Chapter 3: Introduction to Risk Mgmt

Question 1

What is Risk Management?

Answer 1

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.

Question 2

What are the pre-loss objectives of Risk Management?

Answer 2

Prepare for potential losses in the most economical way
Reduce anxiety
Meet any legal obligations

Question 3

What are the post-loss objectives of Risk Management?

Answer 3

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

Question 4

List the steps in the Risk Management Process.

Answer 4

1. Identify potential losses
2. Measure and analyze the loss exposures
3. Select the appropriate combination of techniques for treating the loss exposures
4. Implement and monitor the risk management program

Question 5

What important loss exposures should be identified? (if time permits)

Answer 5

• Property
• Liability
• Business income
• HR
• Crime
• Employee benefit
• Foreign
• Intangible property
• Failure to comply with government rules and regulations

Question 6

What are some sources of information for identifying loss exposures? (if time permits)

Answer 6

• Risk analysis questionnaires and checklists
• Physical inspection
• Flowcharts
• Financial statements
• Historical loss data

Question 7

Loss frequency vs severity:

Answer 7

Freuqency: The probable number of losses that may occur during some time period.

Severity: The probable size of the losses that may occur.

Question 8

True or False: Loss severity is more important than loss frequency.

Answer 8

True

Question 9

What is avoidance in risk control?

Answer 9

A certain loss exposure is never acquired or undertaken, or an existing loss exposure is abandoned.

Question 10

What is loss prevention?

Answer 10

Measures that reduce the frequency of a particular loss, such as installing safety features.

Question 11

What is loss reduction?

Answer 11

Measures that reduce the severity of a loss after it occurs, such as installing an automatic sprinkler system.

Question 12

What does duplication mean in risk control?

Answer 12

Having back-ups or copies of important documents or property available in case a loss occurs.

Question 13

What is separation in risk control?

Answer 13

Dividing the assets exposed to loss to minimize the harm from a single event.

Question 14

What does diversification mean in risk control?

Answer 14

Spreading the loss exposure across different parties, securities, or transactions to reduce the chance of loss.

Question 15

What is risk financing? Method?

Answer 15

Techniques that provide for the payment of losses after they occur.

Methods:
Retention
Non-insurance Transfers
Commercial Insurance

Question 16

What is retention in risk financing?

Answer 16

The firm retains part or all of the losses that can result from a given loss.

Question 17

What are some methods of paying retained losses?

Answer 17

Current net income (current expense)
Unfunded reserve (deduct from book account)
Funded reserve (liquid)
Credit line (borrow)

Question 18

What is a captive insurer?

Answer 18

An insurer owned by a parent firm for the purpose of insuring the parent firm’s loss exposures.

Question 19

What is a single-parent captive?

Answer 19

A captive insurer owned by only one parent.

Question 20

What are reasons for forming a captive insurer?

Answer 20

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

Question 21

When are premiums paid to a single-parent captive generally not income-tax deductible unless

(if time permit)

Answer 21

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

Question 22

What is self-insurance?

Answer 22

A special form of planned retention by which part or all of a given loss exposure is retained by the firm.

Question 23

What is a risk retention group (RRG)?

Answer 23

A group captive that can write any type of liability coverage except employers’ liability, workers compensation, and personal lines.

Question 24

List some advantages + disadvantages of retention.

Answer 24

Save on loss costs and expenses, Encourage loss prevention, Increase cash flow

possible higher losses, expenses, and taxes

Question 25

What are non-insurance transfers?

Answer 25

Methods other than insurance by which a pure risk and its potential financial consequences are transferred to another party.

Question 26

List advantages of non-insurance transfers.

Answer 26

* Can transfer some losses that are not insurable * Less expensive * Can transfer loss to someone who is in a better position to control losses

Question 27

List disadvantages of non-insurance transfers.

Answer 27

* 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

Question 28

What type of loss exposures is commercial insurance appropriate for?

Answer 28

Low-probability, high-severity loss exposures.

Question 29

What is a manuscript policy?

Answer 29

A policy specially tailored for the firm, where the parties must agree on contract provisions, endorsements, forms, and premiums.

Question 30

List advantages of insurance.

Answer 30

* Firm is indemnified for losses * Uncertainty is reduced * Firm may receive valuable risk management services * Premiums are income-tax deductible

Question 31

List disadvantages of insurance.

Answer 31

* Premiums may be costly * Negotiation of contracts takes time and effort * Risk manager may become lax in exercising loss control

Question 32

What is the underwriting cycle in the insurance market?

Answer 32

* Hard market: profitability declining, underwriting standards tightened, premiums increase * Soft market: profitability improving, standards loosened, premiums decline

Question 33

What begins the implementation of a risk management program?

Answer 33

A risk management policy statement.

Question 34

What are the benefits of a risk management program?

Answer 34

* 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

Question 35

What is personal risk management?

Answer 35

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.

Question 36

Methods of risk control

Answer 36

avoidance loss prevention loss reduction duplication separation diversification

Question 37

Maximum possible loss VS probable maximum loss

Answer 37

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

Question 38

Premiums paid to a ___ are usually income-tax deductible

Answer 38

group captive

Question 39

Risk management is concerned with

Answer 39

the identification and treatment of loss exposures

Question 40

A risk manager is concerned with which of the following? I. Identifying potential losses II. Selecting the appropriate techniques for treating loss exposures

Answer 40

Both

Question 41

The worst loss that is likely to happen is referred to as the

Answer 41

probable maximum loss

Question 42

Which of the following statements about the use of a captive insurance company by a parent firm is true? 1. The captive may not write outside, non-parent company, business 2. Captives are not permitted to use reinsurance, so any business insured by the captive stays with the captive 3. The captive may be used to insure loss exposures that the parent firm finds it difficult to insure with private insurers 4. Business placed with the captive is always considered retained risk and is never considered transferred risk

Answer 42

3. The captive may be used to insure loss exposures that the parent firm finds it difficult to insure with private insurers

Question 43

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

Answer 43

excess insurance

Question 44

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

Answer 44

It results in considerable fluctuations in earnings after losses occur

Question 45

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

Answer 45

identify potential losses faced by XYZ Company

Question 46

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?

Answer 46

loss prevention

Question 47

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.

Answer 47

II only