Chapter 3: Introduction to Risk Mgmt Flashcards
What is Risk Management?
A process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating such exposures
A loss exposure is any situation or circumstance in which a loss is possible, regardless of whether a loss occurs, such as 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
List the steps in the Risk Management Process.
- Identify potential losses
- 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 important loss exposures should be identified? (if time permits)
- Property
- Liability
- Business income
- HR
- Crime
- Employee benefit
- Foreign
- Intangible property
- Failure to comply with government rules and regulations
What are some sources of information for identifying loss exposures? (if time permits)
- Risk analysis questionnaires and checklists
- Physical inspection
- Flowcharts
- Financial statements
- Historical loss data
Loss frequency vs severity:
Freuqency: The probable number of losses that may occur during some time period.
Severity: The probable size of the losses that may occur.
True or False: Loss severity is more important than loss frequency.
True
What is avoidance in risk control?
A certain loss exposure is never acquired or undertaken, or an existing loss exposure is abandoned.
What is loss prevention?
Measures that reduce the frequency of a particular loss, such as installing safety features.
What is loss reduction?
Measures that reduce the severity of a loss after it occurs, such as installing an automatic sprinkler system.
What does duplication mean in risk control?
Having back-ups or copies of important documents or property available in case a loss occurs.
What is separation in risk control?
Dividing the assets exposed to loss to minimize the harm from a single event.
What does diversification mean in risk control?
Spreading the loss exposure across different parties, securities, or transactions to reduce the chance of loss.
What is risk financing? Method?
Techniques that provide for the payment of losses after they occur.
Methods:
Retention
Non-insurance Transfers
Commercial Insurance
What is retention in risk financing?
The firm retains part or all of the losses that can result from a given loss.
What are some methods of paying retained losses?
Current net income (current expense)
Unfunded reserve (deduct from book account)
Funded reserve (liquid)
Credit line (borrow)
What is a captive insurer?
An insurer owned by a parent firm for the purpose of insuring the parent firm’s loss exposures.
What is a single-parent captive?
A captive insurer owned by only one parent.
What are reasons for forming a captive insurer?
Difficulty obtaining insurance
To take advantage of a favorable regulatory environment
Costs may be lower than purchasing commercial insurance
Easier access to a reinsurer
Can become a source of profit
When are premiums paid to a single-parent captive generally not income-tax deductible unless
(if time permit)
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
What is self-insurance?
A special form of planned retention by which part or all of a given loss exposure is retained by the firm.
What is a risk retention group (RRG)?
A group captive that can write any type of liability coverage except employers’ liability, workers compensation, and personal lines.
List some advantages + disadvantages of retention.
Save on loss costs and expenses, Encourage loss prevention, Increase cash flow
possible higher losses, expenses, and taxes
What are non-insurance transfers?
Methods other than insurance by which a pure risk and its potential financial consequences are transferred to another party.
List 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
List disadvantages of non-insurance transfers.
- Contract language may be ambiguous
- If the other party fails to pay, firm is still responsible for the loss
- Insurers may not give credit for transfers
What type of loss exposures is commercial insurance appropriate for?
Low-probability, high-severity loss exposures.
What is a manuscript policy?
A policy specially tailored for the firm, where the parties must agree on contract provisions, endorsements, forms, and premiums.
List advantages of insurance.
- Firm is indemnified for losses
- Uncertainty is reduced
- Firm may receive valuable risk management services
- Premiums are income-tax deductible
List disadvantages of insurance.
- Premiums may be costly
- Negotiation of contracts takes time and effort
- Risk manager may become lax in exercising loss control
What is the underwriting cycle in the insurance market?
- Hard market: profitability declining, underwriting standards tightened, premiums increase
- Soft market: profitability improving, standards loosened, premiums decline
What begins the implementation of a risk management program?
A risk management policy statement.
What are the benefits of a risk management program?
- Enables firm to attain pre-loss and post-loss objectives more easily
- Can reduce a firm’s cost of risk
- Reduction in pure loss exposures allows for enterprise risk management
- Society benefits as both direct and indirect losses are reduced
What is personal risk management?
The identification and analysis of pure risks faced by an individual or family, and the selection of the most appropriate technique(s) for treating such risks.
Methods of risk control
avoidance
loss prevention
loss reduction
duplication
separation
diversification
Maximum possible loss VS probable maximum loss
The maximum possible loss is the worst loss that could happen to the firm during its lifetime
The probable maximum loss is the worst loss that is likely to happen
Premiums paid to a ___ are usually income-tax deductible
group captive
Risk management is concerned with
the identification and treatment of loss exposures
A risk manager is concerned with which of the following?
I. Identifying potential losses
II. Selecting the appropriate techniques for treating loss exposures
Both
The worst loss that is likely to happen is referred to as the
probable maximum loss
Which of the following statements about the use of a captive insurance company by a parent firm is true?
- The captive may not write outside, non-parent company, business
- Captives are not permitted to use reinsurance, so any business insured by the captive stays with the captive
- The captive may be used to insure loss exposures that the parent firm finds it difficult to insure with private insurers
- Business placed with the captive is always considered retained risk and is never considered transferred risk
- The captive may be used to insure loss exposures that the parent firm finds it difficult to insure with private insurers
ABC Insurance retains the first $1 million of each property damage loss and purchases reinsurance for that part of any property loss that exceeds $1 million. The insurance for property losses above $1 million is called
excess insurance
All of the following are disadvantages of using insurance in a commercial risk management program EXCEPT
There is an opportunity cost because premiums must be paid in advance
Considerable time and effort must be spent selecting and negotiating coverages
It results in considerable fluctuations in earnings after losses occur
Attitudes toward loss control may become lax when losses are insured
It results in considerable fluctuations in earnings after losses occur
Cal was just hired as XYZ Company’s first risk manager. Cal would like to employ the risk management process. The first step in the process Cal should follow is to
identify potential losses faced by XYZ Company
Parker Department Stores has been hurt in recent months by a large increase in shoplifting losses. Parker’s risk manager concluded that while the frequency of shoplifting losses was high, the severity is still relatively low. What is (are) the appropriate risk management technique(s) to apply to this problem?
loss prevention
Which of the following statements about a personal risk management program is (are) true?
I. Insurance and retention are the only techniques used to handle potential losses.
II. The steps in a personal risk management process are the same steps used by businesses.
II only
