage/
Inadequate: Substandard
System acts Environmental
Standards Job
Compliance factors Substandard impact, etc.
conditions

Measurement Measurement Measurement

of of of
control cause consequence

Figure 3.2 Loss causation model

Measurement of consequence

This measurement gives only a historical view of the performance of the

organisation in terms of the extent to which risk is being controlled. Typical
examples are:
Disabling injury frequency rate (DIFR)
Disabling injury incidence rate (DIIR)
Fatality rate
Cost of incidents
Insurance claims value
Value of losses per unit measure of product, etc.

Although useful, there has unfortunately been an over-dependence on this

type of measurement to date. This is especially the case in terms of injury
rates. In terms of DIFR and DIIR, for example, opinions differ on what
should be classified as a disabling injury, and therefore the figure is
sometimes misleading and not suitable for comparison. This is especially
true in terms of comparisons between different types of industries and to
some extent even between organisations of the same industry, as their risk
exposures differ. The main value of these rates is in self-comparison is
there an improvement in the rates over a period of time or not? It can tell
little more than only that; informing the manager of a department or
organisation that their DIIR = 1,5 may raise the question: "So what? is it

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good or bad?" In terms of their own history it may be good, in terms of their
particular industry it may be bad, but most of all it does not tell the manager
anything about the problem. The main disadvantage of using this
measurement is that it is reactive. The measuring can only be done once
the loss has occurred, and it is therefore reaction and not control!

Measurement of cause

Measurement of cause has more value than measurement of consequence.

It measures the causes of loss in the organisation either immediate
causes or basic causes. The information from incident investigations is
analysed to determine the major causes and trends. From the incident
investigation analysis it may, for example, be learned that 65% of all causes
for loss are due to 1) inadequate maintenance, 2) lack of knowledge or 3)
inadequate purchasing/procurement, etc. This tells the manager that
something ought to be done about the 1) maintenance system, or 2) that
there is a serious problem with the training of employees, etc. The manager
can react on the basis of this information, as measurement of cause is
reactive.

Measurement of control/performance

The third and most valuable measurement is that of control or performance.

The principle of measurement of control is measuring the extent and quality
of the work that is being done that was decided as necessary to control risk
exposures. For example:

CHAPTER 3
After the risk assessment, it was decided that one of the methods of
controlling workplace risk exposures, is to do regular inspections. The
standards are compiled specifying among others, the following:
A checklist of items to be checked for each workplace
Inspections to be carried out by supervisors
One inspection to be conducted once per month

Three months after implementing the system, it is established that between

the 30 supervisors, 90 inspections should have been completed. However,
only 60 inspections were done, which means that there is only a 66%
compliance to standard, or a 34% non-compliance. This implies that the
work required to control risk is not performed adequately, which increases
the likelihood of an incident if it has not already happened! This is due to
the fact that during inspections, hazards and substandard conditions would
have been identified and action taken to correct these; if the inspection is
not done, chances are that it is not identified and that no action is therefore
taken. This information obtained from measurement of control enhances

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both a proactive approach and can be used for comparison, e.g. between
the engineering department and administration department. If engineering
has done only 66% of their inspections and the administration department
did 90% of their inspections, the administration department is performing
better than the engineering department. However, in terms of measurement
of consequence, for example, there is no meaning in comparing the DIIR of,
say, 2,5 of engineering with the DIIR of 0,1 of administration.

Evaluation of the measurement results

Following the measurement or audit, the results need to be analysed in
order to understand what the measurement revealed.
The measurement evaluation may reveal the following:
Everything is on target and therefore you would want to commend
somebody for good performance.
There is a deviation from the set standards, in which case you have to
apply constructive correction.
The control measures are ineffective or the standards or work to be
done are inadequate to control the hazard adequately or possibly that
not all hazards have been identified, in which case the process starts
again at hazard identification.

Correction or commendation
These factors need to form a continuous process, which is illustrated in
figure 3.4.
E
Analyse
risk
Valued
V
judgement

Identify Develop risk

I hazards control and D
finance method

Measure
audit
Evaluate M
results

E
Figure 3.4 The risk management loop

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3.6 COST OF RISK AS CONCEPT

Cost of risk refers to the monetary value of an organisation's exposure to pure
risk. It includes the following:
Administrative expenses
Clerical costs in administrating claims and losses
Cost of investigating losses
Cost of controlling risk
Capital costs to reduce risk, e.g. a sprinkler system, personal protective
equipment, etc.
Cost of man-hours spent in assessing risk
Cost of outside consultants
Cost of risk control personnel
Maintenance of safety equipment
Cost of losses/self-funding
Cost of insurance

These costs are added together and any claims paid out by insurance are
deducted from the total.

The objective of an organisation would be to optimise the cost of risk and

obviously not to reduce it to zero, which is not possible. The strategy should
rather be to assess risks carefully and then to develop appropriate levels of

CHAPTER 3
control and finance measures, thus optimising cost of risk. In terms of
economics, there is a theoretical point where more money is spent on controlling
risk than the potential loss from that exposure. This principle is depicted in
figure 3.5.

Cost of
control

Optimal point

Cost of
losses

Figure 3.5 Cost of control vs. cost of losses

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The diagram shows that initially, as money is spent on controlling risk/reducing

loss, the loss is reduced up to a point where it becomes more expensive to
prevent the loss than the effect would be. However, there is little risk of this
happening when a structured approach is followed by first determining the risk
and then deciding on appropriate levels of control measures.

3.7 QUESTIONS FOR SELF-EVALUATION

3.7.1 Draw and explain the risk management model.

3.7.2 Explain the reasons why people take certain risk management
decisions.

3.7.3 Discuss the loss causation model of Bird and Germain in detail.

3.7.4 How could the loss causation model assist a safety practitioner in
his/her job?

3.7.5 Discuss the risk management process in detail.

3.7.6 What does cost-of-risk mean?

3.8 REFERENCES
Bird, F.E. Jr. 1992a. The control of catastraphic events and the "Big 10" Goals
in Safety Management. Loss Prevention Bulletin, 103, February:21-23.

Bird, F.E. & Germain, G.L. 1992b. Practical Loss Control Leadership.
2nd edition. Loganville, Georgia: International Loss Control Leadership.

Valsamakis, A.C., Vivian, R.W. & Du Toit, G.S. 1992. The Theory and Principles
of Risk Management. Johannesburg: Heinemann.

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CHAPTER 4
RISK ASSESSMENT

CONTENTS PAGE

LEARNING OBJECTIVES ................................................................. 42

4.1 RISK ASSESSMENT ............................................................ 42

4.1.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 42
4.1.2 Hazard identification . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 46
4.1.3 Risk analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 57
4.1.4 Value judgement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 69

4.2 QUESTIONS FOR SELF-EVALUATION .................................... 71

4.3 REFERENCES .................................................................... 71

CHAPTER 4

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LEARNING OBJECTIVES
After studying this chapter, you should understand:
risk assessment
hazard identification and be able to give typical examples of applied
methods
risk analysis and be able to give typical examples of applied methods
value judgement of risk

4.1 RISK ASSESSMENT

4.1.1 Introduction
Risk control/management professionals are not necessarily specialists in all of
the methodologies applied in risk assessment. However, it is important for these
professionals to be familiar with or have a basic understanding of all the
methods and systems, for example what type of hazards are identified by each
hazard identification method, and therefore know when to call for the application
of specific method or risk assessment study. Risk assessment has become a
specialist occupation, and risk assessors/risk assessment consultants do risk
assessments for a living.

"You cannot manage risks until you have assessed them."

Without risk assessment it would not be possible to decide what risk control and
financing measures to apply and, more specifically, the extent of these risk
control and financing measures that would be required to manage risks. Until
recently, risk assessment was considered the domain of science, and public
opinion was regarded as naive and irrelevant except for communicating the
risk. Today, both risk science and the values of society are regarded as central
to sound risk management.

Risk assessment has been conducted for many years, but over the years its role
has changed.

The changes in the different decades can be summarised as follows:

- Before the 1970s we asked: "How do we make it safer?"

- In the 1970s we asked: "Is it safe?"
- During the 1980s we said: "It is safe!"

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- In the 1990s we ask: "Is it cost-effectively safe?"

In its current form, risk assessment is applied to:
- show where improvements are possible
- target areas for risk reduction
- prioritise expenditure
- sometimes, justify not spending any more
- show where further expenditure is or is not REASONABLY PRACTICABLE
When conducting risk assessment studies, the following basic questions should
be asked and answered:
- What is the likely outcome of an action or an event?
- What is the chance of this occurring?
- How desirable or undesirable will the outcome be?
- Can we live with/tolerate this outcome?
- If not, is there anything worthwhile that we can do about it?
Risk assessment can therefore be defined as follows:
"Risk assessment is the identification of undesired events and their causes and
the analysis of their likelihood and potential consequences in order to make a
value judgement as to whether the events in question are acceptable or
tolerable."
Legislation relevant to risk assessment
The requirement to conduct risk assessment as part of a programme of
safety management can now be found in many statutes worldwide. In many
other cases there is an implicit requirement. This legal term involves
determining the degree of risk in a particular situation or activity, then
balancing it against the time, trouble, cost and physical difficulty of taking
measures to avoid the risk. If these are disproportionate to the risk to the
extent that it would be unreasonable to have to incur them, then there is no
obligation to do so. In essence, this requires undertaking of a risk
assessment and cost benefit analysis to determine what is, or is not,
'reasonably practicable'.
In South Africa, risk assessment is now also a legal requirement. The
Occupational Health and Safety Act 85 of 1993 requires the following:
Section 8(1)
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"Every employer shall provide and maintain, as far as reasonably

practicable, a working environment which is safe and without risk to the
health of his employees."

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It is not possible to prove that everything as far as reasonably practicable

has been done without conducting effective risk assessment.
It is also not possible to provide a working environment that is safe and without
risk to the health of employees if all the hazards that could cause injury and ill
health have not been identified.
The Mine Health and Safety Act 29 of 1996 specifies that risk assessments
have to be conducted.
Major types of risk assessment and their focus
You can form an idea of the comprehensiveness and potential complexity of
risk assessment by looking at the table below. Although each risk exposure
has a fairly unique method/system and terminology for risk assessment, the
basic principles remain the same:
- Identify the hazards
- Analyse the risk
- Decide if the risk is acceptable or not
- Develop controls for those that are not
This can best be explained by a comparison of the risk assessment process of
three of these risk exposures safety, human health, and environmental risks,
as depicted in table 4.1.

SAFETY HUMAN HEALTH ENVIRONMENTAL

1. Hazard identification
materials, equipment,
procedures, e.g. inventory
size and location, flammable,
reactive or acutely toxic
materials, and initiating events,
e.g. equipment malfunction,
human error, containment
failure.
1. Data analysis/hazard
identification. Quantities and
concentrations of chemical,
physical, and biological agents
in environmental media at a site
or study area; selection of
chemicals of concern.
1. Problem formulation
(hazard screening)
Resident and transient flora
and fauna, especially
endangered or threatened
species; aquatic and
terrestrial surveys;
contaminants and stresses
of concern in study boundary.

2. Probability/frequency 2. Exposure assessment 2. Exposure assessment

estimation of causes.
Likelihood of initiating/
propagating events and
accidents from internal and
external causes.
Pathways and routes,
potential receptors including
sensitive subgroups,
exposure rates, and timing.
Pathways, habitats, or
receptor populations,
especially valued and
protected species;
exposure point concentrations

3. Consequence analysis 3. Dose-response or toxicity 3. Toxicity effects assessment

Nature, magnitude and
probability of adverse effects,
e.g. fires, explosions, sudden
release of toxic materials,
meteorology, receptors.
assessment Aquatic, terrestrial, and
Relationship between exposure microbial tests.
or dose and adverse health
effects.

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4. Risk evaluation Integration 4. Risk characterisation 4. Risk characterisation

of probabilities and conse-
quences for quantitative
expression of safety risks;
review of acceptable system.
Integration of toxicity and
exposure data for qualitative
or quantitative expression of
health risks; uncertainty analysis
Integration of field survey,
toxicity and exposure data
for characterising
significant ecological risks,
causal relationship, uncertainty

Fatalities, injuries (worker
and public safety)
Economic loss.
TYPICAL ENDPOINTS
Individual and population cancer Ecosystem or habitat impacts,
risks, non-cancer hazards. e.g. population abundance,
species diversity; global
impacts.

Table 4.1 Comparison of three risk exposures

As can be seen from the above table, the methodologies and approaches used
for risk assessment vary according to the type of pure risk that is assessed. The
types of pure risk can be classified as follows:
Occupational safety risks:
Focus on the health and safety of employees
Public safety risks:
Focus on the health and safety of the community (effect of the organisational
activities in particular)
Environmental risks:
Focus on habitat and ecosystems (effect of the organisational activities in
particular)
Society risks:
Focus on public values and perceptions
Legal liability risks:
Focus on legal liabilities and other forms of liability such as product liability
Asset/Engineering risks:
Focus on asset/equipment failures and damage
Crime risks:
Focus on crime risk exposures, such as shrinkage, theft, fraud, etc.
CHAPTER 4

Financial/Business risks:
Focus on financial risks not included in any of the above categories, e.g.
strikes, loss of market share, exchange rate of currency, etc.

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Expression of risk/Risk measures

Risk is expressed in one of two ways quantitative or qualitative. Quantified
Risk Assessment (QRA) methods involve expressing risk in numerical
terms, e.g. a particular hazard has the potential to cause 100 fatalities per
year, or the chances of being killed due to the exposure to a particular
hazard is 1/1 000 000. Qualitative techniques express risk in terms of, for
example, 'numerous fatalities once in the lifetime of a plant'. Use is also
made of 'risk indexes', e.g. if the hazard has the potential to cause multiple
fatalities, it is allocated a rating of 100, and a single fatality a rating of 60. In
terms of frequency or likelihood, a rating of 10 may be allocated if it is
expected that the fatality could occur monthly. The consequence (fatality)
and frequency (monthly) ratings are multiplied to get to a risk rating of 6
000. This method is mostly applied to do a simple risk ranking, as risks with
higher ratings are obviously more critical than those with low ratings.

4.1.2 Hazard identification

The first and most critical step in the management of risk is hazard identification.
If a hazard is not identified it will not be assessed and therefore no control
measures (if required) will be implemented. It should therefore be obvious that
this step in the process is the one requiring most effort and diligence.

Hazard identification is defined as:

"... a systematic process for establishing what can go wrong (cause) and what
harm/loss could be caused (consequence)."

Hazard is a source of risk, but is not risk per se. Hazard can therefore be
defined simply as:

"... any condition or act with the potential to cause harm". In this context harm
can be injury, ill health, damage to property or the environment, etc.

The following are examples of hazards:

- Electricity - Mechanical energy e.g. a rotating shaft

- Temperature extremes - Pressure positive or negative
- Radiation - Hazardous chemicals
- Speeding - Unstable ground conditions
- Earthquakes - Explosives
- Sharp edges - Flammable liquids

Hazard identification methodologies

There are many systems used for hazard identification (HAZID). The methods
range from simple to sophisticated. The method chosen will depend on the type

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of hazard that needs to be identified in terms of the type of risk assessment that
would need to be conducted for example health hazards, process hazards,
equipment or 'hardware' hazards, 'peopleware' hazards (also referred to as
human error), etc.

The methods generally fall within two categories:

- Those that start with the hazards and try to find the causes (top down)
- Those that start with the causes and try to identify potential hazards (bottom
up)

Methods are also categorised as being:

- 'high-level' or 'macro' identification methods

- 'detailed' hazard identification methods.

The distinction is that high-level hazard identification does not go into much
detail. An example would be 'SWIFT' (structured 'What-If' checklists), or
insurance review checklists. Detailed hazard identification, on the other hand,
goes into micro-detailed hazard identification, for example FMEA (Failure Mode
Effect Analysis) or HAZOP (Hazard and Operability Studies). The following
example should explain the difference:

During a high-level hazard identification, using SWIFT, the potential of

derailment of the company's train at a set of points is identified. Potential
hazards that could cause the derailment include speeding, due to equipment
failure of the points, the speed control, brakes, etc. We may decide that a
detailed study would need to be conducted to determine what would cause the
brakes to fail, in which case a FMEA study would be conducted on the brake
system. During the FMEA study it may, for example, be identified that if a
particular seal fails, the total break system fails.

The next section contains a brief discussion of seven methods commonly used
for hazard identification. Thereafter, brief reference will be made to a number of
other methods that are also used. Each method will be discussed under the
following headings:

(a) Description:
Brief description of the method
CHAPTER 4

(b) Hazards identified/When applied:

Type of hazard identified or purpose for applying this particular method

(c) Level:
Indication whether method is high level or detailed

(d) Top-down/Bottom-up:
Indication whether the method is top-down or bottom-up

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(e) Advantages:
Reference to specific advantages of particular value

(f) Disadvantages/Limitations:
Reference to specific limitations or disadvantages

Hazard identification methods include the following:

(i) Checklists

(a) Description
The checklist is probably the most commonly applied method. A list of
known hazards are compiled, and by referring to the checklist the person
using it identifies which hazards are in fact present in a particular section of
the organisation through physical inspection. There are a number of
checklists that have been compiled for the identification of specific types of
hazards. Examples include insurance review guides/checklists, fire surveys,
legal compliance checklists, etc. Table 4.2 is an example of such a
checklist:

HAZARD

1. Electrical Systems
1.1 Open conductors
1.2 Damaged electrical cord insulation
1.3 Equipment not earthed
1.4 Distribution panel faceplate missing/loose
1.5 Breakers not labelled, etc.

2. Mechanical Power Transmission

2.1 Nip points
2.2 Rotating parts, etc.

3. Hazardous Substances
3.1 Flammable liquid
3.2 Corrosive substances, etc.

Table 4.2 Example of a checklist

(b) Hazards identified/When applied:

Identification of visible hazards

(c) Level:
High

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(d) Top-down/Bottom-up:
Top-down

(e) Advantages:
Easy to use

(f) Disadvantages/Limitations:
Requires experience to apply effectively, hazards may be overlooked if not
listed

(ii) Incident/Accident investigation review e.g. own investigations;

industry, national and international databases

(a) Description:
Good quality investigations provide valuable information on hazards that
have already caused losses.

(b) Hazards identified/When applied:

Hazards specific to a particular industry. Incident analysis should be
conducted prior to all hazard identification studies to serve as baseline
information for the study.

(c) Level:
High

(d) Top-down/Bottom-up:
Top-down

(e) Advantages:
Opportunity to identify hazards/causes of 'unique' accidents, i.e. accidents
that have never occurred before, and to learn from others' mistakes.
Valuable information on accidents and disasters are available on the
Internet.

(f) Disadvantages/Limitations:
Not many organisations have good investigation systems and therefore
records are of poor quality. Some databases may be more difficult to
access than others.

(iii) Task analysis

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(a) Description:
Task analysis involves systematic identification of hazardous tasks/jobs and
the hazards related to these tasks. The information is critical for the
compilation of task procedures. Table 4.3 is an example of a task analysis
worksheet.

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DATE REV. PAGE

CRITICAL TASK ANALYSIS WORKSHEET 25-2-96 00 OF

1. OCCUPATION: 2. ANALYSED BY:

3. TASK ANALYSED: 4. REFERENCE:

5 ORG.: 6. SECTION:

7. APPROVED BY: 8. SIGNATURE: 9. DATE:

POTENTIAL or EXISTING HAZARDS RECOMMENDED

STEP Consider safety, health, damage, fire, quality, production EFFICIENCY CHECK CONTROLS
no. problems, etc. Consider people, equipment, materials and
RECOMMENDATIONS (Includes safety rules)
SEQUENCE OF TASK STEPS environment interactions.

PROGRAMME NEEDS: PROCEDURES PRACTICES SKILL TRAINING SPECIAL RULES

Table 4.3 Critical task analysis worksheet

(b) Hazards Identified/When Applied:

Hazards related to tasks/jobs.

(c) Level:
High

(d) Top-down/Bottom-up:
Bottom-up

(e) Advantages:
If done correctly, a task analysis identifies valuable information about
hazards related to human activities/tasks especially hazards related to
occupational health and safety

(f) Disadvantages/Limitations:
Not many organisations have good task analysis systems and therefore
records are sometimes of poor quality.

(iv) Brainstorming

a) Description:
It has been said that only 40% of all knowledge has been documented. The
same goes for knowledge on hazards and risks within organisations/a
particular industry. Conducting what is known as 'brainstorming', taps in on
the knowledge and experience of employees. If the organisation is, for
example, a mine, and you were to select about eight experienced persons
from underground, you may have a total of 100-150 year's of experience on
mining and related problems in one room. In addition, a number of the
participants would probably have worked at other mining houses as well.

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The method involves a well-experienced facilitator and scribe to record the

information. The role of the facilitator is to apply specific facilitation techniques
to obtain the information from the group.

(b) Hazards identified/When applied:

All types of hazards

(c) Level:
High

(d) Top-down/Bottom-up:
Top-down

(e) Advantages:
The method is especially valuable where participation of workers is a
requirement e.g. as prescribed by the Mine Health and Safety Act.

(f) Disadvantages/Limitations:
The quality of the study depends on the knowledge and experience of the
group.

(v) Hazard and operability studies (HAZOP)

(a) Description:
HAZOP was developed by the chemical industry. It is a structured team
approach. Team members (4-6 persons) from different disciplines are
involved because of their expertise, and members may include process
engineers, maintenance engineers, chemists, instrumentation technicians,
etc. The process of HAZOP involves the following:
Identifying a system e.g. a heat exchanger and dividing the system
into what is known as nodes, i.e. scrutinising the system line by line, in
fine detail. Extensive use is made of drawings and diagrams such as
Process and Instrumentation Diagrams (P&IDs). Most of the HAZOP
study is done in the meeting room.
A set of guide words is used to identify deviations. The guide words are:
no, not or none
more of
less of
as well as
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part of
reverse
other than
There are seven stages that are repeated many times during a HAZOP:
Apply a guide word
Develop a deviation

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Examine possible causes

Examine consequences
Consider hazards, or operability problems
Decide upon action
Make a record of the discussion and decision

An example of a HAZOP log sheet can be seen in table 4.4.

Project: REV Date Author Table Sheet 1 of

1
EFD Section / / HAZOP Session
Number:
Design Intention: HAZOP Team:
EFD: REV:
GUIDE-WORD/ POSSIBLE POSSIBLE ACTIONS/QUESTION/
DEVIATION CAUSES CONSEQUENCES RECOMMENDATION
NO flow Valve closes Over-pressure
LESS flow Pump runs dry Pump ceases
MORE flow Flow control Overflow on tank
REVERSE flow valve fails Contamination of
NO pressure One-way valve fails product
MORE pressure Pump fails

Table 4.4 Example of a HAZOP log sheet

(b) Hazards identified/When applied:

'Hardware' system-based method. Identifies equipment and material
hazards and process problems/hazards. It can be applied in various phases
of plant life-cycle from design to operation. It can be used as an aid in
designing a safe plant.

(c) Level:
Detailed

(d) Top-down/Bottom-up:
Bottom-up

(e) Advantages:
The method is systematic and thorough. It draws on the experience of the
study team.

(f) Disadvantages/Limitations:
Time consuming and expensive due to the fact that it requires expert input.

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It is not a quantitative technique but can be used to the identify hazards in order
to complete a quantitative assessment.

(vi) Failure modes and effects analysis (FMEA)

(a) Description:
This is a largely qualitative technique which was developed in the US
civilian and military aerospace industries as a means of systematically
evaluating and documenting the potential impact of each functional failure
on equipment reliability, personnel safety, system performance and
maintainability requirements.

Similar to HAZOP, extensive use is made of drawings and diagrams and

most of the study is done around the table. Table 4.5 is an example of
typical FMEA Worksheet:

SYSTEM: DATE:
INDENTURE LEVEL: SHEET ___ OF ___
REFERENCE DRAWING: COMPILED BY:
MISSION: APPROVED BY:

Item/
Functional Failure Failure
ID identification modes Failure effects detec- Compen- Seve-
no. (Nomen- Function and tion sating rity
clature) causes method provisions class

Local Next End

effects higher effects
level

A- Solenoid To Solenoid Valve SSIV Loss of SSIV None 3

200 operated direct de- position closes plat- position
- hydraulic fluid to energises chan- spuri- form indica-
302 selector the due to ges ously produc- tion
valve SSIV in coil Fluid tion
the failing on returns
open open to tank
position circuit

Table 4.5 Example of an FMEA worksheet

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(b) Hazards identified/When applied:

'Hardware' system-based method. FMEA is used to identify ways in which
components or systems can fail to perform their design intention. It will also
identify the effects of those failures on the system of which those components
or sub-systems are a part.

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(c) Level:
Detailed

(d) Top-down/Bottom-up:
Bottom-up

(e) Advantages:
The method is systematic and very detailed
It provides a method, which can be audited, for the identification of
equipment failure modes and resulting consequences or hazards
It can identify non-compliance with regulatory requirements
It assists in the definition of maintenance strategies, etc.

(f) Disadvantages/Limitations:
It can only be used to identify single failures and not combinations of
failures
It can be time consuming and costly
It is not suitable for quantification of system reliability

(vii) 'What-If' and Structured What-If Checklist Technique (SWIFT)

SWIFT is a Det Norske Veritas (DNV) trademark for its Structured What-If
Checklist Technique for Hazard Identification.

(a) Description:
The 'What-If' technique is commonly used during brainstorming to identify
hazards. 'What-if' has no boundaries, i.e. questions such as "what if an
aeroplane crashes into the building?" are valid. Although it is powerful
technique, there is no structure and it is therefore limited by the abilities of
the study team and the facilitator.

The SWIFT study technique has been developed as an efficient alternative

to HAZOP for providing highly effective hazard identification when it can be
demonstrated that circumstances do not warrant the rigor of a HAZOP.
SWIFT can also be used in conjunction with or complementary to a HAZOP.
It is a thorough, systematic, multi-disciplinary, team-oriented analytical
technique. SWIFT differs from HAZOP in that HAZOP examines the plant
line by line and vessel by vessel; SWIFT, on the other hand, is a systems-
oriented technique that examines complete systems or subsystems. To
ensure comprehensive identification of hazards, SWIFT relies on a
structured brainstorming effort by a multi-disciplinary team of experienced
experts with supplemental questions from a checklist. The structure for
questioning is provided by the following categories:
Material problems
External effects or influences

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Operating errors and other human factors

Analytical or sampling errors
Equipment/instrumentation malfunction
Process upsets of unspecified origin
Utility failures
Integrity failure or loss of containment
Emergency operations
Environmental release

Table 4.6 contains an example of a typical example of a SWIFT worksheet.

Project: Node: Page:

Node Description:
Category Question Conse- Safeguards Rec. # Recommendation Type Priority
quences

General What if - Can Training R1 Conduct FMEA on P High

conveyor cause idlers overload protection
belt runs damage to Siliconics
skew? conveyor control (trip
and major on
production overload)
loss.
- Can
cause
material
spillage.

Table 4.6 Example of a SWIFT worksheet

(b) Hazards identified/When applied:

Originally intended for identification of process hazards, but is successfully
applied for identification of all types of hazards.

(c) Level:
High

(d) Top-down/ Bottom-up:

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Top-down

(e) Advantages:
The method is especially valuable where participation of workers is a
requirement e.g. as prescribed by the Mine Health and Safety Act. It
generally avoids lengthy discussions of areas where hazards are well
understood or where prior analysis has shown that no significant hazards

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exist. Its effectiveness comes from asking questions in a variety of

important areas, according to a structured plan, to help ensure complete
coverage of all the various types of failures or errors that are likely to result
in a hazard within the system being examined.

(f) Disadvantages/Limitations:
The quality of the study depends on the knowledge and experience of the
group.
Other methods for hazard identification include:
Safety indexes
Safety indexes such as the Dow Index, identify process areas with
significant loss potential, primarily for insurance purposes. The Dow
Index has been expanded to include business interruption losses.
Various attempts have been made to expand and improve on this index,
but with limited success.
Applying codes of practice
Applying standard codes of practice can identify risks. For example,
one of the risks associated with manufacturing a product is that it may
be released prematurely to the market before it has passed the
quality control tests, for example. Hazard identification techniques may
or may not identify this risk. Generally it will be identified only once a
claim is filed. Standard requirements of ISO 9000 in terms of status
marking and quarantine requirements can prevent this, as this risk has
been identified and the controls incorporated into the code.
Risk research
There are some hazards on which insufficient information exists. Quite
often, these are hazards to health and the environment that take very long
before the effects are known or visible. One such example is asbestos.
It was only when people started dying from lung cancer that research was
initiated that to establish that asbestos was the cause. Another example
(over which there still is great controversy) is the so-called CFCs, which
are said to cause ozone depletion. Initially, when the product was
manufactured for refrigeration systems, nobody understood the effect it
would have on the environment. Scientists eventually noticed effects in
the form of a hole in the ozone layer of the earth. Developing of new
medicines/drugs is subject to major research to establish potential
hazards/side-effects before they are released onto the market.
Use of documents and databases
A magnitude of documents, books and computer databases on hazards
and statistics of incidents/losses/accidents are available. You can keep

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up-to-date with the latest information on hazards and control techniques

by attending symposiums/seminars/conferences.

4.1.3 Risk analysis

Knowing or having identified a particular hazard, has little meaning if it is not put
in perspective, i.e. knowing the risk that it poses. It would be good to know, for
example, that there are numerous hazards in the form of rotating shafts and
gears that are unprotected, as well as knowing what the risk is. In other words,
what is the likelihood of somebody being injured, and how serious would the
consequences (injuries) be? If we know this, we know what action to take if
any. For example, suppose the rotating shaft is on a very small electric motor
that can easily be stopped by hand the potential for injury and the severity of
the injury are negligible, although the hazard of a rotating shaft exists. On the
other hand, existing controls may or may not be adequate, i.e. existing control
measures have already reduced the level of risk to an acceptable level. For
example, suppose:
the rotating shaft has the potential to cause an amputation, i.e. has severe
consequences, but the likelihood of injury has been reduced by the fact that
the electric motor on which the shaft is mounted, is in a room which is kept
under lock, and in addition there is an interlock on the door, so that if
someone were to open the door the motor would be tripped and stationary
by the time the person reaches the motor, or
the rotating shaft is on an electric motor that can be stopped by hand, so
that potential for only minor injury/consequences exists.

The risk would, in all probability, be acceptable. This analysis, or determining of

the risk involved, is the function of risk analysis.

Due to the fact that risk consists of both likelihood and consequence, only once
both have been established can risk be determined. Put differently, both the
likelihood for an identified hazard to cause harm/result in a loss producing
event/incident, and the consequences of the event/incident, should it occur, have
to be established. The diagram in figure 4.1 explains the relationship between
likelihood/frequency and consequence:
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Likelihood/Frequency Ri
sk

Consequence

Figure 4.1 The relationship between likelihood/frequency and

consequence

The first method to be discussed is frequency analysis.

(I) Frequency analysis

Once a hazard has been identified, the first question would be: "How likely is
the scenario?".

Frequency refers to the frequency at which a particular event can occur.

Frequency can also be calculated in terms of exposure and probability.

Exposure is the actual time period that the resource at risk is exposed to the
hazard. For example, a person could be exposed to high temperatures for eight
hours or only one hour per day.

Probability is the chance of the loss, damage or injury actually taking place
during the exposure time. Probability is greatly influenced by existing control
measures.

Frequency is therefore the combination of exposure and probability. This

relationship is similar to that of frequency, consequence and risk, as shown in
figure 4.2.

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y
enc
qu
Fre
Exposure

Probability

Figure 4.2 The relationship between frequency, exposure and

probability

It should be clear from figure 4.2 that if exposure or probability increases, the
frequency at which the event can take place also increases.

As mentioned earlier in this chapter, risk is measured or expressed either

qualitatively or quantitatively. The risk assessment study requirements will
determine whether qualitative or quantitative techniques have to be applied.

Table 4.7 is a typical example of qualitative risk analysis, also referred to as a

risk matrix:

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Consequences

Multiple fatalities

CRITICAL
Fatalities

Reportable accident

Loss time accident VERY LOW

Once a Once a Once Once in a

month year every 10 lifetime
years

Frequency/likelihood

Table 4.7 An example of qualitative risk analysis

There are various techniques for frequency analysis/quantification. A few of

these methods are discussed briefly in a similar way to the hazard identification
techniques.

Frequency analysis methods

(i) Fault Tree Analysis (FTA)

FTA was developed by the nuclear industry to establish reliability or failure

probability of systems in nuclear power stations. It is an analytical
technique for establishing the likelihood of a potential or actual event. For
example, the single biggest event/catastrophe that can occur is known as
core meltdown, where all control over the process is lost. The result could
be similar to the Chernobyl disaster. It is also applied in incident investigation
to establish, analyse and visually display all causes and interactions that
resulted in the incident. In FTA, the incident is referred to as the 'top event'.
In establishing the causes that could or did result in the top event, the fault
tree can be quantified to arrive at a frequency or likelihood figure of that top
event actually occurring.

Relationships between causes and effects in a fault tree is expressed by

'AND' gates and 'OR' gates. An 'AND' gate is applied if two or more causes
have to be present in order for the result to occur, while 'OR' gates are
applied if any one of the causes could result in the effect/consequence. For

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example, if the effect is that no cooling water is available, one of two

reasons/causes could be identified: no water supply 'OR' pump fails to
pump. If the failure of the pump is analysed, two causes can again be
identified: the pump fails mechanically 'OR' no electricity supply to the
pump. The power failure to the pump can be analysed the power supply
must fail 'AND' the emergency generator must fail to start.

The above scenario can be displayed as follows:

Core meltdown

OR

No cooling water

OR

Pump fails No electricity

AND

Power failure Emergency

generator
fails to start

Figure 4.4 Example of a Fault Tree Analysis (FTA)

Due to the fact that almost everything in nuclear power stations has to be
recorded accurately, databases on failure rates or reliability of equipment is
available and therefore the likelihood of a particular pump failing or the reliability
of a generator can be quantified. These figures are then used to calculate the
likelihood of the top event (core meltdown).

(a) When applied:

CHAPTER 4

FTA is useful for evaluating the likelihood or frequency of an event that can
occur in a large number of ways. It is also a method of describing how an
undesirable event may occur in terms of individual, non-hazardous
component, or operator failures.

(b) Quantitative technique:

FTA can be quantified or not quantified.

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(c) Advantages:
The method is systematic and thorough.

(d) Disadvantages/Limitations:
Time consuming and expensive due to the fact that it requires expert input.
Complex FTAs can be a few thousand pages long.

(ii) Statistical data

In the previous description of FTA reference was made to databases that

exist in the nuclear industry. The use of statistical data is another method to
establish likelihood or frequencies. This data can be invaluable in terms of
deciding if a risk is acceptable or not. An example in this regard is that the
chances of being struck by lightning is on average one in a million per year,
or expressed differently, 0,000001/year, or 1 x 10-6/year, or even "if you
were to stand in one spot for a million years, you would be struck by
lightning!". This was established by considering the number of people struck
by lightning in a year as well as the number of people in the population.
Similarly, by keeping accurate records of equipment failures the nuclear
industry is able to calculate the failure frequencies of different types of
equipment used.

Databases on equipment reliability are just one example of statistical data

that is available in the world. Another example could be a company's own
injury statistics having a Disabling Injury Incidence Rate (DIIR) of 1,5
means that 1,5% of personnel in that organisation have sustained disabling
injuries on the job during the past 12 months. This gives you an indication
of the likelihood of sustaining a disabling injury in a given year if you are
working in that organisation.

Other examples of databases that are available in the nuclear and process
industry are listed in table 4.8.

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Source Availability Basis Comments

Rasmussen Published Nuclear power A basic source,

(1975) plant records much quoted. Supported
by Licensee Event
Report Analysis

IEEE Std-500 Published A large collection of Mainly nuclear sources.

(1984) electrical component No pressure vessel or
reliability data equipment data.

IPRDS in-plant Published and Reviews of nuclear Large detailed database

reliability data computerised plant maintenance on nuclear plant, updated
system records continuously.

NPRDS Nuclear Online access and Nuclear plant data in Only one year of data
Plant Reliability data retrieval a consistent and available, but may
System, managed comprehensive format. become the most
by INPO (Institute significant nuclear
for Nuclear Power database
Operations)

Lees (1980) Published Data on a wide range Numerous tables and a

of process equipment good index make this
easy to use

Rijmond Public Published Process industry Early compilation directed

Authority (1982) reliability data specifically to the
chemical process industry

Workmen's Published Database of reported

Compensation injuries and diseases,
Injury Statistics injury types, injuries per
industry type, etc.

Table 4.8 Databases available in the nuclear and process

industry

The above are merely examples of data that is available and that can be used
for frequency/likelihood analyses.

(a) When applied:

When constructing quantified FTA or when doing frequencies/likelihood
CHAPTER 4

calculations.

(b) Quantitative technique:

Statistical data is mostly used for quantified frequency analysis.

(c) Advantages:
Invaluable for frequency analyses/calculations.

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(d) Disadvantages/Limitations
Reliability of information depends on how conscientiously data is recorded.

(iii) Human reliability analysis/Human error assessment

Human reliability is affected by five factors:
The quality of information that is available and the format in which it is
presented in audio format, visual format, etc.
Quality and nature of operator models
Capacity limitations on processing
Decision-making strategies and processing skills
Metacognitive strategies controlling lower processes
Methods that are available include the following:
Technique for Human Error Rate Prediction (THERP)
Human Cognitive Reliability (HCR)
Human Error Assessment and Reduction Technique (HEART)
Tecnica Empirica Errori Operandi (TESEO)

(a) When applied:

Human error assessment is a means to identify error potential of a person.
It is a means to assess performance-influencing factors and to evaluate the
likelihood of a task being performed successfully and without error. It is also
used to determine assurance that safety critical systems will perform to a
specified reliability.

(b) Quantitative technique:

HRA is applied mainly as a quantitative technique.

(c) Advantages:
Human error is regarded as the major cause of incidents. Applying these
methods can aid greatly in analysing and ultimately reducing human error
potential.

(d) Disadvantages/Limitations:
HRA studies are constrained by the following factors:
- Impaired system knowledge
- Response/Processing time shortages
- Poor/Ambiguous feedback
- Requirements for difficult judgements
- Level of alertness

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(iv) Frequency indexes

A subjective method for allocating frequency to a scenario, is the use of

what is known as frequency indexes. Table 4.9 is an example of a
frequency index:

PROBABILITY FREQUENCY INDEX

Improbable Less than 1 in a lifetime 0
Extremely remote 1 in a lifetime/100 years 2
Remote 1 in 10 years 4
Reasonably probable 1 in a year 6
Probable 1 in a month 8

Table 4.9 Example of a frequency index

Increments of the frequency need to be more or less logarithmic.

(a) When applied:

When there is no need for quantified and accurate frequency calculation.
Together with consequence matrix, it is used for quick ranking of risks.

(b) Quantitative technique:

Not quantified

(c) Advantages:
Quick and easy to understand

(d) Disadvantages/Limitations:
Subjective method

(v) Consequence analysis

Consequence analysis involves determining the potential consequences if the

event occurs. A consequence analysis is always based on the worst case
scenario.
The method used for consequence analysis will depend on:
CHAPTER 4

the nature of event outcome, i.e. injuries/fatalities, property damage,

environmental impact, etc.
the measure of risk being used, i.e. individual risk, societal risk, etc.

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Approaches used for consequence analysis can be classified under one of

the following:
Historical input from the relevant industry
Historical input from the wider industry
Modelling of historical consequences
Structured brainstorming

Specific methods for each approach will not be discussed as it falls outside the
scope of this study guide. However, a few examples will be referred to in order
to provide a 'feeling' for some of the methods that are available.
The steps in consequence analysis are as follows:
Identify/Specify the event to be considered, e.g. the 'initiating event'
from an event tree
Define the consequence groups that would have to be considered, e.g.
people, property, business interruption, environment, etc.
Consider each of these in turn
Decide on the measure of risk to be used, e.g. fatalities, financial loss,
downtime, etc.
(i) Consequence analysis: Effects on people
When analysing the effect on people, you first have to decide if the analysis
will consider:
- employees
- customers
- 3rd parties/the public

You should then consider the effect that it would have on people in terms of
the following:
- Immediate fatalities
- Fatalities while escaping
- Delayed fatalities
- Injury/ill health

(ii) Consequence analysis: Business interruption

For business interruption, the following would have to be considered:
- Duration of the event
- Emergency response
- Damage control and limitation, e.g. fire doors, explosion disks, etc.
- Time to clear the site
- Investigation
- New/Replacement equipment lead time for delivery
- Reconstruction and testing

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(iii) Consequence analysis: Consequence modelling

When considering the potential consequences of a release of toxic or
flammable gas, one needs to perform what it is known as consequence
modelling. This modelling can become extremely complex and therefore
computer software is used. Specially designed software packages, such as
SAFETI and PHAST are available on the market. The software is essential
when doing consequence modelling to calculate risk in terms of the Major
Hazard Installations Act.

It would be best to use an example to briefly explain consequence

modelling:

A vessel containing 30 tons of ammonia gas has been installed on a site.

What would happen if a leak or possibly a catastrophic failure of the vessel
occurs? Ammonia gas is heavier than air and is an asphyxiant. In order to
estimate the consequences of a gas release, the information that would
have to be considered includes the following:
The size of the hole and the pressure at which the gas is stored, in
order to calculate the flow rate
How long it would take before the leak can be detected and stopped
if at all
The maximum quantity of gas stored in any one time
The wind rose for the region concerned annual wind speed and
direction as percentages

The computer would process the information and produce what is known as 'risk
contours', which can be superimposed on a scale map of the area at risk. Each
of the risk contours will indicate the risk of being killed by the gas release, e.g.
10-4, 10-5, 10-6, etc.

Figure 4.5 shows an example of a consequence model.

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10-8

10-7

10-6

10-5

10-4

Point of School
release

Factory
buildings

N
Scale 1:10 000

Figure 4.5 Example of a consequence model

Depending on legislation, the risk to the school would probably be acceptable,

having a risk of 1:100 000 000 for any one person (individual risk) of dying from
an ammonia gas release per year.

(iv) Consequence analysis: Consequence matrix

As with frequency analysis, subjective analysis can be done using a
consequence matrix.

(v) Consequence analysis: Event Tree Analysis (ETA)

(a) When applied:

ETA is useful for evaluating the likelihood or frequency of an event that can
occur in a large number of ways. It is also a method of describing how an
undesirable event may occur in terms of individual, non-hazardous
component, or operator failures.

(b) Quantitative technique:

ETA can be quantified or not quantified

(c) Advantages:
The method is systematic and thorough

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(d) Disadvantages/Limitations:
Time consuming and expensive due to the fact that it requires expert input.
Complex ETAs can be a few thousand pages long.

4.1.3 Value judgement

Having established the risk that a hazard poses to the organisation, the decision
has to be made whether the risk is acceptable or not. This is often an extremely
difficult decision to make, for example when it involves lives. Consider that, even
with existing control measures, four people die on average at a particular
railroad crossing, or, on average, 2 000 workers are fatally injured each year in
South Africa, or the chances of contracting Aids during a blood transfusion due
to contaminated blood is, for argument's sake, 1 in 10 000 is this risk
acceptable or not? And furthermore, how much should be spent to save a life?
Or is there no limit?

When considering risk tolerability, all risks fall into one of three categories in
terms of the "As Low As Reasonably Practical (ALARP)" point of view:
Negligible the level of risk is negligible and nothing further needs to be
done to mitigate the risk.
ALARP something has to be done to reduce the risk to an acceptable
level, or if nothing further can be done, the risk is tolerated only if the benefit
is highly desired (e.g. in the case of parachuting). Despite the control
measures, such as an emergency parachute, the risk of getting killed during
a jump is still very high, but, because the thrill of parachuting is sought after
by certain people, they are willing to accept the risk.
Unacceptable the risk is unacceptably high, regardless of the benefits
gained from taking the risk, e.g. the example of the mining of Richards Bay
sand dunes referred to earlier. The risk of permanently damaging the
ecosystem was perceived to be unacceptably high, despite the benefits of
foreign capital income and employment.

The three categories can best be explained by the Health and Safety Executive
of the UK, as shown in the model in figure 4.6.
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Levels of risk and ALARP

Intolerable
level
(Risk cannot
be justified on
any grounds)

TOLERABLE only if risk

reduction is impracticable
The ALARP region or if cost is grossly dispropor-
(Risk is undertaken only tionate to the improvement
if a benefit is desired) gained.
TOLERABLE if cost of reduction
would exceed the
improvement gained.

Broadly accepted region

(No need for detailed NEGLIGIBLE RISK
working to demonstrate ALARP)

Figure 4.6 Levels of risk and ALARP

South African legislation refers to the phrase 'as far as reasonably practicable'
and provides criteria that has to be considered in order to establish whether
everything as far as reasonably practicable has been done. This is also related
to knowledge about the risk, available resources, etc.

In terms of public safety, some countries have legislated the parameters in

financial terms of what can be regarded as reasonably practicable to spend on
mitigating risk to prevent a fatality. For example, if a particular risk exposure, for
example a release of ammonia gas from a plant, has the potential to kill 100 or
more people per year, and supposing that legislation specified that up to R10
million per life saved is reasonably practicable, the organisation could spend up
to: 100 (lives saved) X R10 million, equalling R1 billion. If the company is not
able to spend so much money, they would have to obtain special permission to
continue and the possibility may exist that the risk may be classified as
'unacceptable'. As a result the company in question would not be allowed to
continue with its business.

The concept of 'as low/far as reasonably practicable' has also been used to
prove that it is not reasonable to expect an organisation to spend more money
on a particular risk exposure. One such example is British Rail in the UK, which
had a problems with train coach doors. When passengers leaned hard against
these doors, they would open automatically. A fail-proof door was designed, but
to replace all doors would have cost in the order of 8 million per life saved, and
it was argued that that the money could be better spent elsewhere.

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4.2 QUESTIONS FOR SELF-EVALUATION

4.2.1 Explain the importance of risk assessments.

4.2.2. List and describe five hazard identification methods.

4.2.3 List the factors to consider when conducting the following

consequence analysis techniques:

Effects on people
Business interruption

4.2.4 Discuss the concept of ALARP.

4.3 REFERENCES
Bird, F.E. & Germain, G.L. 1992. Practical Loss Control Leadership.
2nd revised edition. Atlanta: International Loss Control Institute.

Valsamakis, A.C., Vivian R.W. & Du Toit, G.S. 1992. The Theory and Principles
of Risk Management. Pietermaritzburg: Interpak.

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NOTES

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CHAPTER 5

CHAPTER 5
RISK CONTROL

CONTENTS PAGE

LEARNING OBJECTIVES ................................................................. 75

5.1 INTRODUCTION .................................................................. 75

5.1.1 Loss control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

5.1.2 Risk control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77
5.1.3 Physical risk management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 77

5.2 THE OBJECTIVES OF RISK CONTROL ................................... 78

5.2.1 Risk control decision theory .................................................... 78

5.3 THE PRINCIPLES OF RISK CONTROL .................................... 82

5.3.1 Terminate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
5.3.2 Transfer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 83
5.3.3 Tolerate . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84
5.3.4 Treat . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 84

5.4 GENERIC RISK CONTROL SYSTEMS ..................................... 86

5.4.1 Leadership and administration . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 86

5.4.2 Planned inspections . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
5.4.3 Critical task analysis and procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 87
5.4.4 Incident investigation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 88
5.4.5 Task observations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
5.4.6 Emergency preparedness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
5.4.7 Risk control rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 89
5.4.8 Knowledge and skill training . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
5.4.9 Systems self-evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 90
5.4.10 Engineering and change management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
5.4.11 Personal communications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
5.4.12 Group communications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
5.4.13 General promotions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 91
5.4.14 Hiring and placement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92
5.4.15 Materials and services management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92

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5.5 SPECIFIC SYSTEMS ............................................................ 92

5.5.1 Safety . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 94
5.5.2 Quality assurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
5.5.3 Environmental management . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
5.5.4 Crime prevention . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 95
5.5.5 Maintenance systems . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
5.5.6 Legal liability . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 96
5.5.7 Contractor control . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 97

5.6 QUESTIONS FOR SELF-EVALUATION .................................... 97

5.7 REFERENCES .................................................................... 98

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LEARNING OBJECTIVES
After you have studied this chapter, you should be able to discuss:

CHAPTER 5
the general principles that are applied in designing risk control systems
the specific systems available to control risks

5.1 INTRODUCTION
From the risk management model referred to earlier in this study guide it is
clear that two main methods are applied to manage risks: financial and non-
financial methods. Financial methods such as insurance are well defined. Non-
financial methods have traditionally been fragmented within the organisation in
the form of safety, quality, fire, security departments, etc. Even worse, not even
the risk control and risk financing (e.g. insurance claims) departments were
working together. Understanding the origins of risk control assists in gaining a
better perspective of some of the current thinking.

It is believed that Frank Bird is one of the pioneers of modern thinking on the
principles of safety management and loss control, and that his views and
research have made a significant contribution towards understanding the
principles of risk control. In his book Practical Loss Control Leadership Bird
describes the development of safety management over the years, eventually
expanding the scope of 'safety' management to what he termed 'loss control'.

This evolution started with the prevention of injuries. During the Industrial
Revolution, workers had to work under appalling working conditions with no
sanitation facilities, unguarded heavy machinery, etc. As a result injuries and
fatalities occurred frequently. In 1802 England introduced the Factory Act and
about 80 years later Germany was the first country to introduce a Workmens
Compensation Law. This all added to the emphasis on the prevention of injuries.

"In the mid-1900s, books and journals began to emphasise 'safety

management', a systems approach to accident prevention and control, as well
as management professionalism; a clear movement beyond the strictly injury-
oriented concept of safety toward a broader accident-oriented approach where
accident definition included property damage and safety evolved from 'free from
injuries' toward 'control of accidental loss'. It was realised that most damage
accidents has significant potential to injure and kill people and that from a
financial point of view, not only is damage to property extremely expensive, but it
outweighs the financial loss due to injuries by far." (Bird & Germain, 1992:8)

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Starting in the 1950s, the Lukens Steel Company in the USA led the way to
industrial property damage control. Their system was developed over years and
was published in 1966. The significance of their system was summarised by
Harry van der Vord of the British Iron and Steel Federation and William J Shaw
of the British Iron and Steel Research Association, who wrote in their report
after a visit to Lukens Steel Company:

" Safety, quality, productivity and cost control were regarded as the four main
avenues of approach to the single objective of efficient operations. It was the
belief that these four aims were not conflicting but complementary; that they
ought not to be pursued independently but as an inseparable part of a united
effort." (Bird & Germain, 1992:9)

The principles of professional management were also developed, and in

Management Guide to Loss Control (1974:154) Bird described the application
of professional management principles to safety. Other significant emphases in
his book included the following:
The application of professional management principles to safety and also to
production, quality and cost control.
The new cause-and-effect sequence, citing "lack of management control" as
the first step toward losses.
Application of the I-S-M-E-C system of management control to all types of
loss incidents involving people, property, productivity and profitability.
Broadening the view from 'unsafe' to substandard (e.g. unsafe acts versus
substandard acts and unsafe conditions versus substandard conditions
the difference being that many acts and conditions are not necessarily
unsafe but do lead to loss).
Going beyond symptoms (unsafe/substandard practices and conditions) to
get to basic causes of problems and downgrading incidents be they
matters of safety, quality or cost of production are the same thing.
Broadening the view from the 'safe way' to the 'right way' (safe high quality
productive cost effective)
Recognition that the primary way to improve safety (and/or production;
quality; costs) is to improve the management system.

The terminology used by the different disciplines differs and efforts have been
made to standardise this. A number of important terms and definitions are
included in the 'Glossary of Terms' contained in chapter one. Some of the more
commonly used terms are examined below.

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5.1.1 Loss control

As can be seen from above, safety originally focused on injury prevention, and

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was later expanded to include all 'accidental loss'. Safety can be defined as
follows:

"Safety is the control of accidental loss"

Eventually the term 'loss control' was developed. Bird (1992:43) defines loss
control as follows:

"Loss control is anything done to reduce loss from the pure risks of business."

The author (1992:43) defines loss control management as follows:

"Loss control management is the application of professional management skills

to the control of loss from the risks of business."

As will be seen in the definition of risk control, loss control and risk control are
very similar. However, in South Africa in particular, safety is often still perceived
to be the "prevention of occupational injuries and diseases". The term 'loss
control' is not popular, as 'loss' is regarded as being historical/after the fact.
Furthermore, 'loss' refers to only one dimension of risk, the other being
'frequency'. 'Risk control' therefore encompasses the control of both aspects.
'Risk control' is therefore seen to be the more appropriate term.

5.1.2 Risk control

Risk control can be defined as follows:

"Risk control is the development, implementation, monitoring and upgrading of

appropriate levels of control measures for the control of identified and assessed
pure risks, aimed at reducing the frequency and consequences of the adverse
effects of pure risk."

5.1.3 Physical risk management

'Physical Risk Management' is another term used in South African literature to
denote the non-financial methods for treating risk. (Valsamakis, 1992:119) The
term is said to be conceptually broader than the term risk control, and to include
it. The more commonly used term at this time is, however, risk control.

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5.2 THE OBJECTIVES OF RISK CONTROL

Having assessed the risk facing a company, the decision has to be taken on how
to control these risks, where appropriate. The risk control system is directed at:

- reducing the frequency of the loss-producing events

- reducing the consequences/magnitude of the loss

In controlling risk, it is firstly important that, in principle, risk control measures

should be aimed at controlling the 20% of the risk exposures that have the
potential to cause 80% of the losses. This again stresses the point that risk
assessment has to be conducted in order to establish what risks fall in the 20%
category; that absolute safety is not feasible and that zero risk is unachievable.

5.2.1 Risk control decision theory

Deciding what risk control measures should be applied, can be a daunting task.
The decision will be influenced by the risk management decision criteria
described in chapter 2, par. 2.3. These include risk aversion, cost benefit, policy
and authoritative factors. There are numerous methods that can be applied to
aid decision making and the following examples are briefly discussed in this
section:

1. Risk analysis
2. The maximum rule
3. The maximax rule
4. The minimax regret rule
5. The expected value rule
6. Decision trees
Risk analysis

Due to the fact that the level of risk is directly influenced by risk control
measures, it is possible to use, for example, event tree or fault tree analysis
to calculate the effect that implementing a particular risk control measure
would have on the level of risk. This is done by quantifying the effect that
the added control measure would have if implemented and then
recalculating all probabilities in the 'tree'. This would show the reduction in
the level of risk that would be achieved.
The maximum rule

Reekie, Lingard and Cohen (1991:181) describe the maximum, the maximax
and minimax rules. In using the maximum rule, the strategy is to choose
the course of action that has the largest minimum outcome. The manager
examines each decision alternative and selects the one with the best

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minimum pay-off. Thus in the pay-off matrix shown in table 5.1 below,
where managers have three different decisions to choose from (d1, d2, and
d3), they would choose strategy d3. Strategy d3 has a minimum profit

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outcome of R30, which is larger than d1 at R10 and d2 at -R20.

States of nature

S1 S2 S3

Alternative D1 R10 R20 R90

Strategies D2 -R20 R50 R110

Decisions D3 R30 R35 R45

Table 5.1 Pay-off matrix

Essentially, the maximum rule is for decision makers who are pessimistic by
nature. It enables managers to protect themselves against the worst
possible state of nature or the economy, and to minimise their downside
loss. It is a very conservative decision. Its strength lies in situations where
the worst is almost certain to happen, and where the consequences would
be severe if not tempered in some way.

Despite its advantages, it takes no account of the probability that any one
state of nature is more or less likely to occur than another. S1 may be much
less probable than S3, in which case the pay-off will be only R45 compared
with R90 had d1 been selected. The maximum rule ignores all such pay-offs
and considers only the minimum values, without assessing probable future
states of nature or the economy.
The maximax rule

In contrast to the maximum rule, the maximax rule should be employed in

conditions that justify optimism and playing for high stakes. Here the
decision maker adopts the strategy with the highest possible profit outcome
or pay-off. Therefore, in the pay-off matrix in table 5.1 above, d2 would be
selected with a pay-off of R110.

However, as with the maximum rule, only selected pay-offs are examined in
the decision. On the occasion only the maximum values are examined and
no attention is given to the probable future state of the economy. Should S1
occur, the decision maker following the maximax rule would incur a R20
loss.

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The minimax regret rule

The object of this approach is to minimise decision makers' regret or loss

should they make the wrong decision. Like the maximum rule, it is associated
with conservatism rather than mild optimism. Regret is the difference between
the pay-off actually received and the pay-off or profit that would have been
received had the state of the economy been known in advance. Table 5.2
shows a regret matrix derived from the pay-off matrix referred to earlier.

A regret matrix contains only negative values or zeros. The zeros correspond
to the largest value in each column of the pay-off matrix. The regret for d1,
should S1 occur is -R20. Had it been known in advance that S1 would occur,
then d3 would have been chosen, with a profit of R30, rather than d1 with a
pay-off of only R10. The decision maker will have a regret of R10 - R30 = -
R20. The other values in the matrix are calculated in a similar manner.

Criticism of the minimax regret rule is similar to that levelled against the
maximum and the maximax rules: only some values (the maximum regret)
in the matrix are taken into account; no heed is paid to the probable future
states of nature; and finally, the regrets are calculated by the simple
unweighted subtraction of two pay-offs. This may not adequately reflect the
decision maker's 'true' regret. For example, if one of the pay-offs was, in
fact, a loss (for example d2 S1), then the decision maker's 'regret' might be
far greater than merely a multiple of two-and-a-half times the 'regret' of d2
S1, where the actual pay-off is a positive profit.

States of nature

S1 S2 S3

Alternative d1 -R20 -R30 -R20

Strategies d2 -R50 0 0

Decisions d3 0 -R15 -R65

Table 5.2 A regret matrix

The expected value rule

This rule has been mentioned twice in this chapter. The best strategy is the
one with the highest expected pay-off. The expected pay-off is found by
multiplying the pay-off associated with a state of the economy by the
probability of occurrence of that state, and aggregating all such products for
all the states of the economy. Probabilities can be assigned objectively or
subjectively. If this is not possible, owing to a complete lack of information,

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then equi-probability values can be awarded. If you award probabilities of

0,333 to each state of the economy, you would arrive at the following
expected values:

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expected value d1 = 0,333 (R10) + 0,333 (R20) + 0,333 (R90) = R40
expected value d2 = 0,333 (R-20) + 0,333 (R50) + 0,333 (R110) = R46
expected value d3 = 0,333 (R30) + 0,333 (R35) + 0,333 (R45) = R36

By this criterion, d2 is the best strategy. Strictly speaking, the expected

value of R46,66 is the mean profit that would be received in the long run if
an indefinitely large number of decisions had to be taken, given unchanged
pay-offs and probabilities. One-third of the time a R20 loss would be made,
one-third of the time a R50 profit, and in the remaining third a R110 profit.
With time, however, this would average out at R46,66.

However, although all information is taken into account using this rule, the
implicit assumption is that similar conditions will be repeated and that the
weighed average or expected value will appear in the long run. This is not
realistic, and there is no reason why any decision situation should replicate
this hypothetical average. It may well be that for the one occasion in
question an optimistic or pessimistic approach would be appropriate.
Nevertheless, with time decisions made by this rule may tend to average out
in the decision maker's favour.

These four decision tools chose, as 'optimal' strategies, d3, d2, d1 and d2
respectively. With other information, this disagreement might have been
lesser or greater. However, the differences highlight that the way in which
'optimal' is interpreted depends on the decision makers attitude to risk,
his/her objectives and circumstances, and on the available information.
Decision trees

The various choices that exist, can be shown as a decision tree. For
example, a risk manager may have to decide whether or not to install a
standby transformer. If he/she does, the cost is R40 000. However, if the
operating transformer fails, no loss is suffered. If he/she does not, and the
operating transformer fails, a loss of profit of R1 million occurs. This is
illustrated in figure 5.1 below:

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Fail
- R40 000
0,005
y
db
an No failure
a ll st
Inst - R40 000
0,995
Install
Install
transformer
Transformer
Do Fail
ins no
tal t - R1 000 000
l st
an
db 0,005
y

No failure
-0
0,995
The failure frequency is 0,005

Figure 5.1 A decision tree

The minimax, maximum minimax regret and EMV can be determined from the
tree.

The EMV, for example, is - 40 000 (0,005 + 0,995)

(installed) - 40 000

EMV (not installed), - 0,005 X -1 000 000

- 5 000

5.3 THE PRINCIPLES OF RISK CONTROL

One of the most common reasons for the ineffectiveness of risk control systems,
is that an integrated system integrated into every aspect of business has not
been developed or implemented. The risk control system should contain all
elements of the 'risk management loop' referred to in chapter 1. This 'loop' or
system has a 'built-in' self-monitoring system of performance measurement, i.e.
it measures the extent to which the organisation and its employees comply with
the required systems and standards that have been developed to manage risk.
The risk management loop is once again shown in figure 5.2 for further
discussion.

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CHAPTER 5
Analyse
risk
Value
judgement
V

Develop risk
I Identify
hazards
control and
finance methods
D

Measure
(audit)

Evaluate
results M
E

Figure 5.2 The risk management loop

There are four options that can be applied in controlling risk, and these are also
known as the four Ts:
Terminate the risk exposure
Transfer the risk
Tolerate the risk exposure
Treat the risk exposure

5.3.1 Terminate
Although not often possible, the first option that you should consider after
completing the risk assessment is whether the risk exposure can be terminated
by, for example, not purchasing a particularly hazardous substance at all,
discontinuing a particular product, or shutting down a production line, plant or
even a company such as an asbestos mine.

5.3.2 Transfer
A risk can be transferred to a third party by contracting it out. An example is that
if a component of the company's product is made from asbestos, a hazardous
substance, the manufacturing of the component can be contracted out. In the

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process the contractor takes over the risks attached to processing asbestos and
delivers the completed component which is sealed and without risk to health.

5.3.3 Tolerate
Some risks may fall in the category of 'negligible', or low enough/acceptable. In
such cases any/further action to reduce the risk is not justified, and it is therefore
tolerated. Sometimes it may be more expensive to control the risk than to carry
the potential loss that could result from the exposure. In that case the risk would
be tolerated.

5.3.4 Treat
Most of the time risks are 'treated'. Treating risk implies reducing the risk to a
level that would be acceptable. In terms of treating risk, there are a number of
options available:

There are three stages at which control can be exercised:

(i) before the incident occurs, referred to as the 'pre-contact' or 'pro-active' stage,

(ii) as the event occurs, referred to as the 'contact stage', and

(iii) after the event/incident, referred to as the 'post-contact stage'. This can
best be explained through the loss causation model shown in figure 5.3.

LOSS CAUSATION MODEL

Incident/ Loss/
Inadequate Basic Immediate
control causes causes Accident Injury/
Damage,
Personal Substandard etc.
Inadequate:
Programme factors acts
Standards Substandard
Compliance Job conditions
factors

PRE-CONTACT STAGE OF CONTROL CONTACT POST-

STAGE OF CONTACT
CONTROL STAGE OF
CONTROL

Figure 5.3 The loss causation model

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Pre-contact stage of control

This is the most fruitful stage of control and the only pro-active stage, as it

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is aimed at preventing losses before they occur. It must be clearly
understood that:
these measures are aimed at preventing losses/incidents, and that it is
not guaranteed that losses will not occur at all. The overall objective of
risk control remains that of reducing the frequency and magnitude of
losses resulting from exposure to pure risk.
secondly, it may sometimes not be cost effective to attempt preventing
the loss/incident in the first place. Effectively, the decision can only be
made once a risk assessment has been done.

Examples of the systems for preventing loss include the following:

Training of personnel being taught how to use equipment is a
preventive type of control measure, as it teaches the operator what to
do and not to do in order to operate the equipment safely and
productively in producing quality products. Therefore, the basic cause
the personal factor known as lack of knowledge is eliminated. In turn,
this eliminates the possibility that the person would perform a
substandard act due to lack of knowledge. Other examples include the
following:
Rules
Procedures
Engineering design

As mentioned earlier under this point, no control measure is infallible. Even

after being trained, and with years of experience, people still make mistakes
that result in incidents. Furthermore, it may not always be practically
possible or financially justifiable to prevent a loss/incident. The next stage at
which there is opportunity for control is the point at which the incident takes
place, as discussed under the next heading.
Contact stage of control

In terms of losses of a physical nature, such as injury, illness and damage,

a transfer or contact with a source of energy takes place. This creates a
number of opportunities in terms of reducing loss size. These are described
in Practical Loss Control Leadership (Bird & Germain, 1992:35):
Reducing the amount of energy transferred, e.g. substitution of
alternate forms of energy forms or less harmful substances, such as
less toxic solids, liquids, vapours or gases.

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Reducing the amount of energy used or released, e.g. prohibiting

running in the workplace, and using low-voltage, low-pressure or low-
temperature equipment.
Placing barricades or barriers between the source of energy and the
people or property, e.g. using personal protective equipment (an
example in this regard is eye protection for grinding operations: the
spectacles are damaged every time a spark strikes the lenses, and
sooner or later you would have to replace it, but the loss is negligible
compared to the loss of an eye).
Modifying contact surfaces, e.g. adding bumper guards to a structure
where vehicles are used in-house.
Strengthening the body or structure, e.g. case-hardening of tool parts
such as cutting edges.
Post-contact stage of control

The aim of the post-contact stage of control is to recover from the incident
as quickly and economically as possible. These measures do not prevent
any losses, only reduce them. These control measures include the
following:

- Emergency preparedness and disaster recovery plans

- Rescue operations
- Effective cleanup of spills and leakage
- Incident investigation

5.4 GENERIC RISK CONTROL SYSTEMS

The majority of risk exposures can be controlled through one or more of the
following systems. It is again stressed that, in order for any control measure to
be effective and to remain effective, a system needs to be developed. Systems
differ from programmes in that programmes have a defined beginning and
end/completion, whereas systems have a defined starting point but becomes a
never-ending loop of continuous monitoring and improvement. This continuous
loop is depicted in figure 5.2 above.

5.4.1 Leadership and administration (Control measure at the

pre-contact stage)
Management personnel are responsible for controlling risk and therefore need to
understand the principles of risk and their role in controlling risk. The curriculum
for management degrees and diplomas do not include safety or risk control, although
it is commonly accepted that management is responsible for safety. Management

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personnel and people in leading/advising roles therefore need to be taught the

principles of managing risk by attending training courses to learn the principles
and methods for controlling and managing risk. In terms of the risk

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management loop, the training needs first have to be identified, after which
training takes place. The relevant training is reviewed and updated periodically,
and retraining/update training is presented as necessary.

Management roles and responsibilities for controlling risk have to be clearly

identified and communicated similar to financial/budget control, personnel
management, production control and other management responsibilities.
Management performance standards for controlling risk should be established
and measured in the same way as other measurements of performance.

5.4.2 Planned inspections (Control measure at the pre-contact

stage)
Planned inspections are valuable in three ways:
Hazard identification as discussed in chapter 3.
Compliance monitoring inspecting to monitor compliance with rules,
legislation, standards, etc. Deviations identified during the inspection are
referred to as 'substandard acts/practices' and 'substandard conditions' and
are, in terms of the loss causation model, identified as immediate causes of
incidents. This implies that basic causes for these deviations already exist
and that they exist due to inadequate systems, standards or compliance to
standards.
Loss identification it is not unusual to identify losses during an inspection.
These may include a damaged fire extinguisher, broken window,
substandard quality product, etc. These should have been reported and
investigated as incidents, but often were not.

5.4.3 Critical task analysis and procedures (Control measure at

the pre-contact stage.)
The system involves the systematic identification of tasks and activities
performed by employees, by compiling task inventories, reviewing legislation,
etc. A risk assessment is done to identify critical tasks and these tasks are
analysed to identify logical task steps, risk exposures for each step and the
control activities for each of the steps. It is vital to conduct the analysis, as the
information is then used to compile the procedure. A procedure must contain
for each of the steps what is to be done (task step), how it is to be done
(control measures), and why it is to be done according to the prescribed method

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(risk exposures). The procedures must be used for training purposes, task
observations, incident investigation, etc.

5.4.4 Incident investigation (Control measure at the post-

contact stage)
When an incident occurs, basic causes already exist in the organisation due to
systems that have failed to control/eliminate those basic causes. Unless
thorough investigation is done, those basic causes will continue to exist and in
all probability result in another incident; one does not know when or what the
consequences/loss severity would be the end result of an incident is mostly
dependent on luck. Employees often regard themselves as having been 'lucky'
not to have been injured/involved in an incident, and perceive incidents as fate
and not something that can in fact be prevented. Involving employees in incident
investigations helps to change their perceptions when causes are identified and
positive action taken to eliminate these.

There are two major stumbling blocks in achieving an effective incident

investigation system:
The incident must first be reported before it can be investigated. Often
personnel policies in organisations prescribe punishment for persons
involved in 'causing' incidents, and therefore discourages reporting because
of fear of reprisal. Such personnel policies are often designed by people
with limited/no understanding of the causes of incidents. This is linked to
the next stumbling block.
Most incident investigations identify only immediate causes for incidents, as
this is usually not difficult to determine through eyewitness interviews, etc.
The result is that a 'culprit' is identified, and this person is punishable for
having done something wrong. However, if the person did something wrong
due to inadequate training, or due to the poor design of the equipment, who
is actually to blame? ISO 9000, ISO 14000, and almost every other system
requires the reporting of incidents. In ISO 9000 it is referred to as 'non-
conformances', and then there are 'environmental impact', injuries, damage,
production losses, etc. These losses are all the end result of the same
causes one incident, e.g. a transformer that explodes, can result in
injuries, fire, damage, non-conformances in terms of a poor quality product,
environmental impact/pollution, etc. It is therefore possible to apply the
same investigation technique for the investigation of all of these loss types.

The emphasis should therefore be on constructive and systematic identification

of immediate causes; for each of the immediate causes, more basic causes
have to be identified, and for each basic cause, the system that has failed to
control it adequately to prevent the incident in the first place, should be

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identified. Changing the system would have long-term results, as the basic
cause/reason for the existence of the substandard condition, or the substandard
act, would be eliminated.

CHAPTER 5
In terms of the above discussion, it should be clear that incident investigation is
based on the principles of the loss causation model. Furthermore, effective
incident investigation techniques have to be taught to those responsible for
investigations. Incident investigations are powerful in identifying shortcomings in
the organisation.

It is furthermore vital to calculate loss values. Very few organisations have

effective reporting systems, mostly due to the above reasons. Because of this,
few managers know what incidents are costing the organisation.

5.4.5 Task observations (Control measure at the pre-contact

stage)
Task observation is an effective method to determine the adequacy of
procedures, knowledge and skills training, etc. It can also be applied to aid
hazard identification or information-gathering for task analysis. The system
requires the training of supervisory personnel in the techniques of task
observation, observing the employee performing the task according to the
procedure at hand, and identifying any deviations from the procedure.
Deviations must then be investigated again on the basis of the principles of the
loss causation model and action taken to eliminate the basic causes for the
deviation observed.

5.4.6 Emergency preparedness (Control measure at the post-

contact stage)
An emergency preparedness system requires the systematic identification of all
types of emergencies that may arise: severe injuries/fatalities, major fire,
flooding, toxic substance release, computer system failure, etc. Plans are
developed, the necessary equipment is purchased and emergency drills are
practised so that when the emergency occurs, personnel will be performing their
functions almost 'automatically'. During these practice sessions, deviations and
problems are observed and corrected.

5.4.7 Risk control rules (Control measure at the pre-contact

stage)
In contrast to task analyses and procedures, the risk control rules are both task
specific and general. The rules are prescriptions for employees on how to
prevent incidents, comply with legislation, etc. In terms of the risk management

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loop, it is often the case that compliance monitoring/auditing is not done on a

regular basis, with the result that non-compliance is identified only when an
incident has occurred. It is therefore vital to regularly monitor rule compliance.

5.4.8 Knowledge and skill training (Control measure at the pre-

contact stage)
Training must be one of the most powerful tools in controlling risk. Personnel
have to be taught the following:

- Knowledge
- Skills

An example in this regard is training to operate a forklift or other mobile

equipment. Firstly, knowledge is acquired on how to operate and maintain the
equipment. Then skill is acquired through supervised practice.

Furthermore, personnel have to be taught about the hazards/risks they are

exposed to and how to control these risks.

In order to be effective, training needs to be a structured process. It should not

be a case of training for the sake of training. Applying the 'risk control loop' to
training would imply that training needs would first have to be established. The
information from the risk assessments could, for example, serve as a solid base
for determining training needs.

5.4.9 Systems self-evaluation (Control measure at the pre-

contact stage)
All things deteriorate if they are not maintained properly. This applies to risk
control systems as well. As discussed under the risk management process,
specifically under performance measurement, a formal, unbiased measurement
has to be performed periodically in order to determine the status of compliance
to own standards. This boils down to a self-examination. There are a few
'measuring tools' that can be used. These include the International Safety
Rating System (ISRS) from DNV, the Management by Objectives from NOSA,
the Mine Safety Management System from the Chamber of Mines, etc. Other
internal evaluations that are conducted include financial audits, evaluation of the
environmental management system by using the International Environmental
Rating System (IERS), evaluation of the quality management system by using
the International Quality Rating System (IQRS), evaluation of the maintenance
management system by using the International Maintenance Evaluation System
(IMES), or even evaluating crime prevention efforts by using the International
Crime Prevention Evaluation System (ICPES), fire surveys, etc.

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5.4.10 Engineering and change management (Control measure

at the pre-contact stage)

CHAPTER 5
The first consideration in treating risk should be in engineering control
measures, i.e. designing or upgrading control measures in
equipment/plant/machinery, as opposed to changing worker behaviour, for
example. Engineering and change management applies to the following:

- Concept to engineering design

- Construction
- Commissioning
- Operational changes
- Decommissioning

Again, the risk management process should be followed by first conducting a

risk assessment in order to determine the extent of the control measures that
are required, setting standards, etc.

5.4.11 Personal communications (Control measure at the pre-

contact stage)
Effective communication systems within an organisation are vital to ensure the
continued existence of the organisation. These include conveying assignments,
directing personnel, conveying grievances, educating staff, etc. Personal
communication involves regular, planned and formal communication between
supervisor and subordinate, on a one-to-one basis, on risk control matters. It
also involves formal orientation of new and transferred employees.

5.4.12 Group communications (Control measure at the pre-

contact stage)
The group communications system is a two-way communication channel
between top management and shop floor employees, through the various
organisational levels. It ensures that concerns and hazards are communicated
to the appropriate level where they can be solved, and that top management
communication reaches the shop floor.

5.4.13 General promotions (Control measure at the pre-contact

stage)
Increasing awareness on specific risk control measures, may require special
campaigns from time to time. Through the use of competitions, slogans, bulletin
boards, banners, etc., awareness on safety, quality, road safety, etc. is increased.

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5.4.14 Hiring and placement (Control measure at the pre-contact

stage)
Also referred to as personnel selection, this function is normally performed by
the human resources/personnel department. The objective of the system is to
identify and appoint only personnel that are mentally and physically capable of
performing the work in the position applied for, thus reducing the risk of the
person making mistakes due to ignorance, low productivity, etc. Mental
capability refers to knowledge and skill requirements and physical capability
refers to the physical demands of the job. In order to establish what physical
demands will be made on the person, a physical capability analysis will have to
be performed on the position applied for, identifying factors such as exposure to
occupational hygiene stresses.

5.4.15 Materials and services management (Control measure at

the pre-contact stage)
Bringing new equipment and substances into the organisation, potentially also
brings new hazards and risks. Thus, before the purchasing is done, a risk
assessment is performed to identify the hazards and then to decide on
appropriate control measures before purchasing commences.

5.5 SPECIFIC SYSTEMS

The systems referred to above are largely generic and are used to control most
of the pure risks that an organisation is exposed to. In addition to the above, a
number of specific systems have been developed. These systems are
associated with specific disciplines in the control of risks, such as safety, quality,
etc. These systems therefore focus on controlling only a limited range/type of
pure risks. The systems will be referred to briefly and not discussed in great
detail. The relationship/difference between the generic and specific systems can
best be described by table 5.3 below.

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 SAFETY & ENVIRONMENT QUALITY CRIME MAINTENANCE LEGAL LIABILITY
HEALTH

Health and hygiene Environmental Customer Access and egress Proactive/ Control and
Special safety programmes satisfaction control prolongation direction
systems inspection Performance Post sales service Records programme Uniformity
Work permits monitoring Production Personnel Predictive Casual
Personal protection Environmental process controls protection programme employees
Off-the-job safety assessment Quality inspection Information Preventative Trade union
Community and testing protection protection involvement
relations Quality results Fraud Hidden failure Medical programme
Permit to operate Support services Assets in transit finding task Compliance with
Hazard issue Employee crime programme legislation
identification Riots and strikes Administration Legal liabilities
Sabotage Preventative
Vandalism decision making
Computer crime strategies
Off-the-job security Damage/corrective
programme
Quality control
maintenance
optimisation

GENERIC SYSTEMS
Leadership and administration Systems self-evaluation
Planned inspections Personal communications
Critical task analysis and procedures Group communications
Task observations General promotions
Incident investigation and analysis Hiring and placement
Emergency preparedness Engineering and change management
Risk control rules Materials and services management
Knowledge and skill training Knowledge and skill training

Table 5.3 Specific systems vs. generic systems

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5.5.1 Safety
Traditionally, safety has included the disciplines of occupational health,
consisting of occupational hygiene and occupational medicine, fire prevention
and protection, property damage and occupational injuries. Each of these
disciplines has developed its own systems and methods to identify hazards and
control risk exposures which are essentially based on the same principles.
The fact remains that each of these disciplines requires specialist knowledge.
These disciplines and/or systems are briefly discussed below:

(i) Occupational health

Occupational hygiene

Occupational hygiene deals with the effects that the working environment
can have on people. The effects are caused by three categories of
stress factors that have to be assessed and for which control measures
have to be developed to reduce the risk. The last resort in controlling
the hazards is the use of personal protective equipment, such as
respirators, etc. The three categories of workplace stresses are:

- Biological stresses
- Chemical stresses
- Physical stresses
Occupational medicine

Occupational medicine deals with the monitoring of the biological effect

that workplace stresses have on the human body, and is therefore
closely related to occupational hygiene. Occupational medicine usually
also involves treatment of occupational injuries and diseases.

(ii) Fire prevention and protection

Fire prevention is a critical discipline in the control of catastrophic loss a

single fire could bankrupt a company. Prevention and control of fire and
explosion are covered by this discipline.

(iii) Occupational safety

Occupational safety normally includes occupational health. Occupational

injuries result from contact with substances and sources of energy. Specific
systems include the following:

- Work permit systems (hot work/cold work, etc.)

- Road/vehicle safety
- Personal protective equipment

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- Special safety systems inspections

- Off-the-job safety

CHAPTER 5
5.5.2 Quality assurance
The quality assurance/management system is aimed at reducing the risk of
producing substandard quality products, or rendering substandard quality
service. Many definitions for quality management have been compiled, such as
'conformance to standards' in terms of ISO 9000 requirements. ISO 9000 has
become, to a large extent, the international standard for recognition of quality
management, and to this end many South African companies had to obtain ISO
9000 certification before companies from other countries were prepared to do
business with them.

Specific quality management systems include the following:

- Customer satisfaction
- Post-sales service
- Production process controls
- Quality inspection and testing
- Quality results
- Support services

5.5.3 Environmental management

Until recently environmental management was perceived to be the subject of
'environmental fanatics' from the Green Peace movement. This has changed to
the point that in Europe today, it is said that society can still forgive when a
disaster kills a number of people, but damaging the environment is not easily
forgiven or forgotten. Similar to ISO 9000, a code ISO 14000 was developed
for environmental management. Especially in terms of the chemical and
petrochemical industry, more international organisations are demanding ISO
14000 certification from organisations that want to do business with them.
Systems that are specific to environmental management include the following:

- Environmental programmes
- Performance monitoring
- Environmental assessment
- Community relations
- Permit to operate

5.5.4 Crime prevention

Other than safety and environmental management that are supported by a moral
obligation from the organisation, crime prevention in an organisation is aimed

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purely at reducing losses losses from stock shrinkage, fraud, sabotage, etc.
There has been much dependency on financial auditing and security measures
in the form of guards, fences and police to control losses, and, it may be added,
with limited effect. Systems have been developed to assess potential for crime
within an organisation in terms of, for example, fraud. Apart from the generic
systems, other specific systems that can be implemented to control crime risk
exposures include the following:

- Access and egress control

- Records
- Personnel protection
- Information protection
- Fraud
- Assets in transit
- Employee crime
- Riots and strikes
- Sabotage
- Vandalism
- Computer crime
- Off-the-job security

5.5.5 Maintenance systems

Maintenance is aimed primarily at reducing the risk of premature/unexpected
failure of equipment. The international market has reduced the chances of
survival of organisations that sell poor quality equipment and machinery, but it
still remains a critical function to maintain equipment to ensure maximum return
on investment. Systems specific to maintenance management include:

- Proactive/prolongation programme
- Predictive programme
- Preventative programme
- Hidden failure finding task programme
- Administration
- Preventative decision-making strategies
- Damage/corrective programme
- Quality control maintenance optimisation

5.5.6 Legal liability

Liability will be discussed in greater detail in later chapters. It would suffice to
say at this point that liability is not the event itself, but the consequence of an
event. However, it is possible to determine the potential for liability before it
occurs and thus develop control measures to reduce the risk or, in some cases,

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to take out insurance. There are a number of actions and systems that assist in
reducing legal liability:

CHAPTER 5
- Control and direction
- Uniformity
- Managing casual employees
- Trade union involvement
- Medical programme
- Compliance with legislation

5.5.7 Contractor control

World-wide, the tendency is towards what is known as 'outsourcing' contracting
out most activities that are not part of the 'core business' of the organisation.
Accommodation, catering and transport are a few examples. There are very
good reasons for doing so, but outsourcing brings with it its own set of risk
exposures. Over and above the application of the generic risk control systems,
specific risk control systems have been developed, including the following:
Contractor selection and approved vendors listing
Contracts

The control system would involve a number of disciplines from the organisation
such as the safety, environmental, quality and legal specialists in controlling
contractors. Auditing contractors on their control systems is vital to measure the
extent to which they control their risks, as it would have a direct effect on the
organisation if the contractor suffers a major loss or goes bankrupt as a result.

5.6 QUESTIONS FOR SELF-EVALUATION

5.6.1 Explain the difference between loss control, risk control, physical risk
management and risk management.
5.6.2 Explain what is meant by risk control decision theory and discuss the
methods given in the study guide.
5.6.3 Discuss the four options that can be applied in controlling risk.
5.6.4 Explain the stages where control can be applied in managing risk and
give an example of each.
5.6.5 Discuss the generic risk control systems in detail.

5.6.6 Explain the difference between the generic risk control systems and
specific risk control systems.

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5.7 REFERENCES
Bird, F.E. 1974. Management Guide to loss control. 3rd edition. Atlanta,
Georgia: Institute Press.

Valsamakis, A.C., Vivian, R.W. & Du Toit, G.S. 1992. The Theory and Principles
of Risk Management. Johannesburg: Heinemann.

Bird, F.E. & Germain, G.L. 1992. Practical Loss Control Leadership. 2nd edition
Loganville, Georgia: International Loss Control Institute.

Reekie, W.D., Lingaard, G.S. & Cohen, M.D. 1991. Elements of South African
Business Finance. 2nd edition. Halfway House: Southern.

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CHAPTER 6
RISK FINANCING

CONTENTS PAGE

LEARNING OBJECTIVES ................................................................ 100

6.1 INTRODUCTION ................................................................ 100

6.2 RISK AS A FUNDING PROBLEM .......................................... 101

6.2.1 Loss sizes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 101

CHAPTER 6
6.2.2 Consequential losses arising out of damage to company assets . . . 102
6.2.3 Financial losses arising out of damage to third party assets . . . . . . . . 103
6.2.4 The indemnity period . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103
6.2.5 Long tail losses loss of market share . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 103
6.2.6 Determining the loss . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104

6.2.6.1 A decrease in income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104

6.2.6.2 An increase in expenditure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104
6.2.6.3 Pure financial losses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 104
6.2.6.4 The MFL, EML, and NLE . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 105
6.2.6.5 Loss probabilities and frequencies . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106

6.3 STATISTICAL TREATMENT OF RISK ..................................... 109

6.3.1 Elements of uncertainty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109

6.3.2 The law of large numbers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 109

6.4 VARIOUS STATISTICS ........................................................ 119

6.4.1 Statistic sources . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119

6.4.2 Occupational injuries and diseases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119
6.4.3 Motor vehicle accident statistics . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 119
6.4.4 Insurance market results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

6.4.4.1 The South African market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 120

6.4.4.2 The Road Accident Fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 121
6.4.4.3 The COID fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122
6.4.4.4 The American market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 122
6.4.4.5 Lloyds of London . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 123

6.5 QUESTIONS FOR SELF-EVALUATION ................................... 124

6.6 REFERENCES ................................................................... 124

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LEARNING OBJECTIVES
After studying this chapter the students should be able to:
explain risk as a funding problem
explain the statistical treatment of risk and the various statistics available
to assist in making risk financing decisions

6.1 INTRODUCTION
Risk financing can be defined as:

The provision of appropriate and adequate funds/funding measures to pay

for the losses that do occur.

Risk financing therefore, does not prevent losses it only pays for it it is a funding
issue/ problem, yet a critical component of risk management as companies go
bankrupt because of insufficient funds to pay for losses. Risk financing and more
specifically insurance theory and principles apparently have leaned more towards
the economist's view of risk as discussed in chapter 1. Statistics and the law
of large numbers play a major role.

Risk assessment is the first step in the risk management process. Risk financing,
and more specifically insurance, requires specific information to structure it. One
of the issues, for example, is that insurance policies provide cover for a specific
peril. Peril is also referred to as the incident, as the policy would cover 'losses
from the peril of fire and explosion' or 'the peril of accidental damage' or 'the peril
of storm or flood', etc. Perils, therefore have been sufficiently covered in previous
chapters as losses/loss categories. What will be discussed though, are specific
insurance policies such as fire, motor fleet, marine, etc.

Structuring a company's risk financing programme can be an extremely complex

task and falls outside the scope of this study guide. However, the fundamentals
such as loss sizes and basic funding options will be discussed.

As can be seen from the risk management model, there are two options in
financing losses:
Retention financing
Retention financing is simply paying for losses from the company's own
sources.

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External financing
External financing includes a number of options:
Insurance
Taking out an insurance policy means that one buys into a fund
After a loss has occurred, one can approach a bank, for example, and
apply for a loan to pay for the loss
Statutory funds
Statutory funds like the Compensation for Occupational Injuries and
Diseases Fund [COID]
Captive insurance company
Some of the large organisations establish their own insurance company
that funds only their owner's losses
Mutual funds

CHAPTER 6
Some groups of people, e.g. doctors, form their own fund to pay for losses.
Instead of paying premiums to insurance, the premiums are paid into a
mutual fund, which then pays for losses.

6.2 RISK AS A FUNDING PROBLEM

The law of large numbers makes one wonder whether insurance is not merely a
question of funding. It will be shown that, as the number of exposure units
increases, the average cost of events becomes so certain that one can be
confident that the premium income, based on that average, will not be exceeded
by the claim cost per unit. Then the question of risk largely falls away and the
problem becomes a matter of raising sufficient funds to cover the claims and
how to invest those funds. From this analysis, it could be argued that insurance
is, in its final analysis, merely a funding problem and not a risk problem.

Indeed, some writers such as Doherty, have successfully applied the portfolio
theory, which is so well developed and researched in the investment field to the
financial risk field, that it seems there is scope for the two fields to converge.

6.2.1 Loss sizes

Determining loss sizes is part of risk assessment, but, simply because it deals purely
with the financial consequences of risk, it is more appropriate to discuss it under
the heading of 'Risk Financing'. This has generally been one of the problems facing
risk management in organisations the risk control and risk financing departments
have traditionally not been working together and therefore conducted analyses
separate from each other, thus often duplicating work and missing the opportunity
to learn from each other. Although an integrated approach is advocated for
insurance/underwriting information requirements, there may be specific

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information that would need to be determined, that may or may not always be of
value to risk control.
As discussed in chapter one, risk has two dimensions consequence and
frequency/likelihood. These two aspects of uncertainty lend themselves to statistical
analysis. A great deal of insurance and risk management work is involved in trying
to determine statistically the relationship between the two elements.
Notwithstanding the safeguard of the 'average clause' in insurance policies, one
of the most important problems facing an insurer wishing to accept the risk of
paying for a major loss, is the size of the possible loss. For example, if the insurer
is asked to carry the risk of damage to a house due to the peril of fire, the insurer
will, naturally, want to know the value of the house. A single asset such as a house
does not pose a great problem. A large industrial company with a large number
of operations, however, does.
Take for example, the company which has three operational locations as follows:

LOCATION ASSET VALUE

Johannesburg R25 million

Durban R15 million
Cape Town R10 million

Total Value R50 million

It is quite clear from the table that the insurance company which accepts the above
risk, is exposed to a possible claim of R50 million. However, it is highly improbable
that all three operations will burn to the ground in the same year the period the
policy will be valid before it is renewed. In all probability, the largest exposure is
from the Johannesburg plant. This information is important to the insurer, since
he will arrange reinsurance cover for losses which he is not in a position to carry.
The matter is further complicated by the fact that if one visited the Johannesburg site,
one may well find that the operation consists of a number of buildings, not merely
a single building. These buildings may be separated so that it is unlikely that a
fire, starting in one building, will spread easily to another building. The insurer's
probable exposure is therefore less than the R25 million indicated by the asset
value.

6.2.2 Consequential losses arising out of damage to company

assets
From the risk manager's point of view, the most important is the consequential
loss associated with damage to company assets. For example, if an electrical

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transformer is damaged, a factory may be without electricity. The cost of repairs

to the transformer may be nominal compared to the loss of profits associated with
the loss of production. In some instances, this type of risk is referred to as
Business Interruption (BI) risk. Here, the loss is related to the damage of
the transformer which is an asset. As a general rule, if cover can be arranged
to protect the profit producing asset, then cover can be arranged for the
consequential losses, which result from damage or loss of the asset.

6.2.3 Financial losses arising out of damage to third party assets

A company can suffer losses if the assets belonging to a third party are damaged
for example, if the supply transformer belonging to the local authority is
sabotaged, the company can suffer losses due to the resultant power failure. Here,
the assets of the company have not been damaged, yet it suffers a pure financial

CHAPTER 6
loss. Since the loss is associated with damage to assets, insurance cover for
consequential losses arising out of the damage to third party property is arranged
as an extension to existing asset policies. This is arranged through what is known
as the supplier's extension, where nominated usually key suppliers are covered.

6.2.4 The indemnity period

By nature, consequential losses are time-related. In the example above, the longer
it takes to repair the damaged transformer, the greater the consequential losses.
It is clear that the insurance company cannot make payments for an indefinite
period, and it is necessary to determine a period for which the cover is required.
Furthermore, it is important to determine the period so that the exposure of the
insurance company and the insurance premium can be determined. Usually,
periods from one to two years are provided for.

It is also clear that it is not practical for the insurance company to pay compensation
for every minor business interruption. For example, it is not unusual for a machine
to be off-line for an hour or so while a minor part is being replaced. Therefore, a
minimum period is specified, usually seven days.

6.2.5 Long tail losses loss of market share

It is possible for a company to suffer long tail or permanent losses. For example,
in the consumer market, competition may be such that, while the product is off
the market, a competitor increases its market share. In this case, the absence
of the product from the market place may cause the company to suffer permanent
loss. It is an unfortunate fact that many companies become insolvent after a
major fire, even if they are fully insured.

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6.2.6 Determining the loss

It is clear that the risk manager should be concerned with the threat of a
consequential loss. However, a further problem is how to calculate the loss
which is not easy to determine.

A company functions according to the following profit equation:

Profit = Income Expenditure

If the business is interrupted, the ability to make a profit is at risk. This loss can
take place in two ways:

- the income can decrease, or

- the expenditure can increase

6.2.6.1 A decrease in income

Again, using the transformer as an example, a loss of production can result in a

loss of sales. Because of this, income is lost. When income is lost, profit is
decreased. Even if the company works overtime to make up the lost production,
it may not result in the recovery of income. For example, the company produces a
consumer product such as soap. By the time the additional product is manufactured,
the buyers in this case the retail stores may have bought the product from
another supplier.

6.2.6.2 An increase in expenditure

A loss of profits can be realised even when there is no loss of sales and therefore
no loss of income. For example, it may be possible to meet sales commitments
by working overtime, or by transporting the product from another site, or even from
another country. However, the profits will decrease, because there has been an
increase in production cost.

Obviously, the determining of the loss of profits requires a sound knowledge of

financial statements and this calculation is usually done by a qualified accountant.

Not every interruption results in a loss of profits. For example, a company may
have sufficient stocks to keep the market supplied while the damaged asset is
repaired or replaced.

6.2.6.3 Pure financial losses

It is also possible for a company to suffer pure financial losses losses not
related to damage to assets. For example, the loss of production caused by a
labour dispute. In this case, the company may suffer losses as extensive, if not
more, than damage to assets. Normally, insurance cover is not readily available
for this type of loss, and special markets must be sought.

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There are other ways in which pure financial losses can occur, for example, product
extortion. In a well-known case, a medication product was poisoned. When it
became known, the public refused to purchase any of the company's products. In
this case, the company suffered several millions in loss of sales. In another case,
in Japan, there were only threats made to poison chocolates, and as a result, the
public refused to purchase any of the company's products, and the company
faced ruin.

Many forms of product or liability claims can result in pure financial losses, which
can be a problem from a risk financing and insurance point of view.

In the majority of the cases, pure financial losses fall outside the scope of the risk
manager, but in a holistic point of view, the risk manager should share in the
information.

CHAPTER 6
6.2.6.4 The MFL, EML and NLE

In determining loss sizes, the following are usually determined.

- Maximum Foreseeable Loss (MFL)

- Estimated Maximum Loss (EML)
- Normal Loss Expectancy (NLE)
Maximum foreseeable loss (MFL)

Very little has been written on the various classes of loss and agreement does
not always exist between the various writers on the terminology used. The
terminology used here, is according to Friedlander, (1977:26 et seq.), with
the use of the EML, which finds wide acceptance in South African and
British Insurance practice.

The MFL is, as the name suggests, the largest foreseeable loss which is
reasonably conceivable. For example, if one wishes to determine the asset
MFL of a single high-rise building, in all probability it will be the value of the
building itself. It is well known that entire highrise buildings have been
destroyed by a single fire. So, unless very convincing reasons exist, the
MFL will be equal to the value of the building.

On the other hand, if a number of buildings on a site are separated in such

a way as to totally preclude the spread of fire, the MFL is not necessarily
the combined value of the buildings.

It must be emphasised that the MFL is a pessimistic forecast of the loss size,
i.e. the size of the loss if all control measures fail.
The estimated maximum loss (EML)

The EML, is the loss size if the fire defences successfully contain the fire,
i.e. the control measures operate as expected.

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A manufacturing facility may consist of a production section and storage area.

The storage area may, for example, be sprinkler protected and separated by
a firewall. The only opening between the two areas could be a doorway fitted
with an automatic fire door. Despite these precautions, it is not impossible
for the fire to break through the dividing wall. Accordingly the MFL is equal
to the total value of both areas. However, in all probability the fire defences
will operate and the fire will be contained. The EML is therefore less than
the MFL and in the example could be either the cost of the store or production
area, depending which is larger. The insurer may often be prepared to trust
the EML figure.
The normal loss expectancy (NLE)

In most situations, the loss is nowhere near the EML. For example, in general
a fire in a hotel may cause minor damage to one room, possibly only damaging
the bedspread. Or, in the case of a motor vehicle accident the damage may
be a minor scratch or dent. This type of loss size represents the NLE.
Important aspects on loss sizes

It is important to realise that loss size calculations are done for different
perils or circumstances. One can thus talk about a fire EML, an earthquake
EML or terrorist EML.

6.2.6.5 Loss probabilities and frequencies

As noted above, a loss can have various magnitudes. It could range from a few
Rand to millions. One is not only interested in the size of the loss, but also the
likelihood of the occurrence of the loss. This likelihood can be expressed in a
number of ways the most common being the frequency of loss and the probability
of loss. The difference between loss frequencies and loss probabilities is often
not realised even by some very distinguished writers.
Loss frequencies

The loss frequency is a measure of the number of times an event with

a specified outcome occurs during a defined time interval, for example,
the number of motor vehicle accidents per year per million kilometres
travelled or industrial accidents per year per million man-hours worked. The
total frequency is usually divided into class intervals. In practice, one is not
only interested in the frequency of events, but also in the consequences of
these events. Therefore events are arranged according to cost intervals.

For example, in a fleet, consisting of 601 vehicles, one is not only interested in
the number of motor vehicle accidents, but also the cost of the accidents. If
one had to analyse the loss of motor vehicle accidents, then the cost of the
loss would be arranged into class loss intervals as illustrated in the following
table:

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Class cost interval Number of accidents

R 1 - R250 6
R 251 - R500 11
R 501 - R750 20
R 751 - R1 000 8
R1 001 - R1 250 5
R1 252 - R1 500 4
R1 501 - R1 750 3
R1 751 - R2 000 2
R2 001 - R2 250 1
R2 251 - R2 500 0

CHAPTER 6
R2 501 - R2 750 1
61

From the table it can be seen that the fleet experienced 61 accidents during the
year under review. Not all accidents cost the same though, the cost has been
arranged in intervals. The tendency exists to express the figures in a graph as
depicted below. The loss tendency is clearly seen in the graph. The larger losses
are less frequent and conversely, the high frequency losses are smaller in magnitude.

Incidents

Intervals

Figure 6.1

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Using the approach above, a curve can be constructed. Such a curve is referred
to as a frequency-distribution curve. These curves can have various shapes. A
number of very well known curves exist and these have been extensively studied
in the field of statistics. If a loss pattern falls within the ambit of a known curve,
a great deal about the loss can be predicted.

The following are well known curves:

- The Binomial Distribution

- The Poison Distribution
- The Normal Distribution
- The Log Normal Distribution
- The Pareto Distribution
- The Gamma Distribution
- The Exponential Distribution

The Log Normal Distribution describes most of the usual high frequency losses
encountered in practice and the Pareto provides a good approximation.

A typical distribution curve, with the abovementioned parameters, is indicated below.

One of the most important issues the risk manager must determine, is the level
of self-funding. To illustrate the various parameters which are evaluated, the loss
distribution curve below will be used.

Incidents A B C

Interval

Figure 6.2

Area A

Area A in the above graph represents the accumulated loss due to high
frequency losses. For example, in a reasonably sized motor vehicle fleet,
this area represents the cost of the annual losses incurred. In the case of a

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machinery breakdown, this represents the normal downtime associated with

the maintenance budget expected with machinery. It stands to reason that
this cost is reoccurring and not the subject of insurance. This area represents
normal business expenses. To insure these losses would simply represent
an expensive Rand swapping exercise.
Area B

Area B, between losses 1 and 2 represents losses of such magnitude, that

they can be financed by careful application of self-funding techniques. In
the case of machinery breakdown, this represents downtimes of about one
week. The losses are substantial but not catastrophic.
Area C

Area C represents the catastrophic losses that are usually insured. In the

CHAPTER 6
case of machinery breakdown, the loss would be downtimes of six months to
three years.

Risk financing is aimed at determining where to draw the lines. If line 2 is

drawn too far to the right, the company is exposed to unnecessarily large
claims. If it is too far left, then the insurance premiums are too high.

6.3 STATISTICAL TREATMENT OF RISK

6.3.1 Elements of uncertainty

Risk lends itself to extensive statistical analysis. In any year numerous different
events, which result in losses, take place. Being events with consequences, these
are suitable for statistical analysis. The two elements of uncertainty, namely the
uncertainty of the event and of the consequence, lend themselves to a number of
different methods of representation, depending on how they are combined statistically.

The most common method is by means of a statistical distribution curve. Probably

the most common and well-known distribution, which occurs frequently in nature,
is the normal distribution.

6.3.2 The law of large numbers

One statistical theory which is of significance to the insurance industry is the so-
called law of large numbers. This theory forms the crux of insurance practice
and will, therefore, be considered in greater detail. The law of large numbers is
discussed in most texts in insurance (Diacon & Carter, 3); (Hansell, DS), and risk
management (Greene & Serbein, 25); (Doherty, 109 & 114), as well as on statistics
(Larsen, 1968:184).

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The insurance industry works on the basis that it collects income referred to as
premium income, and that claims are paid against this premium income. It refers
not only to the actual claims paid during the period, but also to provisions for
claims incurred but not reported (IBNR). The basic principle of insurance business
is that the amount received by way of premium income must exceed the amount
which is paid out in claims. The premiums statistically represent the expected
cost of the insured events plus an amount for administrative costs and profits. If,
in the long run, the cost of claims incurred exceed the amount received by way
of the premium income, the insurance company will become insolvent.

In order to remain solvent the insurance industry must, therefore, have some basis
to determine the premiums for various risks.

The premiums levied in the long-term market, that is the market which insures in
terms of life insurance policies, annuities and so forth, have been determined as
a result of actuarial work.

In the short-term market, matters are somewhat different. The premiums set in
the short-term market are not determined so much by statistical principles, but
rather, are the products of market forces. If a large homogenous sample of
events such as motor car accidents exists, the average cost per accident can be
determined. The insurance industry could base its premiums on this figure.
However the reliability of this figure can be questioned. If, for example, an
insurance company took the total amount paid on motor vehicle accident claims
and divided the figure by the number of accidents, the average cost per claim
could be determined. The question of whether the insurance company can trust
that figure as the basis of their premium calculation, may be answered by
reference to the law of large numbers.

The law of large numbers is usually illustrated by experiments involving the toss
of a coin. If one were to toss a coin a number of times and let Xn be the number
of heads observed, it seems that Xn/n should be close to one half. In other words,
one would expect the heads to turn up on average, 50% of the time. Intuitively, it
seems that the larger one becomes, the closer the calculated ratio will be to one half.

What the law of large numbers says, is that the larger the numbers involved in the
experiment, the more confident one can be that the average value determined
by those numbers is in fact the true or theoretical average. Put in another way,
the average which is calculated from observed data differs from the true average
by an ever-decreasing amount as the numbers of events increase. This can be
observed in figure 6.4.

The law of large numbers will be illustrated by means of an experiment involving

three dice. If three dice are used, the different outcomes can vary from 1 to 18
as indicated in table 6.1.

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OUTCOME WAYS A PRIORI PROBABILITY

3 1 0,0046296

4 3 0,0138889

5 6 0,0277778

6 10 0,0462963

7 15 0,0694444

8 21 0,097222

9 25 0,1157407

10 27 0,125

CHAPTER 6
11 27 0,125

12 25 0,1157407

13 21 0,097222

14 15 0,0694444

15 10 0,0462963

16 6 0,0277778

17 3 0,0138889

18 1 0,0046296

216 1

Table 6.1 Theoretical outcome of three dice

The number of ways the different outcomes can arise is shown in column 2 under
the heading Ways. Therefore, the number of ways in which the outcome of 3 can
arise is only one; and that is three 1's. Similarly the number of ways in which 18
can arise is only one, and that is three 6's. By applying the theory of combinations
and permutations one can construct column 2, showing the number of ways in
which any particular outcome can arise. The outcomes which have the maximum
number of ways, are the outcomes of 10 and 11. These outcomes can arise in
27 different ways. There is a total of 216 different ways in which the different
outcomes can arise. Knowing the number of ways in which a particular outcome
can arise and the total number of ways, one can determine the theoretical probability
of any outcome. In this way one can construct column 3 of table 6.1 indicating
the theoretical probability of any outcome.

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If the dice were thrown 206 times, one would not however expect the number of
ways to coincide with the theoretical number indicated in column 2. Therefore an
error between the theoretical and calculated averages derived from the experiment
can be determined.

This experiment was carried out for a number of throws varying from 10 to
1 000 000 using a computer simulation. The various outcomes of the
experiment are recorded in tables 6.2-6.7.

EMPIRICAL A PRIORI %
OUTCOME TIMES
PROBABILITIES PROBABILITY ERROR

3 0 0,0 0,0046296 (100,00)

4 0 0,0 0,0138889 (100,00)
5 3 0,3 0,0277778 983,03
6 2 0,2 0,0462963 332,90
7 0 0,0 0,0694444 (100,00)
8 1 0,1 0,097222 2,88
9 1 0,1 0,1157407 13,57
10 0 0,0 0,125 (100,00)
11 1 0,1 0,125 (20,00)
12 1 0,1 0,1157407 (13,57)
13 1 0,1 0,097222 2,88
14 0 0,0 0,0694444 (100,00)
15 0 0,0 0,0462963 (100,00)
16 0 0,0 0,0277778 (100,00)
17 0 0,0 0,0138889 (100,00)
18 0 0,0 0,0046296 (100,00)
10 1 216,82

Table 6.2 10 Throws with three dice

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EMPIRICAL A PRIORI %
OUTCOME TIMES
PROBABILITIES PROBABILITY ERROR

3 0 0,0 0,0046296 (100,00)

4 1 0,01 0,0138889 (27,54)
5 3 0,03 0,0277778 8,30
6 2 0,02 0,0462963 (56,70)
7 7 0,07 0,0694444 0,86
8 9 0,09 0,097222 (7,41)
9 11 O,11 0,1157407 (4,93)
10 14 0,14 0,125 12,00

CHAPTER 6
11 15 0,15 0,125 20,00
12 8 0,08 0,1157407 30,86
13 11 0,11 0,097222 13,17
14 11 0,11 0,0694444 58,50
15 5 0,05 0,0462963 8,23
16 1 0,01 0,0277778 (63,90)
17 2 0,02 0,0138889 44,93
18 0 0,00 0,0046296 (100,00)
1000 1 1

Table 6.3 100 Throws with three dice

EMPIRICAL A PRIORI %
OUTCOME TIMES
PROBABILITIES PROBABILITY ERROR

3 2 0,002 0,0046296 (56,52)

4 9 0,009 0,0138889 (34,78)
5 30 0,03 0,0277778 8,30
6 43 0,043 0,0462963 (6,93)
7 78 0,073 0,0694444 5,19
8 95 0,095 0,097222 (2,26)
/continued...

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9 100 0,100 0,1157407 (13,57)

10 130 0,130 0,125 4,00

11 147 0,147 0,125 17,60

12 119 0,119 0,1157407 2,85

13 92 0,092 0,097222 (5,35)

14 73 0,073 0,0694444 5,19

15 31 0,031 0,0462963 (32,90)

16 34 0,034 01,0277778 22,74

17 15 0,015 0,0138889 8,70

18 2 0,002 0,0046296 (56,52)

1 000 1 1

Table 6.4 1 000 Throws with three dice

EMPIRICAL A PRIORI %
OUTCOME TIMES
PROBABILITIES PROBABILITY ERROR

3 35 0,0035 0,0046296 (23,91)

4 119 0,0019 0,0138889 (13,77)
5 271 0,271 0,0277778 (2,17)
6 521 0,521 0,0462963 12,77
7 702 0,0702 0,0694444 1,15
8 971 0,0971 0,097222 (0,10)
9 1 169 0,1169 0,1157407 1,04
10 1 297 0,1297 0,125 3,76
11 1 234 0,1234 0,125 (1,28)
12 1 150 0,1150 0,1157407 (0,61)
13 916 0,0916 0,097222 (5,76)
14 698 0,0698 0,0694444 0,58
15 490 0,0490 0,0462963 6,06
/continued...

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16 258 0,0258 0,0277778 (6,86)

17 117 0,0117 0,0138889 (15,22)
18 52 0,0052 0,0046296 13,04
10 000 1 1

Table 6.5 10 000 Throws with three dice

EMPIRICAL A PRIORI %
OUTCOME TIMES
PROBABILITIES PROBABILITY ERROR

3 484 0,00484 0,0046296 4,35

CHAPTER 6
4 1 345 0,01385 0,0138889 0,00
5 2 711 0,02711 0,0277778 (2,17)
6 4 649 0,04649 0,0462963 0,43
7 6 993 0,06693 0,0694444 0,72
8 9 663 0,09663 0,097222 (0,62)
9 11 285 0,11285 0,1157407 (2,51)
10 12 394 0,12394 0,125 (0,88)
11 12 581 0,12581 0,125 0,64
12 11 623 0,11623 0,1157407 0,43
13 9 848 0,09848 0,097222 1,23
14 7 010 0,07010 0,0694444 1,01
15 4 659 0,04659 0,0462963 0,65
16 2 850 0,02850 0,0277778 2,89
17 1 388 0,01388 0,0138889 0,00
18 477 0,00477 0,0046296 2,17
100 000 1 1

Table 6.6 100 000 Throws with three dice

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EMPIRICAL A PRIORI %
OUTCOME TIMES
PROBABILITIES PROBABILITY ERROR

3 4 495 0,004495 0,0046296 (4,35)

4 13 815 0,013815 0,0138889 0,00
5 27 860 0,027860 0,0277778 0,36
6 46 343 0,046343 0,0462963 0,22
7 69 219 0,069219 0,0694444 (0,29)
8 97 462 0,097462 0,097222 0,21
9 115 995 0,115995 0,1157407 0,17
10 125 145 0,125145 0,125 0,08
11 124 770 0,124770 0,125 (0,24)
12 116 177 0,116177 0,1157407 0,35
13 96 728 0,096728 0,097222 (0,51)
14 69 669 0,069669 0,0694444 0,29
15 46 266 0,046266 0,0462963 0,00
16 27 648 0,027648 0,0277778 (0,36)
17 13 856 0,013856 0,0138889 0,00
18 4 552 0,004552 0,0046296 (2,17)
1 000 000 1 1

Table 6.7 1 000 000 Throws with three dice

For each of these experiments a percentage error has been determined. This
error is expressed as a percentage of the theoretical or calculated probability
and is collated in table 6.8.

OUTCOME 10 102 103 104 105 106

3 100,00 100,00 56,52 23,91 4,35 4,35

4 100,00 27,54 34,78 13,77 0,00 0,00
5 983,03 8,30 8,30 2,17 2,17 0,36
6 332,90 56,71 61,93 12,77 0,43 0,22

/continued...

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7 100,00 0,86 5,19 1,15 0,72 0,29

8 2,88 7,41 2,26 0,10 0,62 0,21
9 13,57 4,93 13,57 1,04 2,51 0,17
10 100,00 12,00 4,00 3,76 0,88 0,08
11 20,00 20,00 17,60 1,28 0,64 0,24
12 13,57 30,86 2,85 0,61 0,43 0,35
13 2,88 13,17 5,35 5,76 1,23 0,51
14 100,00 58,50 5,19 0,58 1,01 0,29
15 100,00 8,23 32,90 6,06 0,65 0,00
16 100,00 63,90 22,74 6,86 2,89 0,36

CHAPTER 6
17 100,00 44,93 8,70 15,22 0,00 0,00
18 100,00 100,00 56,52 13,04 2,17 2,17

Table 6.8 Summary of errors for various throws

From the percentage errors for the outcomes of 10 and 11 in table 6.8, it is seen
that these continually decrease until the one millionth throw where the percentage
errors are only 0,08% and 0,24%. It is interesting to note that even after one million
throws the error is still not zero. The errors at one million throws are indicated in
figure 6.3 and the change in errors in figure 6.4 as the experiment progresses
from ten to a million.
Figure 6.5 shows how the normal distribution appears as the experiment
progresses to one million. After ten throws, the errors are substantial while the
calculated values almost coincide with the theoretical values after a million throws.

Law of large numbers

Errors after 1 million throws

% Error 3

3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18

Outcomes

Figure 6.3 Errors for various outcomes

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Law of Larg Numbers

Distribution Curve
120

100

% Error 80

60

40

20

0
10 100 1000 10 000 100 000 1000 000
Number of throws Legend Outcome = Three
Outcome = Ten

Figure 6.4 Percentage errors as a function of throws

Law of Large Numbers

Distribution Curve
0,36

0,3
Legend
0,25
Relative frequency

Hundred throws
0,2 Million throws
Ten throws
0,15
Theoretical freq.
0,1

0,06

0
3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Outcome

Figure 6.5 Distribution curve

An observation of the above figures confirms the very important law of large
numbers. The probability of the difference or error being greater than 0 decreases
to zero as the numbers increase. Figure 6.4 shows this clearly.

The importance of the law of large numbers to the insurance industry should now
become apparent. The larger the number of independent homogenous risks an
insurer has on his books, the more certain it can be that the average cost will be
accurate. Therefore if an insurer can thus write a million motor vehicle risks and
from this million risks, determine the average cost per claim, one can be reasonably
certain that the average cost is correct and that the premium based on this average
cost is accurate. As the number of motor vehicles on risk increases, so the risk

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to the insurer decreases. If the number of vehicles on risk is large enough, the
insurer no longer faces a risk.

The law of large numbers only holds true for independent events, but there are
instances where the events are not independent. For example, an insurer may
offer cover in terms of a group life policy. A company may provide transport for
its employees. If a bus carrying 50 employees is involved in an accident, 50
claims will be instituted. An insurer needs to protect himself against a risk of this
nature by reinsurance.

Aids is another example of a non-independent event which can result in claims

against an insurer.

6.4 VARIOUS STATISTICS

CHAPTER 6
6.4.1 Statistic sources
Risk management is concerned with the real world. Few things are as real as a
major disaster costing many millions of rands and involving the loss of human life.
The risk manager makes considerable use of real world statistics. These could
be the statistics of accidents or the financial consequences of losses such as the
insurance results. The statistics could be of South African origin or, since
insurance is of an international nature, of international origin.

The risk manager is interested in various real world statistics. These are used
for a number of purposes such as for cost-to-benefit calculations, comparisons,
et cetera. The following are some of the more important statistics used by the
risk manager.

6.4.2 Occupational injuries and diseases

The South African Compensation Commissioner issues very comprehensive
accident statistics annually. These are useful to determine the accident incidence
as well as causes of accidents.

6.4.3 Motor vehicle accident statistics

A most useful source of statistics in South Africa is the Statistics South Africa.
These statistics include motor vehicle accidents statistics. The following is a
summary of the statistics extracted from the reports.

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NUMBER OF NUMBER OF % ACCIDENTS/

YEAR VEHICLES LICENSED LICENSED
INVOLVED VEHICLES VEHICLES
1977 455 363 3 838 000 12%
1978 495 336 3 932 000 13%
1979 450 023 3 987 000 11%
1980 545 421 4 126 000 13%
1981 652 534 4 430 000 15%
1982 674 321 4 769 000 14%
1983 657 756 4 944 000 13%
1984 696 917 5 225 000 13%

Table 6.9 Road accident statistics

6.4.4 Insurance market results

The most important statistics used by the risk manager are those relating to the
insurance market results. If these indicate that the various world markets are
running at a loss, the risk manager can expect rates to harden and insurance
premiums will increase.

6.4.4.1 The South African market

The basic source for South African results is the statutory returns submitted to
the Registrar of financial institutions. A very comprehensive analysis is also
carried out by a company called Quest. The results of the South African market
indicated below are typical:

Figures in R 000s
GROSS PROFIT LOSS COST
RISK
PREMIUM (LOSS) TO PUBLIC
Fire and Perils R543,0 (R27,6) R570,6
Motor vehicles R842,5 R32,3 R810,2
Marine R107,3 (R3,8) R111,1
Miscellaneous R523,0 (R18,5) R541,5
Personal Accident R75,6 (R0,45) R76,05
Guarantee R25,4 (R1,7) R27,1
TOTALS R2 116,8 (R19,75) R2 136,55

Table 6.10 The South African insurance results 1985

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6.4.4.2 The Road Accident Fund (RAF)

The fund which pays for injuries to third parties arising from motor vehicle accidents
is the third party Road Accidents Fund.

Table 6.11 gives an indication of statistics available from the RAF.

Claim Size
Number % R Amount % Total
(Rm)

655 620,3 20,3 0- 1 000 0,8 0,1 0,1

807 925,0 45,2 1 001- 5 000 22,8 3,0 3,0

CHAPTER 6
593 618,3 63,6 5 001- 10 000 43,6 5,8 8,9
29 989,3 72,8 10 001- 15 000 36,7 4,9 13,7
17 765,5 78,3 15 001- 20 000 30,7 4,1 17,8
11 553,6 81,9 20 001- 25 000 25,9 3,4 21,2
10 583,3 85,1 25 001- 30 000 29,0 3,8 25,1
7 012,2 87,3 30 001- 35 000 22,7 3,0 28,1
4 731,5 88,8 35 001- 40 000 17,7 2,3 30,4
3 661,1 89,9 40 001- 45 000 15,5 2,1 32,5
3 121,0 90,9 45 001- 50 000 14,8 2,0 34,4
15 274,7 95,6 50 001- 100 000 106,9 14,1 48,6
5 451,7 97,3 100 001- 150 000 65,9 8,7 57,3
2 730,8 98,1 150 001- 200 000 47,0 6,2 63,5
1 380,4 98,5 200 001- 250 000 30,7 4,1 67,6
1 010,3 98,8 250 001- 300 000 27,8 3,7 71,2
760,2 99,1 300 001- 350 000 24,7 3,3 74,5
660,2 99,3 350 001- 400 000 24,8 3,3 77,8
410,1 99,4 400 001- 450 000 17,2 2,3 80,1
250,1 99,5 450 001- 500 000 11,8 1,6 81,6
1 650,5 100,0 500 001- 138,9 18,4 100,0

Table 6.11 Distribution of claim size by numbers and by total

amounts

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It is noticeable that for example 91% of the number of claims are smaller than
R50 000, and that they account for only 34% of the total amount paid; or conversely,
the highest 9% of claims occasion nearly two-thirds of the total amount paid

6.4.4.3 The COID fund

Figures in R 000 000s

YEAR PREMIUM UNDERWRITING INVESTMENT NET PROFIT

INCOME PROFIT INCOME

1970/80 47,984 3,211 11,788 14,999

1981/2 55,335 3,091 16,460 13,369

1982/3 92,883 18,697 16,085 34,782

1983/4 91,416 13,278 20,263 33,540

Table 6.12

6.4.4.4. The American market

The American people are good at preparing statistics. The insurance industry is
no exception. The company which prepares the Insurance statistics is called
Bests. The following table is a summary of the American results.

YEAR UNDERWRITING INVESTMENT NET PROFIT

PROFIT INCOME

1980 (3,3) 11,1 7,8

1981 (6,3) 13,2 6,9

1982 (10,3) 14,9 4,7

1983 (13,3) 15,8 3,5

1984 (21,0) 17,3 (3,7)

1985 (25,2) 19,7 (5,5)

Table 6.13

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6.4.4.5 Lloyds of London

Lloyds, the great insurance institution worldwide, also releases its results which
are then published in most insurance journals in the world. Some results are
indicated in the table below (see table 6.14).

Lloyds Five Year Summary [all figures in 000s]

1983 1982 1981 1980 1979

Total All classes combined

Premiums [114 690] 2 569 637 2 892 476 2 258 249 1 862 287 1 456 654
Underwriting profit [loss] 416 889 [187 941] [43 516] 21 748 37 133

CHAPTER 6
Investment income and 441 980 361 397 374 427 233 625
appreciation

Accidents and health

Premiums 13 056 188 383 169 748 108 346 89 046 75 902
Underwriting profit [loss] [6 202] 11 057 18 125 14 084
Investment income and 13 999 13 961 11 627 13 163 8 819
appreciation

Motor vehicle, damage

and liability
Premiums 283 439 273 594 262 211 237 060 196 799
Underwriting profit [loss] 34 603 40 133 52 063 38 920 26 882
Investment income and 25 510 29 288 33 424 34 075 21 710
appreciation

Property damage
Premiums 570 427 653 477 510 608 434 052 342 202
Underwriting profit [loss] 43 096 63 943 81 012 28 954 13 115
Investment income and 49 234 63 802 63 632 65 065 43 547
appreciation

General liability
Premiums 312 425 346 149 260 826 223 146 199 825
Underwriting profit [loss] [384 443] [425 134] [195 573] [128 752] [35 767]
Investment income and 143 568 142 371 111 371 114 218 66 438
appreciation

/continued...

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Pecuniary loss
Premiums 650 528 419 323 562
Underwriting profit [loss] 178 [178] [64] 32 45
Investment income and 66 33 42 72 78
appreciation

Short-term life
Premiums 2 886 2 227 1 949 1 458 1 559
Underwriting profit [loss] 1 028 681 496 585 450
Investment income and 262 251 268 286 194
appreciation

Table 6.14

6.5 QUESTIONS FOR SELF-EVALUATION

6.5.1 Discuss the various components to be considered when explaining
risk as a funding problem.

6.5.2 Explain, with examples, the concept of the law of large numbers.

6.6 REFERENCES
Doherty, N.A. & Carter, R.L. 1974. Handbook of Risk Management. London:
Kluwer-Harrap.

Diacon, S.R. & Carter, R.L. 1992. Success in Insurance. 3rd edition. London:
J. Murray.

Greene, M.R. & Serbein, O.N. 1983. Risk Management: text and cases.
2nd edition. Reston: Reston Publishing Company.

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CHAPTER 7
COMPENSATION FOR OCCUPATIONAL
INJURIES AND DISEASES (COID)

CONTENTS PAGE

LEARNING OBJECTIVES ................................................................ 126

7.1 COMPENSATION FOR OCCUPATIONAL INJURIES AND DISEASES 126

7.1.1 The background to the Act .................................................... 126

7.1.1.1 Employees' rights in the previous century . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 126

7.1.1.2 Workmen's compensation in Britain . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 127
7.1.1.3 Development of Workmen's compensation in South Africa . . . . . . . . . . 127

7.1.2 An overview of the Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128

7.1.3 Who pays the compensation? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129
7.1.4 Compensation and reserve funds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 129
7.1.5 Right of employees to compensation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 130
7.1.6 Who is a employee in terms of the Act? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 131
7.1.7 What does the Act cover? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132

7.1.7.1 Compensation of personal injuries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132

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7.1.7.2 Compensation for occupational diseases . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 132

7.1.8 The exposure of the Compensation Fund . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133

7.1.9 The right of recovery from a third party . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 136

7.1.9.1 Recovery by the employee . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137

7.1.9.2 Recovery by the commissioner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137
7.1.9.3 Recoveries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 137

7.2 QUESTION FOR SELF-EVALUATION ..................................... 138

7.3 REFERENCES ................................................................... 138

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LEARNING OBJECTIVES
After you have studied this chapter, you should be able to explain:
the development of the COID Act
the scope of cover
the limitation of employer's liability

7.1 COMPENSATION FOR OCCUPATION INJURIES AND

DISEASES

7.1.1 The background to the Act

7.1.1.1 Employees' rights in the previous century

Closely allied to the question of compensation is the right of the employee to sue
his employer and hence the exposure of the employer to the so-called
employer's liability risk. This risk is covered by an employer's liability policy and
the COID Act. The position regarding employer's liability must be viewed against
the historical development of these actions.

In the previous century an employee injured in the course of employment had

little chance of recovering damages for injuries sustained at work. [The position
of employer's liability and compensation in England, in the last century, is
succinctly covered by Ruegg (1901:268-279). At this time SA law was strongly
influenced by the English position and most writers commenting on the
development of South African law rely on English law. See for example
Budlender (1979:157).] His remedies were confined to the common law which,
a study of English cases clearly indicates, was not kindly disposed to this type of
action. Essentially he had to prove negligence on the part of the employer. Not
only this, in 1837, in the well-known and oft criticised [the case is often used as
the point of departure in legal theory as with Dworkin (1986:2)] case of Priestly v
Fowler (1837 3M and W1) the English courts set the precedent when the court
ruled that the employer was not liable for the negligence of a fellow employee.
This established the so-called doctrine of common employment. The doctrine of
assumption of risk applied and hence the injured workman was assumed to run
the risk of injury. The doctrine of volenti nonfit iniuria also applied to protect the
employer from claims and the employer was free to contract out of liability.

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It is clear that whatever the theory may have been, in reality the rights of injured
employees to recover damages in the commonlaw during the previous century
were very limited indeed.

7.1.1.2 Workmen's compensation in Britain

England has a long history of employment legislation. In 1802 [it is interesting to

note that the first Act mentioned by Pascoe (1974:474) is the 1825 Act], the first
Factory Act, (42 Geo III c73) was passed followed by a number of other Acts
which were consolidated in 1878. The Act of 1844 allowed the inspector to bring
an action for damages on behalf of a workman injured by means of machinery.
This was the first movement towards granting compensation to the injured workman
and the precursor to the Employers' Liability Act (43 and 44 Vict c 42) of 1880. A
Workmen's Compensation Act was passed in 1897 based on the German system
and a further Act passed in 1900, but these Acts did not displace the doctrine of
common employment. In 1877 a select committee of the House of Commons was
appointed to consider the subject. However, they did not go so far as to
recommend that the doctrine of common employment be abolished, but advised
that the master be liable for the negligence of certain persons to whom he had
delegated his rights of master over the workmen called in the report as Vice-
Masters.

Although the Act imposed liability, it was established soon thereafter that the
employer may contract out of this liability (Griffiths v Earl Dudley 9 QBD 357). By
1900 legislation passed by the Conservative government of the day had established
that the employer would be liable not only for injury caused by fellow workmen but

CHAPTER 7
also for injury not caused by fellow workmen and that he should pay compensation
for every accident arising out of the work, whether caused by negligence or not.

Other Acts were also applicable to accidents as for example the Fatal Accidents
Act (1845, 9 and 10 Vict c 93).

7.1.1.3 Development of Workmen's compensation in South Africa

At the turn of the century South Africa's legal system depended heavily on
developments in England and hence limited rights of recovery existed for injured
employees. Large employers, such as the mining industry, however, were not
satisfied with the state of affairs and introduced a scheme to compensate injured
workers. As early as 1894 the mining industry established the Rand Mutual
Assurance Company (Budlender, 1984:27). Since the mining industry established
its own fund, it was largely unconcerned with the efforts to develop a statutory
scheme.

In 1914 a consolidating Act was passed [Act 25 of 1914 which consolidated Acts
promulgated in the Cape, Transvaal and Natal. For a commentary on this Act

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Barry et al. (1914) can be consulted]. The 1914 Act, based on the British Act of
1906 and the New Zealand Workmen's Compensation Act, altered the common
law. The new Act provided for compensation in the case of all accidents 'arising
out of or in the course of employment' and where the accident was not due to
the 'serious and wilful misconduct of the employee'.

Under the 1914 Act the injured worker could choose between making a claim
under the common law or under the new statutory provisions. The worker could
however not obtain both remedies. In 1917 the Act was extended to provide
compensation for certain industrial diseases.

In the early form, the obligation was on the employer to pay the compensation.
There was, however, no guarantee that the employer would be able to pay. The
next step was to make the purchase of insurance cover compulsory.

The Workmen's Compensation Act 25 of 1914 [a commentary by Barry et al. (1914)

was published on this Act] was repealed by the Workmen's Compensation Act
38 of 1934 [a commentary was published by Nathan (1935) on this Act], which
in turn was repealed by the Workmen's Compensation Act 30 of 1941 which in
turn was repealed by the COID Act, 130 of 1993.

In so far as the risk manager is concerned, the COID Act is an important Act
which has, to date, largely prevented much of the liability crises which occurred
in the rest of the Western world (Vivian, 1986:44) since an injured workman cannot
sue his employer but must seek compensation in terms of the mechanism set up
in the Act.

7.1.2 An overview of the Act

The Act is divided into 11 chapters and contains four schedules. Regulations
have been promulgated in terms of the Act and rules for making applications for
increased compensation were promulgated in 1956.

Chapter 1 deals with definitions and application of the Act. Chapter 2 deals with
administrative issues, 3 with administration of the fund and chapter 4 consists of
determination and payments of compensation. Chapter 5 deals with the procedure
for claiming compensation, while chapter 6 deals with the calculation and
determination of claims. Chapter 7 deals with the compensation for occupational
diseases. Chapter 8 deals with medical aid to injured workmen. Chapter 9 deals
with the obligations of employers i.e. keep records, payment of assessments.
Chapter 10 deals with legal issues e.g. review of decisions by the Commissioner.
Chapter 11 deals with miscellaneous issues. Schedule 1 deals with the WCA laws
which are repealed while Schedule 2 deals with the percentage of disablement
for various injuries. Schedule 3 deals with occupational diseases. Schedule 4
deals with calculating compensation.

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It is not intended to discuss the Act in detail, but some of the provisions which
are important to the risk manager will be considered.

7.1.3 Who pays the compensation?

Compensation is not paid by the employer. McKerron (1971:101) in what was
for many years the leading textbook on the law of delict, incorrectly states: "By
this Act an employer is made liable to pay compensation payable to a workman
in his employ for any personal injury sustained " The employer does not pay
the employee but contributes to the various funds (which to pay the compensation)
but in terms of section 29 of the Act, compensation is payable to any workman
entitled thereto either:
by the employer individually liable (the employer individually liable is defined in
terms of section 1 of the Act to mean an employer who in terms of section
84 is exempt from paying assessments to the compensation fund); or
by the commissioner from the compensation fund.

The employer individually liable is defined in the Act to mean an employer who in
terms of section 84 is exempt from paying assessments to the compensation fund.
This class of employer generally includes the provincial administration, government,
exempted local authorities and mutual funds. Judging by the number of accidents
reported, this is the exception to the rule. Exemption is permitted for mutual funds
in terms of section 84 and refers to arrangements such as the Rand Mutual in the
mining industry and a similar arrangement in the building industry.

CHAPTER 7
In the majority of cases, however, compensation is payable by the commissioner out
of the accident fund. For the sake of simplicity, in this chapter reference will be
made to the commissioner and accident fund only and it must be borne in mind the
same conditions usually apply to the employers individually liable. The commissioner
reports on the accidents from all funds, not only the compensation fund.

7.1.4 Compensation and reserve funds

Compensation payable from the compensation fund is established in terms of
section 15 of the Act. The fund is financed mainly out of contributions paid by
the employers who fall under the provisions of the Act. Employees are not
required to contribute towards the fund and hence enjoy free protection in terms of
the Act. The purposes for which the fund can be applied are set out in section
16. Undoubtedly the most important purpose of the fund is to pay compensation
and the medical aid costs to and on behalf of workmen who are entitled to
benefits under the Act. A summary of the revenue and expenditure account is
indicated in table 7.1.

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YEAR REVENUE EXPENDITURE SURPLUS

R-m R-m R-m

1984/5 R115 R 93,00 R22

1985/6 R162 R109,00 R53
1986/7 R150 R122,00 R28

Table 7.1 Revenue and expenditure: compensation fund (R-m)

In terms of section 19(1) the commissioner must establish a reserve fund. The
surplus indicated above is accordingly transferred to an appropriation account
where certain costs are met, such as the costs to NOSA. The balance is
transferred to the reserve fund. The fund is invested with the Public Debt
Commissioners.

Medical costs have risen dramatically in recent years as indicated below:

YEAR MEDICAL COSTS % INCREASE

1980 R 14 855 17,44

1982 R 22 321 27,92
1983 R 27 910 25,10
1984 R 28 711 2,87
1985 R 32 857 14,42
1986 R 38 941 18,54
1987 R 41 576 6,75
1988 R 43 62 4,93
1989 R 61 98 42,09
1990 R 90 45 45,93

Table 7.2 Medical costs [Source: Safety Management (July 1990:22)]

7.1.5 Right of employees to compensation

The injured employee is entitled to compensation by virtue of which reads:

"22(1) If an employee meets with an accident resulting in his disablement or death

such employee or the dependants of such employee shall, subject to the provisions
of this Act, be entitled to the benefits provided for and prescribed in this Act."

It is important to note that fault on the part of the employer is not a requirement
for compensation to become payable in terms of the Act. In other words the
injured employee does not have to prove that his injuries were caused by the
negligence of his employer. From this section it is clear that all that is needed to
bring a claim under its purview is to show that (1) an accident happened (2) to

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an employee (3) in the course of his employment (4) resulting in his disablement
or death. Negligence is not a requirement for compensation.

Most of the above keywords are defined in the Act.

Table 7.3 indicates the number of accidents reported each year.

YEAR ACCIDENT OTHER TOTAL

FUND CARRIERS

1981 222 126 85 390 307 517

1982 220 573 81 148 301 721
1983 193 271 77 781 271 052
1984 194 690 76 696 271 659
1985 187 475 68 415 255 890
1986 178 332 64 423 242 755

Table 7.3 Number of accidents reported

7.1.6 Who is an employee in terms of the Act?

The main purpose of the Act is to provide for compensation for disablement caused
by accidents to or industrial diseases contracted by employees in the course of
their employment or for death resulting from such accidents and diseases.
The employee thus plays a central role in the Act. Employee is defined in the
Act in terms of section 1, a definition which runs into two pages. The definition
contains a general part and then lists some specific cases. The definition also

CHAPTER 7
enumerates exclusions from the definition.
The essential part for our purposes, of the general part of the definition reads as
follows:
"1.(xviii) 'employee' in this Act means any person who has entered into or
works under a contract of service with an employer,
A specific case included in the definition of employee is the dependants of an
employee who is dead or under disability. This is included specifically in the
definition of employee in terms of section 1(xviii)(d) which reads:
9b) in the case of a deceased employee, his dependants, and in the case of
an employee who is a person under disability, a curator acting on behalf of
that employee;
The Act contains a number of exemptions in terms of section 1(xviii)(d)(i). The
most important are:
(a) persons in military service or members of the South African Police, in
terms of the Defence Act 44 of 1957 and Police Act 7 of 1958
respectively, subject to certain conditions.

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(b) a person who contracts for the carrying out of work and himself
engages other persons to perform such work."
It is clear from the above definition that an employee is not limited to persons
employed in factories. All that is required is that an employment contract should
be involved. Therefore persons employed in shops and offices, universities, et
cetera, all fall under the purview of the definition. Even ministers of religion may
be employees in terms of the Act.
The definition of employee is also not dependent on whether the assessment or
'premium' has been paid or not. The cover provided by the Act is not the same
as an insurance policy. Therefore the employee is entitled to compensation even
if the employer does not pay the assessment. The employee has a statutory
claim for compensation under the Act, not a contractual or delictual claim.

7.1.7 What does the Act cover?

7.1.7.1 Compensation of personal injuries

The Act provides compensation losses arising out of personal injuries only. It
does not cover loss for material damage. Should an explosion take place at a
workplace and damage an employees motor car, the fund will not provide
compensation for the cost of repairs to the car. It is also important to note that
the Act makes provision for compensation and not damages and does not make
provision to pay the injured employee for pain and suffering.

7.1.7.2 Compensation for occupational diseases

The Act does not only provide compensation for workmen who suffer an injury
but also provides, in terms of section 6, for some occupational diseases.
Compensation is however not payable for all occupational diseases, but only
those specified in terms of the Third Schedule to the Act. Compensation for
industrial diseases is controlled in terms of section 65 of the Act which reads:
"65(1) Subject to the provisions of this Chapter, an employee shall be entitled to
the compensation provided for and prescribed in this Act if it is proved to the
satisfaction of the commissioner
65(1)(a) that an employee has contracted an occupational disease; or
65(1)(b) that an employee has contracted a disease other than an occupational
disease and such disease has arisen out of and in the course of his employment."
From this section it can be seen that once the scheduled disease is shown to
meet the requirements of the Act, it is equated with an accident.
The liability of the employer section 15 deals with The Compensation Fund
which is financed by compulsory contributions by the employer. In a way the
fund can be seen as a form of compulsory insurance cover arranged through a
state fund rather than through a private insurance company with the premiums

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paid by the employer. In return for providing this cover, the employer is relieved
of any civil liability in terms of section 35 of the Act, which reads as follows:
"35(1) No action shall lie by an employee or any dependant of an employee for
the recovery of damages in respect of any occupational injury or disease
resulting in the disablement or death of such employee against such employee's
employer, and no liability for compensation on the part of such employer shall
arise save under the provisions of this Act in respect of such disablement or
death."
Therefore, if an employee who falls under the ambit of the Act is injured, he is
entitled to compensation but cannot sue his employer.

7.1.8 The exposure of the Compensation Fund

The levels of compensation are not determined by the courts, but are specified
in terms of the Act itself. This makes the Act easier and less expensive to
administer than the common law system where fault and quantum must be
provided. Compensation is not, however, generous by any standard and does
not provide for claims of pain and suffering.
Applications for increased compensation is dealt with in section 56. Some people
may feel that it is unfair for the employer to escape liability in those cases where
he is negligent and the injured employee must accept smaller compensation in
terms of the Act. The Act makes provision for increased compensation under
certain circumstances involving negligence or patent defects, in terms of section
56 which is a fairly lengthy section. [For a comment on WCA consult Benjamin
(1987:15) 'Additional compensation for accidents at work: an underutilised

CHAPTER 7
remedy' 1987 8 1 lLJ 15.] The portion relevant for our purposes reads as follows:
"56(1) If an employee meets with an accident or contracts an occupational
disease which is due to the negligence
56(1)(a) of his employer;
56(1)(b) of an employee charged by the employer with the management or
control of the business or of any branch or department thereof;
56(1)( c) of an employee who has the right to engage or discharge employees
on behalf of the employer;
56(1)(d) of an engineer appointed to be in general charge of machinery, or of a
person appointed to assist such engineer in terms of any regulation made under
the Minerals Act, 1991 (Act No. 50 of 1991); or
56(1)(e) of a person appointed to be in charge of machinery in terms of any
regulation made under the Occupational Health and Safety Act,1993 (Act No. 85
of 1993),

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the employee may, notwithstanding any provision to the contrary contained in

this Act, apply to the commissioner for increased compensation in addition to the
compensation normally payable in terms of this Act.
56(2) For the purposes of subsection 56(1) an accident or occupational disease
shall be deemed also to be due to the negligence of the employer if it was
caused by patent defect in the condition of the premises, place of employment,
equipment, material or machinery used in the business concerned, which defect
the employer or a person referred to in paragraph (b), (c), (d) or (e) of
subsection 56(1) has failed to remedy or cause to be remedied."
This section appears to be derived from the vice-employer of the previous
century. Application for the additional compensation is made against the
commissioner and not the employer.
In terms of section 54(4)(b) the amount of additional compensation together with
any other compensation awarded under the COID Act shall not exceed the
amount of pecuniary loss suffered by the applicant. Therefore the applicant
cannot recover non-pecuniary losses such as pain and suffering by way of
additional compensation.

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 YEAR Number Withdrawn Lodged Heared formally Succeeded Outstanding Total
of or outside without a
applications abandoned prescribed Succeeded Dismissed formal
time hearing

1979/0 84 2 1 0 0 14 21

1980/1

1981/2 20 2 5 0 2 6 23 38

1982/3 88 1 2 0 0 20 31

1983/4 30 13 5 2 3 3 24 50

1984/5 27 11 2 2 4 2 35 56

1985/6 32 19 6 3 3 5 22 58

1986/7 26 26 3 5 3 1 12 so

Table IV application for increased compensation: section 56 (Source: Various reports of the COID Act)

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7.1.9 The right of recovery from a third party

Accidents may arise in circumstances which create obligations to a third party,
other than the workman's employer, to pay compensation to the workman. In
these circumstances the workman may have a claim against the commissioner
and the third party. Also since the commissioner may pay compensation, the
possibility of the commissioner recovering amounts from the third party should
be considered.

Section 36 deals with this situation. (The following can be consulted with regard
to section 8: South African Railways & Harbours v South African Stevedores
Services Co 1983 (1) SA 1006 A. Blumenfeld, J. (1983:261) 'Workmen's
compensation: Third party liability' 1983 4 ILJ 261.) This section reads as
follows:

"36(1) If an occupational injury or disease in respect of which compensation is

payable, was caused in circumstances resulting in some person other than the
employer of the employee concerned (in this section referred to as the 'third
party') being liable for damages in respect of such injury or disease

36(1)(a) the employee may claim compensation in terms of this Act and may
also institute action for damages in a court of law against the third party; and

36(1)(b) the commissioner or the employer by whom compensation is payable

may institute action in a court of law against the third party for the recovery of
compensation that he is obliged to pay in terms of this Act.

36(2) In the awarding damages in an action referred to in subsection 36(1)(a)

the court shall have regard to the amount to which the employee is entitled in
terms of this Act.

36(3) an action referred to in subsection 36(1)(b) the amount recoverable shall

not exceed the amount of damages, if any, which in the opinion of the court
would have been awarded to the employee but for this Act.

36(4) For the purpose of this section compensation includes the cost of medical
aid already incurred and any amount paid or payable in terms of section 28,
54(2) or 72(2) and, in the case of a pension, the capitalised value as determined
by the commissioner of the pension, irrespective of whether a lump sum is at
any time paid in lieu of the whole or a portion of such pension in terms of
section 52 or 60, and periodical payments or allowances, as the case may be."

This section thus deals with the rights of the workman and commissioner to
recover from the third party.

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7.1.9.1 Recovery by the employee

Clearly from section 36 the right of recovery of the employee against the third
party is not interfered with. Section 36 does not, however, create rights of
recovery and the employee must look to other sources such as contract and
delict to base his claim on.

7.1.9.2 Recovery by the commissioner

Section 36 grants the commissioner a statutory right of recovery. Some

statutory bodies such as government departments may regard themselves as
obliged to make such a recovery. It is for example common practice for the
South African Police to seek recovery for amounts it has paid to injured
policemen.

Section 36 specifies a number of procedural matters which are important.

The manner in which section 38 is applied can be illustrated by way of example.

In the case of South African Railways & Harbours v South African Stevedores
Services Co 1981 (1) SA 353 D an employee of the SAR&H was killed as a
result of the joint negligence of the SAR&H and South African Stevedores
Services Co. The SAR&H was an employer individually liable in terms of the
COID Act and paid an amount of R7 287,72 to the widow of the deceased
worker. The widow sued South African Stevedores Services Co and was
awarded an amount of R20 300. From this amount, the amount previously paid
by the SAR&H was subtracted and the widow received R7 012,28.

CHAPTER 7
7.1.9.3 Recoveries

The following table indicates the number of claims made and the aggregate
recovered in terms of section 36. It is clear from this that section 36 is
frequently applied.

YEAR Number of Total value Value

claims of claims recovered
instituted

1983/4 1 256 R2 514 076 R2 241 434

1984/5 1 150 R3 167 452 R2 500 198
1986/7 741 R2 928 363 R2 682 236

Table 7.5 Recoveries in terms of section 8 (Source: Reports of the

Commissioner )

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7.2 QUESTION FOR SELF-EVALUATION

7.2.1 Mr X is injured by Mr Y a fellow employee. Mr X wishes to sue Mr Y.

Discuss the implications in terms of the COID Act.

7.3 REFERENCES
Benjamin, P. 1987. Additional compensation for accidents at work: An
underutilised remedy. Industrial Law Journal, vol. 8, Issue 1:15-20.

Blumenfeld, J. 1983. Workmen's compensation: Third party liability. Industrial

Law Journal, vol. 4, Issue 1:261.

Budlender, D.J. 1979. Labour Legislation in South Africa, 1924-1945. MA

dissertation, University of Cape Town, Cape Town.

McKerron, R.G. 1971. The Law of Delict. 7th edition. Cape Town: Juta.

Pascoe, L.C. 1981. Encyclopedia of dates and events. 2nd edition. London:
Hodder & Stoughton.

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CHAPTER 8
ROAD ACCIDENT FUND

CONTENTS PAGE

LEARNING OBJECTIVES ................................................................ 140

8.1 COMMENT ON THE RISK .................................................... 140

8.2 THE ROAD ACCIDENT FUND ACT 56 OF 1996 (RAF) .............. 140

8.2.1 Overview of the Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 141

8.2.2 Liability of the RAF section 17 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 142
8.2.3 The type of cover personal injury claims . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144
8.2.4 Liability of the owner, negligent driver, etc. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 144
8.2.5 Who is the third party? . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145
8.2.6 Limitation of the RAF's liability section 18 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145

8.2.6.1 Passenger liability section 18(1) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 145

8.2.6.2 Compensation for Occupational Injuries and Diseases Act 130
of 1993 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 146

8.2.7 Liability excluded in certain cases section 19 . . . . . . . . . . . . . . . . . . . . . . . . . 147

8.2.8 The limit of the liability of the RAF . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 148
8.2.9 The appointed agent's right of recourse section 25 . . . . . . . . . . . . . . . . . 149

8.3 QUESTIONS FOR SELF-EVALUATION ................................... 151

8.4 REFERENCES ................................................................... 151

CHAPTER 8

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LEARNING OBJECTIVES
After you have studied this chapter you should understand:
the extent of cover provided by the RAF
the protection provided to drivers and owners of motor vehicles

8.1 COMMENT ON THE RISK

Each year South Africa experiences about 700 000 motor vehicle accidents in
which approximately 10 000 people die. Since multimillion rand awards have
been made for single injuries, motor vehicle accidents pose a major threat to
owners and users of motor vehicles.

These accidents and injuries involve a great deal of money, paid out as
compensation. An analysis of the expenditure of insurance companies indicates
that 50% of the South African insurance industry is devoted, in one way or
another, to paying claims associated with motor vehicle accidents.

The scheme established in terms of the Road Accidents Fund Act, (RAF Act) 56
of 1996 and the previous schemes, form the main part of the arrangement to
pay personal injury claims arising out of motor vehicle accidents.

8.2 THE ROAD ACCIDENTS FUND ACT 56 of 1996

Liability for motor vehicle accidents has been governed by a number of Acts.
The latest is the RAF. The Act is clearly aimed at establishing a uniform system
of dealing with personal injury claims arising from motor vehicle accidents in
Southern Africa.

This Act contains most of the provisions concerning indemnification of persons

injured due to negligence or other wrongful acts of persons such as drivers and
owners arising out of motor vehicle accidents.

In terms of article 2(2)(a) of the RAF Act, the operation of the Multilateral Motor
Vehicle Accidents Fund (MMF) established by the Agreement concluded
between the Contracting Parties on 14 February 1989, shall cease to exist. This
Agreement was an arrangement between the RSA and the independent
homelands within its borders. The RAF will naturally replace the MMF.

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8.2.1 Overview of the Road Accident Fund Act 56 of 1996

The following sections are covered in the Act:

a. Section 1: Definitions
b. Section 2: Establishment of Fund
c. Section 3: Object of Fund
d. Section 4: Powers and functions of Fund
e. Section 5: Financing of Fund
f. Section 6: Financial year of and budgeting for Fund
g. Section 7: Use of resources and facilities of Fund
h. Section 8: Appointment of agents for Fund
i. Section 9: Co-operation with other Institutions
j. Section 10: Board of Fund and Executive Committee
k. Section 11: Powers and functions of the Board and procedure
l. Section 12: Chief Executive Officer and staff
m. Section 13: Annual report
n. Section 14: Financial control
o. Section 15: Legal status and proceedings by Fund, and limitation of
certain liability
p. Section 16: Exemption from taxation
q. Section 17: Liability of Fund and agents
r. Section 18: Liability limited in certain cases
s. Section 19: Liability excluded in certain cases
t. Section 20: Presumptions regarding driving of motor vehicle
u. Section 21: Claim for compensation lies against Fund or agent only
v. Section 22: Submission of information to Fund, agent and third party
w. Section 23: Prescription of claim
x. Section 24: Procedure
y. Section 25: Right of recourse of Fund or agent
z. Section 26: Regulations
aa. Section 27: Repeal and amendment of laws
ab. Section 28: Savings
ac. Section 29: Short title and commencement

It must be remembered that the present Act is a progression from the previous
Acts and therefore the interpretation given to these must be consulted for a
CHAPTER 8

proper understanding of the current legislation. Also, no branch of law or

legislation has been subject to such a volume of cases as the legislation dealing
with personal injury claims arising out of motor vehicle accidents. Therefore, a
formidable body of case law exists.

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8.2.2 Liability of the RAF section 17

An important point to note is that liability on the part of the fund to pay
compensation is based on fault or negligence. This salient point is covered in
terms of section 17 of the act which reads:

"17.(1) The Fund or an agent shall-

(a) subject to this Act, in the case of a claim for compensation under
this section arising from the driving of a motor vehicle where the
identity of the owner or the driver thereof has been established;

(b) subject to any regulation made under section 26, in the case of a
claim for compensation under this section arising from the driving
of a motor vehicle where the identity of neither the owner nor the
driver thereof has been established, be obliged to compensate any
person (the third party) for any loss or damage which the third
party has suffered as a result of any bodily injury to himself or
herself or the death of or any bodily injury to any other person,
caused by or arising from the driving of a motor vehicle by any
person at any place within the Republic, if the injury or death is
due to the negligence or other wrongful act of the driver or of the
owner of the motor vehicle or of his or her employee in the
performance of the employee's duties as employee."

For a proper understanding of the liability of the RAF this section should not be
read by itself since the liability of the RAF is subject to a number of
qualifications. In some cases the liability is limited and in others excluded.
Section 17 in particular must be read together with section 19 which reads:

"19. The Fund or an agent shall not be obliged to compensate any person in
terms of section 17 for any loss or damage-

(a) for which neither the driver nor the owner of the motor vehicle
concerned would have been liable but for section 21; or

(b) suffered as a result of bodily injury to or death of any person who, at

the time of the occurrence which caused that injury or death-

(i) was being conveyed for reward on a motor vehicle which is a motor
cycle; or

(ii) is a person referred to in section 18(1)(b) and a member of the

household, or responsible in law for the maintenance, of the driver
of the motor vehicle concerned, and was being conveyed in or on
the motor vehicle concerned; or

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(c) if the claim concerned has not been instituted and prosecuted by the
third party, or on behalf of the third party by-

(i) any person entitled to practise as an attorney within the Republic;

or

(ii) any person who is in the service, or who is a representative of the

state or government or a provincial, territorial or local authority; or

(d) where the third party has entered into an agreement with any person
other than the one referred to in paragraph (c)(i) or (ii) in accordance
with which the third party has undertaken to pay such person after
settlement of the claim-

(i) a portion of the compensation in respect of the claim; or

(ii) any amount in respect of an investigation or of a service rendered

in respect of the handling of the claim otherwise than on instruction
from the person contemplated in paragraph (c)(i) or (ii); or

(e) suffered as a result of bodily injury to any person who-

(i) unreasonably refuses or fails to subject himself or herself, at the

request and cost of the Fund or such agent, to any medical
examination or examinations by medical practitioners designated
by the Fund or agent;

(ii) refuses or fails to furnish the Fund or such agent, at its or the
agent's request and cost, with copies of all medical reports in his
or her possession that relate to the relevant claim for
compensation; or

(iii) refuses or fails to allow the Fund or such agent at its or the agent's
request to inspect all records relating to himself or herself that are
in the possession of any hospital or his or her medical practitioner;
or

(f) if the third party refuses or fails-

(i) to submit to the Fund or such agent, together with his or her claim
form as prescribed or within a reasonable period thereafter and if
CHAPTER 8

he or she is in a position to do so, an affidavit in which particulars

of the accident that gave rise to the claim concerned are fully set
out; or

(ii) to furnish the Fund or such agent with copies of all statements and
documents relating to the accident that gave rise to the claim

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 RMN111ZE

concerned, within a reasonable period after having come into

possession thereof."

It is clear that the RAF is only obliged to pay compensation if negligence or fault
is involved. For example, if the father of six children is killed in a motor vehicle
accident and as a result of his death, his wife and children stand to lose their
home no compensation will be forthcoming, unless it can be proved that the
father died as a result of the negligence of the driver or owner. In other words,
the fact that a person has been injured in a motor vehicle accident is not
sufficient to justify compensation. Not only this but negligence must be proved.
Even if negligence is suspected as the cause of the death of the father, no
compensation is payable. Many people have felt that this is unfair and that all
that should be required is that a person be injured in a motor vehicle accident.
This type of system is the so called no-fault system. The question of introducing
a no-fault system has been investigated on numerous occasions but the
commission has recommended against its introduction on each occasion.

8.2.3 The type of cover personal injury claims

From section 17(1)(b) it can be seen that RAF only covers claims for loss or
damage suffered as a result of personal injury or death, which includes loss of
earnings and support. In terms of section 17(4) these include claims by
dependants for loss of support and other persons who have a claim arising out
of personal injuries. The scope of section 17 can be illustrated by an example.
Assume an employee negligently crashes into a brand new car causing R30 000
damage to the car and injuring its driver. The damage to the car is not covered
by the fund but the cost of compensating the driver's injuries is covered. If the
driver dies, claims by his dependants are also covered.

8.2.4 Liability of the owner, negligent driver, etc.

It has just been noted that in the event of an accident caused by negligence, the
RAF will pay the compensation for most of the third party's personal injuries.
What is the liability of the person who caused the accident? Can he also be
sued to pay compensation? As a general rule the answer is no. This aspect is
provided for by section 21 of the Act which reads:

"21. When a third party is entitled under section 17 to claim from the Fund or an
agent any compensation in respect of any loss or damage resulting from
any bodily injury to or death of any person caused by or arising from the
driving of a motor vehicle by the owner thereof or by any other person with
the consent of the owner, that third party may not claim compensation in
respect of that loss or damage from the owner or from the person who so
drove the vehicle, or if that person drove the vehicle as an employee in the

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performance of his or her duties, from his or her employer, unless the Fund
or such agent is unable to pay the compensation."

In other words, as a general rule the person injured in a motor accident must
submit and pursue his claim to the RAF and cannot institute a claim against the
person who caused his injury.

8.2.5 Who is the third party?

The Act often refers to a third party. This third party is important for insurance
purposes. The first and second parties usually refer to the parties who entered
into the insurance contract. The third party refers in general terms to someone
else not party to the insurance contract between the insurer and insured. The
term third party is not defined in the definition article of the Act, the meaning is
assigned as in terms of section 17 quoted above.

In broad terms the third party is the person who is injured through the negligent
driving of a motor vehicle.

8.2.6 Limitation of the RAF's liability section 18

Not all third parties can receive compensation from the RAF. In some cases
even if they do receive compensation, they may not receive full compensation.
Two particular cases are dealt with, people described as passengers and
persons who fall under the provisions of the COID Act (Compensation for
Occupational Injuries and Diseases Act 130 of 1993). Section 18(1) deals with
persons being conveyed in or on the motor vehicle. This class of person is
generally referred to as passengers. Section 18(2) deals with certain persons
who are entitled to compensation under various COID Act enactments.

8.2.6.1 Passenger liability section 18(1)

There are cases where liability of the RAF is limited to a specified amount.
These cases are governed by section 18 of the Act. This section contains one
of the longest single sentences to be found in legislation. The relevant extract of
section 18 reads as follows:

"18.(1) The liability of the Fund or an agent to compensate a third party for any
CHAPTER 8

loss or damage contemplated in section 17 which is the result of any

bodily injury to or the death of any person who, at the time of the
occurrence which caused that injury or death, was being conveyed in or
on the motor vehicle concerned, shall, in connection with any one
occurrence, be limited, excluding the cost of recovering the said
compensation, and except where the person concerned was conveyed
in or on a motor vehicle other than a motor vehicle owned by the South

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African National Defence Force during a period in which he or she

rendered military service or underwent military training in terms of the
Defence Act, 1957 (Act No. 44 of 1957), or another Act of Parliament
governing the said Force, but subject to subsection (2)-

(a) to the sum of R25000 in respect of any bodily injury or death of

any one such person who at the time of the occurrence which
caused that injury or death was being conveyed in or on the motor
vehicle concerned-

(i) for reward; or

(ii) in the course of the lawful business of the owner of that motor
vehicle; or

(iii) in the case of an employee of the driver or owner of that motor

vehicle, in respect of whom subsection (2) does not apply, in
the course of his or her employment; or

(iv) for the purposes of a lift club where that motor vehicle is a
motor car; or

(b) in the case of a person who was being conveyed in or on the motor
vehicle concerned under circumstances other than those referred
to in paragraph (a), to the sum of R25000 in respect of loss of
income or of support and the costs of accommodation in a hospital
or nursing home, treatment, the rendering of a service and the
supplying of goods resulting from bodily injury to or the death of
any one such person, excluding the payment of compensation in
respect of any other loss or damage."

Reduced to its bare essentials, section 18(1) limits the liability of the Fund to pay
compensation to people conveyed in a motor vehicle.

8.2.6.2 Compensation for Occupational Injuries and Diseases Act 130 of

1993

In many instances a third party injured in a motor accident is also an employee

who falls under the provisions of the COID Act. The legislation (RAF) makes
provision for this eventuality in terms of section 18(2) which reads:

"(2) Without derogating from any liability of the Fund or an agent to pay
costs awarded against it or such agent in any legal proceedings, where
the loss or damage contemplated in section 17 is suffered as a result of
bodily injury to or death of any person who, at the time of the
occurrence which caused that injury or death, was being conveyed in or
on the motor vehicle concerned and who was an employee of the driver

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or owner of that motor vehicle and the third party is entitled to

compensation under the Compensation for Occupational Injuries and
Diseases Act, 1993 (Act No. 130 of 1993), in respect of such injury or
death-

(a) the liability of the Fund or such agent, in respect of the bodily injury to
or death of any one such employee, shall be limited in total to the
amount representing the difference between the amount which that
third party could, but for this paragraph, have claimed from the Fund or
such agent, or the amount of R25000 (whichever is the lesser) and any
lesser amount to which that third party is entitled by way of
compensation under the said Act; and

(b) the Fund or such agent shall not be liable under the said Act for the
amount of the compensation to which any such third party is entitled
thereunder."

8.2.7 Liability excluded in certain cases section 19

Whereas section 18 deals with those cases where the injured third party's claim
is limited to R25 000, section 19, specifies a whole range of instances where no
liability attaches to the RAF or its appointed agents and a portion of the section
reads

"19. The Fund or an agent shall not be obliged to compensate any person in
terms of section 17 for any loss or damage-

(a) for which neither the driver nor the owner of the motor vehicle
concerned would have been liable but for section 21; or

(b) suffered as a result of bodily injury to or death of any person who, at

the time of the occurrence which caused that injury or death-

(i) was being conveyed for reward on a motor vehicle which is a motor
cycle; or

(ii) is a person referred to in section 18(1)(b) and a member of the

household, or responsible in law for the maintenance, of the driver
of the motor vehicle concerned, and was being conveyed in or on
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the motor vehicle concerned; or ..."

The instances where the RAF incurs no liability are important to the risk
manager since other risk financing and strict loss control measures may have to
be introduced to ensure that the provisions of the Act are complied with.
Therefore in some of the cases where the Act does not apply, cover in terms of
a group personal accident scheme can be arranged.

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8.2.8 The limit of the liability of the RAF

A study of the Act indicates that it does not stipulate a limit of liability. The
courts determine this limit. Table 8.1 below indicates some of the awards, which
have been made in South Africa.

Table 8.1 Personal injury awards in South Africa

INJURY AWARD STATUS OF INJURED
PERSON

Spinal damage R14,8 (Outcome Hyper store manager

pending)

Brain damage R2 500 000 35-year-old computer systems

analyst

Paraplegic R1 350 000 21-year-old university student

(computer science)

Quadriplegic R1 200 000 24-year-old Polish immigrant.

(former trade union member)

Loss of sight, bedridden R1 000 000 11-year-old child, injured in a

motor accident

Quadriplegic R712 000 49-year-old fitter

Quadriplegic R500 000 23-year-old university student

Loss of eye sight R330 000 31-year-old body builder

Brain damage R322 000 21-year-old woman passenger,

occupation not stated

Paraplegic R300 000 20-year-old resident in Ikageng

Loss of a leg R225 000 29-year-old carpenter

Loss of hearing R220 000 11-year-old girl

Loss of lower leg R240 000 40-year-old welder

Loss of an arm R62 000 Soweto resident

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8.2.9 The appointed agent's right of recourse section 25

The person injured in a motor vehicle accident must look to the RAF, a statutory
fund, or the appointed agent for compensation and, generally because of
section 21, the injured party has no right of action against the person who
caused the accident. The next issue to be addressed is whether, once the RAF
or the appointed agent has paid the claim, the amount paid can be reclaimed
from the person who caused the accident or some other person?

As a general rule the funds cannot be recovered, other than under specified
circumstances. This point, referred to as the right of recourse, is governed by
section 25 of the Act. Essentially the right of recovery does exist but only under
prescribed circumstances. Section 25 reads:

"25.(1) When the Fund or an agent has paid any compensation in terms of
section 17 the Fund or agent may, subject to subsections (2) and (3),
without having obtained a formal cession of the right of action, recover
from the owner of the motor vehicle concerned or from any person
whose negligence or other wrongful act caused the loss or damage
concerned, so much of the amount paid by way of compensation as the
third party concerned could, but for the provisions of section 21, have
recovered from the owner or from such person if the Fund or agent had
not paid any such compensation.

(2) The Fund's or agent's right of recourse against the owner of a motor
vehicle under subsection (1) shall only be applicable in any case where
the motor vehicle at the time of the accident which gave rise to the
payment of the compensation was being driven-

(a) by a person other than the owner and the driver was under the
influence of intoxicating liquor or of a drug to such a degree that
his or her condition was the sole cause of such accident and the
owner allowed the driver to drive the motor vehicle knowing that
the driver was under the influence of intoxicating liquor or of a
drug; or

(b) by a person other than the owner without the driver holding a
licence issued under any law governing the licensing of drivers of
motor vehicles which the driver was required to hold, or the driver,
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being the holder of a learner's or other restricted licence issued

under such law, failed, while he or she was so driving the motor
vehicle, to comply with the requirements or conditions of such
learner's or restricted licence, and the owner allowed the driver to
drive the motor vehicle knowing that the driver did not hold such a
licence or that the driver failed to comply with the requirements or

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conditions of a learner's or restricted licence, as the case may be;

or

(c) by the owner and he or she was under the influence of intoxicating
liquor or of a drug to such a degree that his or her condition was
the sole cause of such accident; or

(d) by the owner without holding a licence issued under any law
governing the licensing of drivers of motor vehicles, which he or
she was required to hold, or the owner, being the holder of a
learner's or other restricted licence issued under such law, failed,
while he or she was so driving the motor vehicle, to comply with
the requirements or conditions of such learner's or restricted
licence; or

(e) by the owner and he or she failed to comply with any requirement
contemplated in section 22(1) with reference to the said accident,
or knowingly furnished the Fund or the agent with false information
relating to such accident and the Fund or agent was materially
prejudiced by such failure or by the furnishing of such false
information, as the case may be.

(3) The provisions of subsection (2)(c), (d) and (e) shall apply mutatis
mutandis in respect of any right of recourse by the Fund or the agent
against any person who, at the time of the accident which gave rise to
the payment of the compensation, was driving the motor vehicle
concerned with or without the consent of its owner."

From this it can be seen that a right of recourse does exist under the
circumstances set out in the section. Essentially recovery is permitted if the
owner or driver was driving under the influence of intoxicating liquor or drugs or
driving without a valid driver's licence or if the accident was not reported to the
fund within the prescribed period (if reasonably possible within 14 days after the
occurrence) or if a person knowingly provided false information relating to an
occurrence which could give rise to a claim. It is therefore important to ensure
that these conditions are not breached or the owner could be faced with a claim
totalling the amount that was paid out to the third party.

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8.3 QUESTIONS FOR SELF-EVALUATION

8.3.1 What does the RAF essentially want to achieve?

8.3.2 Explain the liability of the different parties involved, the limitations and
exclusions of liability of the RAF.

8.3.3 Why is it necessary for a risk manager to know about the RAF and its
stipulations?

8.3.4 Can the RAF or its agent reclaim the money it paid, from the driver or
owner of the vehicle?

8.3.5 What compensation is payable in terms of the RAF?

8.4 REFERENCE
South Africa. 1996. The Road Accident Fund Act 56 of 1996. Pretoria:
Government Printer.

CHAPTER 8

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NOTES

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CHAPTER 9

CHAPTER 9
EMPLOYEE BENEFITS

CONTENTS PAGE

LEARNING OBJECTIVES ................................................................ 154

9.1 INTRODUCTION ................................................................ 154

9.2 THE FIELD OF EMPLOYEE BENEFITS .................................. 154

9.3 GROUP PERSONAL ACCIDENT INSURANCE ........................ 155

9.4 STATED BENEFITS ............................................................ 156

9.5 UNEMPLOYMENT INSURANCE ........................................... 156

9.6 COMPENSATION FOR OCCUPATIONAL INJURIES AND

DISEASES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 156

9.7 GROUP LIFE COVER .......................................................... 157

9.8 GROUP PERSONAL INSURANCE SCHEMES ......................... 157

9.9 MEDICAL AID .................................................................... 157

9.10 PENSION FUNDS .............................................................. 157

9.11 VARIOUS SOCIAL BENEFITS SUCH AS SICK LEAVE AND

RETRENCHMENT BENEFITS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 158

9.12 QUESTION FOR SELF-EVALUATION ..................................... 158

9.13 REFERENCES ................................................................... 158

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LEARNING OBJECTIVES
After you have studied this chapter, you should be able to explain:
the various aspects which constitute employee benefits

9.1 INTRODUCTION
Most large companies provide a number of employee benefits, for example,
most companies make provision for at least a pension for its employees.

Some of these benefits are closely related to pure risk. If an employee is injured
in a motor vehicle accident, which is an event involving pure risk, some
employee benefit schemes and insurance policies such as the motor vehicle
policy respond to the event. The injured employee may also receive assistance
from benefit schemes. If he is treated in hospital, the company's medical aid
scheme is involved; if he suffers permanent disability, the group pension and
accident scheme may be involved; and if he dies, the group life policy is
involved. If he is off work, sick leave is involved as in the Compensation Fund
established in terms of the Compensation for Occupational Injuries and
Diseases Act 130 of 1993.

An important question for the risk manager is who administers the various
employee benefit schemes within the company. Historically the various schemes
have not been administered by any single person within the organisation, but in
recent years there has been a trend toward the centralisation of the
administration of some employee benefit schemes. Those schemes which
involve pure risk and the purchase of short-term insurance are becoming the
responsibility of the risk manager.

The addition of employee benefits to the responsibilities of the American risk

manager is a recent development in the field of risk management. This
development has caught on in South Africa only to a limited extent.
Nevertheless, it is possible that the same development will take place in
South Africa and accordingly the subject of Employee Benefits (EB) is dealt with
briefly in this chapter for the sake of completeness.

9.2 THE FIELD OF EMPLOYEE BENEFITS

The following items are generally regarded as falling under the ambit of
employee benefits:

- Group personal accident insurance

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- Stated benefits
- Group life cover
- Medical aid

CHAPTER 9
- Compensation for Occupational Injuries and Diseases
- Unemployment insurance
- Group personal insurance schemes
- Various social benefits such as pensions, sick leave and retrenchment
benefits.

These will be discussed briefly.

9.3 GROUP PERSONAL ACCIDENT INSURANCE

One of the most traumatic events in the life of an employee is a serious
accident. If the employee falls under the provisions of the Compensation for
Occupational Injuries and Diseases Act 130 of 1993 (COID Act), which implies
that should the accident occur at work, the employee is entitled to the benefits
laid down in the Act. While these are not overly generous, the employee will
receive some compensation, rehabilitation and hospitalisation.

On the other hand, if the accident occurs outside the employment situation or
the injured employee does not fall under the provisions of the COID Act, the
employee will not receive any benefits in terms of the COID Act. If no other
provision exists, the consequences to the employee could be disastrous.

A serious accident could ruin the life of the employee. To obviate this risk many
employers arrange group personal accident cover. Typically the operative clause
will define the event as:

"bodily injury caused by accidental, violent external and visible means to any
parties in or of a director or employee of the insured specified in the schedule."

Thus in terms of this cover employees who suffer bodily injury caused by
accidental, violent, external and visible means are entitled to the compensation.
The amount of compensation is specified in a schedule to the policy and various
percentages of compensation are laid down for degrees of disability. For
example, the permanent loss of hearing in one ear shall be regarded as 25%
permanent disability. Compensation is paid for various degrees of injury ranging
from death and permanent disability to temporary total disability and medical
expenses. All of these must arise from the accident.

The policy may contain a number of clauses which help to clarify possible areas
of misunderstanding. Examples of these clauses include the disappearance of
the employee and presumption of death.

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The policy may also contain a number of exceptions such as that no

compensation is payable for death by suicide, limitations for age, drugs,
intoxicating liquor, injury due to sport and other hazardous activities.

Most policies give the company the option of extending the cover on a 24-hour
basis. If this is not done the cover applies only to work-related accidents. In this
event the cover is similar to the COID Act cover and is used often to provide
cover for employees who do not fall under the provision of the COID Act.

9.4 STATED BENEFITS

The stated benefits policy is very similar to the group personal accident policy
and as implied by the name, the extent of benefits are stated in the policy.
Should a person die as a result of an accident, his estate will receive five times
his annual salary, in terms of this type of policy.

9.5 UNEMPLOYMENT INSURANCE

In South Africa unemployment insurance is arranged in terms of the
Unemployment Insurance Act 30 of 1966 which replaced Act 53 of 1946. In
terms of these Acts an unemployment fund was established to pay
unemployment benefits to the unemployed worker.

In terms of section 29(1) of the Act every employer is obliged to contribute

towards the fund on his own account and also on behalf of his employees who
fall under the Act. In terms of section 29(2) the minister shall contribute to the
fund money appropriated for that purpose by Parliament. The UIF is financed by
contributions from employers, employees and public funds. Not all the workers
qualify for the unemployment fund. For example, workers who earn more than
R82 776 per annum (as from 97/09/01) are excluded. The abovementioned
amount changes from time to time.

9.6 COMPENSATION FOR OCCUPATIONAL INJURIES

AND DISEASES
In South Africa, compensation is very much part of risk management and is
dealt with more fully in a previous chapter.

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9.7 GROUP LIFE COVER

Many of the larger firms arrange group life insurance cover for their employees.

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In some instances the employees are asked to contribute towards the cost,
otherwise the cost is borne by the company itself. One of the advantages of the
group life scheme is that the individual who is covered is not usually asked to
undergo a medical examination. A disadvantage is that the cover generally
ceases once the employee retires or leaves the employment of the company.

9.8 GROUP PERSONAL INSURANCE SCHEMES

Many of the very large companies arrange personal insurance schemes for their
employees. This is comprehensive cover for household contents, crime, motor
vehicles, public liability, etc. As a rule the company is only responsible for
arranging the cover and is not the insurer. The cover is still provided by the
insurance company.

9.9 MEDICAL AID

Most companies have a group medical aid scheme which provides assistance to
employees to pay for medical care.

Most employers make a contribution towards medical aid costs. Medical costs
are escalating dramatically throughout the world and the increasing costs are a
matter of great concern to the employer. In America the cost escalated to such
an extent that special programmes were introduced to reduce them.

Medical aid schemes are usually administered by specialist companies and the
function of the risk manager or other person charged with the co-ordinative
responsibilities is to liaise with the specialised medical aid consultants.

9.10 PENSION FUNDS

Pension funds involve the investment of funds in the long-term market and
requires a sound knowledge of investment theory and practice. This includes
aspects such as the Capital Asset Pricing Model (CAPM), Portfolio Theory and
the Arbitrage Pricing Theory (APT). These form part of Investment Theory.
Generally risk managers are not trained in these disciplines and it is unlikely that
the risk manager will be responsible for the administration of the pension funds.
Pension funds are usually vested with and administered by a separate company
or trust.

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9.11 VARIOUS SOCIAL BENEFITS SUCH AS SICK

LEAVE AND RETRENCHMENT BENEFITS
In South Africa these aspects form part of the personal or human resources
programmes and need not concern us any further.

9.12 QUESTION FOR SELF-EVALUATION

9.12.1 List the employee benefits that one normally receives when working
for a large corporation.

9.13 REFERENCES
South Africa. 1993. Compensation for Occupational Injuries and Diseases Act
130 of 1993. Pretoria: Government Printer.

South Africa. 1966. Unemployment Act 30 of 1966. Pretoria: Government

Printer.

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