Chapter 3 Flashcards
How do you define risk management?
A process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating such exposures
What is a loss exposure?
Any situation or circumstance in which a loss is possible, regardless of whether a loss occurs
E.g., a plant that may be damaged by an earthquake, or an automobile that may be damaged in a collision
What are the pre-loss objectives of risk management?
- Prepare for potential losses in the most economical way
- Reduce anxiety
- Meet any legal obligations
What are the post-loss objectives of risk management?
- Survival of the firm
- Continue operating
- Stability of earnings
- Continued growth of the firm
- Minimize the effects that a loss will have on other persons and on society
What are the 4 steps of the risk management process?
- Identify potential losses
- Measure and analyze the loss exposures
- Select the appropriate combination of techniques for treating the loss exposures
4.Implement and monitor the risk management program
What are the 2 subsets of step 3 of the loss management process?
- Risk control
- Risk financing
Important loss exposures include:
- Property loss exposures
- Liability loss exposures
- Business income loss exposures
- Human resources loss exposures
- Crime loss exposures
- Employee benefit loss exposures
- Foreign loss exposures
- Intangible property loss exposures
- Failure to comply with government rules and regulations
Risk managers have several sources of information to identify loss exposures, those being:
- Risk analysis questionnaires and checklists
- Physical inspection
- Flowcharts
- Financial statements
- Historical loss data
Industry trends and market changes tend to…
create new loss exposures
Ex: Acts of terrorism
What two types of loss exposure are estimated for?
- Loss frequency
- Loss severity
Define loss frequency
Loss frequency refers to the probable number of losses that may occur during some time period
Define loss severity
Loss severity refers to the probable size of the losses that may occur
Loss severity is _____ than loss frequency.
More important
What is maximum possible loss?
The worst loss that could happen to the firm during its lifetime
What is maximum probable loss?
The worst loss that is likely to happen
Step 1 in the risk management process:
Identify potential losses, Risk Managers have several sources of information to identify loss exposures
Step 2 in the risk management process:
Measure and Analyze Loss Exposures, Estimate for each type of loss exposure, Rank exposures by importance
Step 3 in the risk management process:
Methods for Treating the Loss Exposure, Select the appropriate combination of techniques for treating the loss exposures
Risk control refers to:
Techniques that reduce the frequency and severity of losses
Methods of risk control include:
- Avoidance
- Loss prevention
- Loss reduction
- Duplication
- Separation
- Diversification
What is avoidance?
- Certain loss exposure is never acquired or undertaken, or an existing loss exposure is abandoned
- The chance of loss is reduced to zero
- It is not always possible, or practical, to avoid all losses
What is loss prevention?
Loss prevention refers to measures that reduce the frequency of a particular loss
e.g., installing safety features on hazardous products
What does loss reduction refer to?
Loss reduction refers to measures that reduce the severity of a loss after it occurs
e.g., installing an automatic sprinkler system
What does duplication mean?
Refers to having back-ups or copies of important documents or property available in case a loss occurs
What does seperation mean?
Dividing the assets exposed to loss to minimize the harm from a single event
What does diversification mean?
Spreading the loss exposure across different parties, securities, or transactions, to reduce the chance of loss
Define risk financing:
Techniques that provide for the payment of losses after they occur
3 Methods of risk financing are:
- Retention
- Non-insurance Transfers
- Commercial Insurance
Define retention in regards to handling risk:
The firm retains part or all of the losses that can result from a given loss
Retention is effectively used when:
- No other method of treatment is available
- The worst possible loss is not serious
- Losses are highly predictable
The retention level is:
The dollar amount of losses that the firm will retain
When handling risk via retention, risk managers can pay for retained losses by these ways:
- Current net income: losses are treated as current expenses
- Unfunded reserve: losses are deducted from a bookkeeping account
- Funded reserve: losses are deducted from a liquid fund
- Credit line: funds are borrowed to pay losses as they occur
What is a captive insurer and its two types?
Is an insurer owned by a parent firm for the purpose of insuring the parent firm’s loss exposures
- Single-parent captive
- An association or group captive
A single-parent captive:
A single-parent captive is owned by only one parent
An association or group captive:
An association or group captive is an insurer owned by several parents
What are reasons that a firm may form a captive insurer?
- The parent firm may have difficulty obtaining insurance
- To take advantage of a favorable regulatory environment
- Costs may be lower than purchasing commercial insurance
- A captive insurer has easier access to a reinsurer
- A captive insurer can become a source of profit
Premiums paid to a single parent (pure) captive are generally not income-tax deductible, unless:
- The transaction is a bona fide insurance transaction
- A brother-sister relationship exists
- The captive insurer writes a substantial amount of unrelated business
- The insureds are not the same as the shareholders of the captive
Premiums paid to a group captive are usually:
Income-tax deductible
Self-insurance or self-funding is:
a special form of planned retention by which part or all of a given loss exposure is retained by the firm
A risk retention group (R R G) is:
-A group captive that can write any type of liability coverage except employers’ liability, workers compensation, and personal lines
- They are exempt from many state insurance laws
What are some advantages of retention?
- Save on loss costs
- Save on expenses
- Encourage loss prevention
- Increase cash flow
What are some disadvantages of retention?
- Possible higher losses
- Possible higher expenses
- Possible higher taxes
Define non-insurance transfer:
Methods other than insurance by which a pure risk and its potential financial consequences are transferred to another party
Ex: contracts, leases, hold-harmless agreements
What are advantages of non-insurance transfers?
- Can transfer some losses that are not insurable
- Less expensive
- Can transfer loss to someone who is in a better position to control losses
What are disadvantages of non-insurance transfers?
- Contract language may be ambiguous, so transfer may fail
- If the other party fails to pay, firm is still responsible for the loss
- Insurers may not give credit for transfers
Insurance is appropriate for ______, _______ loss exposures.
low-probability, high severity loss exposures
The risk manager:
Selects the coverages needed, and policy provisions
A deductible is:
A specified amount subtracted from the loss payment otherwise payable to the insured
In an excess insurance policy:
The insurer pays only if the actual loss exceeds the amount a firm has decided to retain
Step 4 in the risk management process:
Implement and monitor the risk management program
Implementation of a risk management program begins with a:
risk management policy statement that:
- Outlines the firm’s objectives and policies
- Educates top-level executives
- Gives the risk manager greater authority
- Provides standards for judging the risk manager’s performance
A risk management manual may be used to:
- Describe the risk management program
- Train new employees
A successful risk management program requires:
Active cooperation from other departments in the firm
The risk management program should be:
-Periodically reviewed and evaluated to determine whether the objectives are being attained
- The risk manager should compare the costs and benefits of all risk management activities
What are the benefits of risk management?
- Enables firm to attain its pre-loss and post-loss objectives more easily
- A risk management program can reduce a firm’s cost of risk
- Reduction in pure loss exposures allows a firm to enact an enterprise risk management program to treat both pure and speculative loss exposures
- Society benefits because both direct and indirect losses are reduced
Personal risk management refers to:
The identification and analysis of pure risks faced by an individual or family, and to the selection of the most appropriate technique(s) for treating such risks
