Chapter 3 - Introduction To Risk Management Flashcards
What is the process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating such exposures.
Risk management
Define loss exposure
is any situation of circumstance in which a loss is possible, regardless of whether a loss actually occurs.
Risk management has two important objectives. these objectives are?
Pre-loss Objectives
Post-loss Objectives
Pre-loss objectives- important objectives before a loss occurs include _____, ______, and ________. (3)
Economy, reduction of anxiety, and meeting legal obligations
Post-loss objectives- important objectives after a loss occurs include ________, _______,______,______, and _____. (5)
Survival of the firm, continued operations, stability of earnings, continued growth, and social responsibility.
What are the four steps in the risk management process?
- identify loss exposures
- measure and analyze the loss exposures
- select the appropriate combination of techniques for treating the loss exposures
- implement and monitor the risk management program
What are the NINE important loss exposures? (Mahaha)
- 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 laws and regulations
What are the five sources of information to identify the preceding loss exposures?
- risk analysis questionnaires and checklists
- physical inspection
- flowcharts
- financial statements
- historical loss data
What does the loss frequency refer to?
refers to the probable number of losses that may occur during some given time period.
What refers to the probable size of the losses that may occur?
Loss severity
What refers to techniques that reduce the frequency or severity of losses?
risk control
What does risk financing refer to?
refers to techniques that provide for the funding of losses.
What are the three major risk-control techniques?
- Avoidance
- Loss prevention
- Loss reduction
What are the three major risk financing techniques?
- Retention
- Non-insurance transfers
- Commercial insurance
Define retention
means that the firm retains part or all of the losses that can result from a given loss.
Retention can be effectively used in a risk management program under the following conditions: (3)
- no other method of treatment is available
- the worst possible loss is not serious
- losses are fairly predicable
If retention is used, the risk manager must have some method for paying losses. the following methods are typically used: (4)
- 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
Define captive insurer
an insurer owned by a parent firm for the purpose of insuring the parent firm’s loss exposures.
Define a single parent captive (pure captive)
an insurer owned by only one parent, such as a corporation.
Define association or group captive
is an insurer owned by several parents
What are the six main reason captive insurers are formed?
- Parent company may have difficulty in obtaining insurance
- To take advantage of favorable regulatory environment
- lower costs
- easier access to a re-insurer
- formation of a profit center
- may be income-tax advantages to the parent under certain circumstances
True or False
premiums paid to a single parent captive (pure Captive) are NOT income- tax deductible
True
The IRS argued that there is no substantial transfer of risk from an economic family to an insurer, and that the premiums paid are similar to contributions to a self-insurance reserve.
Premiums paid to captives are not income-tax deductible unless some or all of the following factors are present: (4)
- The transaction is a bona fide insurance transaction, and the captive insurer takes some risk under a defensible business plan.
- the captive insure’s owner is organized such that subsidiaries, and not the parent, pay premiums to the captive insurer under a “brother-sister” relationship. (the term brother-sister refers to separate subsidiaries owned by the same parent, such as a captive insurer and an operating subsidiary.)
- The captive insurer writes a substantial amount of unrelated business.
- ownership of the captive insurer is structured so that the insureds are not the same as the shareholders.
Define risk retention group (RRG)
is a group captive that can write ant type if liability coverage except employers’ liability, workers compensation, and personal lines.
What are the four advantages of the risk retention technique?
- save on loss costs
- save on expenses
- encourage loss prevention
- increase cash flow
What are the three disadvantages of the retention technique?
- Possible higher losses
- Possible higher expenses
- Possible higher taxes
Define non-insurance transfers
are methods other than insurance by which a pure risk and its potential financial consequences are transferred to another party. Ex: contracts, leases, and bold-harmless agreements.
What are the three advantages of a non-insurance transfers?
- the risk manager can transfer some potential losses that are not commercially insurable
- non-insurance transfers often cost less than insurances
- the potential loss may be shifted to someone who is in a better position to exercise loss control.
What are the three disadvantages of a non-insurance transfers?
- the transfer of potential loss may fail because of the contract language is ambiguous
- if the part to whom the potential loss is transferred is unable to pay the loss, the firm is still responsible for the claim
- an insurer may not give credit for the transfers, and insurance costs may not be reduced
What are the five key areas that must be emphasized when using commercial insurance?
- selection of insurance coverage
- selection of an insurer
- negotiation of terms
- dissemination of information concerning insurance coverages
- periodic review of the insurance program
What are the four advantages of commercial insurance in a risk management program?
- the firm will be indemnified after a loss occurs.
- uncertainty is reduced, which permits the firm to lengthen its planning horizon
- insurers can provide valuable risk management services, such as risk-control services, loss exposure analysis, and claims adjusting
- insurance premiums are income-tax deductible as a business expense
What are the three disadvantages of commercial insurance in a risk management program?
- The payment of premiums is a major cost because the premiums consists of a component to pay losses, an amount to cover the insurer’s expenses, and an allowance for profit and contingencies. There is also an opportunity cost.
- Considerable time and effort must be spent in negotiating the insurance coverage.
- the risk manager may have less incentive to implement loss-control measures because the insurer will pay the claim if a loss occurs.
What is the appropriate risk management technique for a low frequency and low severity of loss? Ex: potential theft of office supplies.
Retention because the loss occurs infrequently and, when it does occur, it seldom causes financial harm
What is the appropriate risk management technique for a loss occur frequently, but severity is relatively low? Ex: physical damage losses to automobiles, workers compensation claims, shoplifting, and food spoilage.
Loss prevention and retention
Loss prevention should be used here to reduce the frequency of losses. loesses occur regularly and are predicable, the retention technique can also be used
What is the appropriate risk management technique for a low-frequency, high-severity losses. High severity means that a catastrophic potential is present, while a low probability of loss indicates that the purchase of insurance is economically feasible. Ex: fires, explosions, natural disasters, and liability lawsuits.
Transfer including insurance
The risk manager could also use a combination of retention and commercial insurance to deal with these exposures.
What is the appropriate risk management technique for a high frequency and high severity. Ex: harmful side effects of a new drug.
Avoidance. The exposure to liability arising from this drug can be avoided of the drug is not produced and sold.
What happens during a period of hard market conditions?
Profitability is declining, or the industry is experiencing underwriting losses.
As a result, underwriting standards tighten, premiums increase, and insurance becomes expensive and more difficult to obtain. A risk manager may decide to retain more of a given loss exposure and cut back on the amount of insurance purchased.
What happens during a period of soft market conditions?
profitability improving, underwriting standards loosen, premiums decline, and insurance is easier to obtain. Insurance may be viewed as relatively inexpensive. A risk manager may decide to retain less of a given loss exposure and increase the amount of insurance purchased.
What are the four benefits of risk management?
- a formal risk management program enables a firm to attain its pre-loss and post-loss objectives more easily
- the cost of risk is reduced which may increase the company’s profits
- the adverse financial impact of pure loss exposures is reduced, a firm may be able to implement an enterprise risk management program that treats both pure and speculative loss exposures
- society also benefits since both direct and indirect losses are reduced.
Define personal risk management
the identification and analysis of pure risks faced by an individual or family, and to the selection and implementation of the most appropriate technique for treating such risks.
What are the four steps that is involved in a personal risk management program?
- identify loss exposures
- measure and analyze the loss exposures
- select appropriate techniques for treating the loss exposures
- implement and review the risk management program periodically.
What are the four implementation of a risk management program that involve the risk management policy statement?
- outlines the firm’s objectives and polices
- educates top-level executives
- gives the risk manager great authority
- provides standards for judging the risk manager’s performance
