Class 14

Question 1

General criteria to evaluate relative merits of alternatives RM tools

Answer 1

• choose tools to support org objectives

- choose tools to promote efficiency (org characteristics affect the efficiency of various options)

Question 2

choose tools to support org objectives

Answer 2

• vision/mission (which offer info on):
• risk attitude
• risk tolerance

Question 3

risk attitude

Answer 3

• relatives values of negative effects of risk
• risk averse or want more volatility?
• businesses make these decisions based on what shareholders want

Question 4

risk tolerance

Answer 4

• level of “acceptable” worst possible outcomes at given probability
• whats the point where you think there is too much volatility?

Question 5

choose tools to promote efficiency

Answer 5

• employ best opportunities to pool
• encourage efficient risk/loss control
• minimize current taxes

Question 6

pooling

Answer 6

• combining loss experience across a group (gives you a more accurate estimate)
• you have to factor in both peoples probabilities of loss (may include a loss amount per individual numerous times)

Question 7

equation for expected loss (mean)

Answer 7

loss1 (p1) + loss2 (p2) +…+ lossx (px)

Question 8

equation variance

Answer 8

(loss-mean)^2 * probability

Question 9

equation for stdev

Answer 9

sq. rt. (x-m)^2 * p (sq. rt. of variance)

Question 10

what is a benefit of pooling?

Answer 10

the stdev. per individual decreases

Question 11

mutually exclusive

Answer 11

don’t depend on one another

Question 12

collectively exhaustive

Answer 12

all outcomes considered

Question 13

consider what happens when many people pool their outcomes

Answer 13

• the expected loss per individual is unchanged

- the standard deviation per individual declines

Question 14

what happens to negatively correlated events?

Answer 14

they are dampened

Question 15

what happens to positively correlated events?

Answer 15

they are strengthened

Question 16

retention

Answer 16

pay for losses directly out of the org’s own funds; hence retain risk

Question 17

passive retention

Answer 17

not even being aware of the potential for loss

Question 18

most active retention

Answer 18

the formation of a separate insurance company (a captive) to accept the risks associated with potential losses for its owner

Question 19

value of retention

Answer 19

can be full value of possible negative consequences or it can be partial

Question 20

current expensing

Answer 20

paying losses as they occur as normal, current operating expenses
(common for retail-loss from shoplifting)

Question 21

reserving

Answer 21

• set up a liability account that reflects expected losses over a given time period;
• expense losses in each period even though they will be paid in the future (cannot deduct reserves for tax purposes)
• when losses actually occur, use liquid assets to pay for them and reduce reserves

Question 22

unfunded reserve

Answer 22

no assets are set aside to pay for losses when liability account is increased

Question 23

funded reserve

Answer 23

relatively liquid assets are set aside and designated to be used to pay for losses

Question 24

which type of reserve is more liquid?

Answer 24

funded reserves (and liquid assets have lower returns ,so expected return on resources is also lower)