Chapter 2: Managing Risks.

Question 1

Costs of pure risk?

Answer 1

1) Actual losses
2) Fear and worry
3) Less-than-optimal use of resources because of the difficulty of estimating the probability of loss.
4) The expenses that must be incurred to treat risks.

Question 2

Risk Management

Answer 2

Risk management is the term commonly used to describe a systematic process for dealing with these risks.

Question 3

Enterprise Risk Management

Answer 3

Is an approach to managing all an organization’s risks and opportunities in order to maximize the organization’s value. Risk management then takes place at the enterprise level.

Question 4

The key steps in the risk management process are?

Answer 4

1) Identification. The process begins with the recognition and classification of various risks.
2) Measurement. The next step is the analysis and evaluation of risks in terms of frequency, severity, and variability.
3) Choice and use of methods to treat each identified risk. Some risks can be avoided, some controlled, some retained under planned programs, and some transferred by a method such as insurance.
4) Administration. Once the methods of treatment are chosen, plans for administration of the program must be instituted. This last step includes both implementing
the methods selected and monitoring the choices to see that they are effective.

Question 5

Risk Financing

Answer 5

Refers to techniques used to pay for any losses that do occur.

Question 6

Risk Control

Answer 6

Risk control refers to risk management techniques used to minimize the frequency and severity of losses.

Question 7

The major methods of risk control that a client might use can be classified in various ways. Each of the following risk control methods aims to minimize losses to assets and income:

Answer 7

• Risk avoidance
• Loss prevention
• Loss reduction
• Non-insurance transfers

Question 8

Risk Avoidance

Answer 8

The most extreme form of risk control, is used when a party decides not to incur a loss exposure or to eliminate one that already exists.

Question 9

Loss Prevention

Answer 9

Refers to risk control measures intended to lower the probability of loss or the frequency with which a given type of loss occurs.

Question 10

Loss Reduction

Answer 10

Refers to risk control measures that aim to reduce the severity of loss.

Question 11

Non-insurance Transfers

Answer 11

These transfers use a contract, other than an insurance contract, in which one party transfers responsibility for a
specific activity and any resulting losses to another party.

Question 12

Risk financing may be divided into two major types:

Answer 12

1) Risk retention

2) Risk transfer

Question 13

Hold-Harmless Agreement

Answer 13

is a common type of noninsurance transfer in which the transferee agrees to hold the transferor harmless in case of legal liability to others. The transferee agrees to pay claimants or the defense costs of claims or lawsuits, or to repay these losses if they fall on the transferor. If the transferee is unable to pay the losses, the ultimate responsibility remains with the transferor.

Question 14

The following four concepts help explain how insurance works?

Answer 14

• the insurance equation
• probability and uncertainty
• the law of large numbers
• adequate statistical data

Question 15

Insurance Equation

Answer 15

The equality between the sources of income and the uses of income constitutes the insurance equation. An insurer receives income from three sources: (1) premium payments from policyowners, (2) investment earnings, and (3) other income. The other side of the insurance equation includes the uses of this income: (1) covered losses, (2) the cost of doing business, or expenses, and (3) covered profits (retained earnings and dividends). The
tables below explain each of these cost factors.

Question 16

Probability of Uncertainty

Answer 16

Insurers try to avoid operating at a loss by applying probability concepts. Within calculable limits, the insurer can foresee the normal losses and can also estimate losses from catastrophes in order to compute the premium necessary to pay all losses, as well as to cover
expenses and profits.

Question 17

Law of Large Numbers

Answer 17

The law of large numbers is especially important to insurance. Also known as the law of averages, this principle states that as the number of independent events increases, the likelihood increases that the actual results will be close to the expected results.

Question 18

Adequate Data

Answer 18

Sound application of the mathematical laws of probability and large numbers requires adequate statistical data. Predictions in the form of probabilities must be based on adequate and accurate statistical information.

Question 19

The steps in risk management are:

Answer 19

• risk identification
• risk measurement
• choice and use of alternative methods of treatment
• risk administration

Question 20

Risk Identification

Answer 20

The process of risk management begins with risk identification, the careful and systematic discovery of all risks that confront a household or an organization.

Question 21

Techniques for Risk Identification?

Answer 21

• Survey forms
• Financial statement analysis
• Personal inspections
• Contract analysis

Question 22

What are the three ways risk management can be measured?

Answer 22

(1) loss frequency, (2) loss severity, and (3) variability

Question 23

Personal Insurance Building Blocks

Answer 23

1) Social Insurance
2) Employer Sponsored Insurance
3) Individual Insurance

Question 24

Cafeteria Plans?

Answer 24

A cafeteria plan allows employees to choose among several different types of benefits options, much as a person eating in a cafeteria decides among various available food items. In its purest form, a cafeteria plan gives employees a certain specified amount of employer-
provided dollars, and the employee may select which combination of available benefits will be purchased with these funds.

Question 25

Premium-conversion Plan?

Answer 25

Some cafeteria plans also permit the employee to obtain additional benefits and pay for them with salary deductions. Various cafeteria plan options enable employees to select a before-tax salary reduction to pay for their contributions to an employer-sponsored health
plan or to obtain certain other types of employee benefits. This option, called a premium- conversion plan, may be part of a broader cafeteria plan, or the premium-conversion plan may stand alone.

Question 26

Risk management

Answer 26

A systematic process for treating risks based upon risk identification, risk measurement, choice and use of methods of treatment and administration.

Question 27

Risk control

Answer 27

Risk management techniques used to minimize losses through such activities as avoidance, loss prevention, loss reduction and noninsurance transfers.

Question 28

Risk financing

Answer 28

risk management techniques used to pay for losses through such means as risk retention in the various ways and risk transfer, including insurance.

Question 29

Risk avoidance

Answer 29

A risk control method that involves not incurring certain types of risks or eliminating existing risks.

Question 30

Loss prevention

Answer 30

Risk control measures intended to lower the probability of loss or the frequency with which a given type of loss occurs. Loss prevention measures must obviously be put I place before loss occurs.

Question 31

Loss reduction

Answer 31

Risk control measures that aim to reduce the severity of loss. Loss reduction measures may be taken either before or after the loss occurs.

Question 32

Non-insurance transfer

Answer 32

The contractual transfer of risk by a contract other than an insurance contract. Subcontracting is an example.

Question 33

Risk retention

Answer 33

The risk financing method used when a person or organization keeps, or retains, the financial burden of any losses that occur rather than transferring them to an insurer or some other party.

Question 34

Deductible

Answer 34

The initial amount or portion of covered losses that is born by the insured, rather than by the insurance company.

Question 35

Self insurance

Answer 35

A formal program or risk retention usually characterized by factors necessary for a sound insurance enterprise, including funding based on actuarial calculations.

Question 36

Captive insurer

Answer 36

An insurance company owned by a parent corporation and formed primarily to insure the loss exposures of the parent company.

Question 37

Deductibles can be used to:

Answer 37

handle high-frequency, low-severity losses efficiently and are a form of partial risk retention.

Question 38

Self insurance is primarily applicable for:

Small business or personal insurance
or
Large companies or entities

Answer 38

Self-insurance is generally appropriate only for large businesses that can act like an insurance company for their own risks.

Question 39

Insurance equation?

Answer 39

Premiums plus investment earnings plus other income must equal losses, expenses, and profits.

Question 40

The law of large numbers states?

Answer 40

The law of large numbers states that as the number of independent events increases, there is a greater chance that the actual results will be close to the expected results.