Chapter 6 - Risk Treatment Flashcards
What are the options for risk treatment?
- Eliminate
- Control
- Transfer
- Retain
Describe risk elimination
Involves closing the part of the business or activity that causes the risk
Describe risk control
Range of risk controls that seek to remove or improve the risk. i.e. monitoring complaint numbers to understand the effectiveness of training
Describe risk transfer
Passing the risk to another party by means of a contract conditions
Describe risk retention
Where a risk of low maturity and cost of controls is uneconomical, firm may decide to tolerate the risk
What are the downsides of risk elimination?
- Economic costs (ceasing profitable but risky operations)
- Unintended consequences (may increase the probability of another risk with the elimination of the current risk
When is the best time to achieve risk avoidance?
At the design/planning stage
What are the four control risk categories?
- Preventive
- Corrective
- Detective
- Directive
Examples of corrective tools
- Contract terms
- Business continuity planning
- Diversification of business risk
- Diversification of financial investment risk
Examples of directive controls
- Rules and training
- Procedural Manuals
- Job descriptions
What is a potential weakness of directive controls?
Human factor
Examples of detective controls
- Accident Investigations
- Fraud detection
- Audits and Inspections
How do we measure cost effectiveness of controls
Difference between inherent risk and residual risk. Difference must be at least greater than the cost of implementing the measure
What are the advantages of insurance as a vehicle for risk transfer?
- Economic vehicle for sharing exposures with a large number of other organisations
- Insurers have wealth of experience in risk and risk funding mechanisms
- insurers can provide additional services
- Fast access to insurance funds means organisations have more cash for long term investments
- Co-insurance
- Premiums may be tax deductible
What are the disadvantages of insurance as a vehicle for risk transfer?
- Insurers look at cause of loss whilst organisations see severity of loss
- Insurers want to contain risk acceptance and pricing to a short period
- Policies offered may not include risks that are the greatest concern to the organisation
Define CAT bonds?
Catastrophe bonds - provide returns based on insurance type events, life is 3-5 years. A trigger mechanism would be determined in the bond
Why do people invest in securitisation and securitised risk products
- Spread risk of their portfolios
- High Cat. losses have exposed the inability of the insurance market to respond adequately.
Examples of transfers by contract
- Leases and hiring agreements
- Surety agreements
- Guarantees
- Waivers
- Indemnity and ‘hold harmless’ agreements
- Disclaimers
What is a surety agreement
A contract between 3 parties where the surety takes the risk that the principal to a contract does not perform or complete, but can claim back losses from the principal
What is a guarantee?
A contract between 2 parties where the guarantor takes the risk the principal to a contract does not complete or perform
What is a waiver?
Where the contracting party gives up, for a financial consideration, its rights to sue in the event of a breach on contract.
What is an indemnity and ‘hold harmless’ agreement?
Agreements between two parties designed to release one from legal claims
How to finance risk retention
- Non replacement
- Current expense
- Contingency reserve
- Internal risk fund
- Captive Insurance company
- Borrowing
Non Replacement
Organisation absorbs the loss out of income and does not replace the asset
