Module 2 - Risk Concepts and Employee Benefit Planning Flashcards
(A) Risk and Employee Benefits
Definition of Risk
- Risk means uncertainty with respect to personal loss
- The inability to determine a future loss and figure out how expensive it will be should the loss take place
- Loss is meant to convey any decrease in value suffered
(A)1 Risk and Employee Benefits
Peril and Hazard Distinguished from Risk
Peril and hazard are insurance terms used primarily in property and liability insurance but also in life and health insurance.
(A-1A) Risk and Employee Benefits
Peril and Hazard Distinguished from Risk
Definition of Peril
- Defined as the cause of personal or property loss, destruction, or damage.
- Common perils involving property are fires, floods, earthquakes, thefts, burglaries
- Common perils involving personal are illnesses, bodily injuries, and death
- Originally called death insurance and accident and sickness policies but their names were changed for euphemistic and marketing reasons
(A-1B) Risk and Employee Benefits
Peril and Hazard Distinguished from Risk
Definition of Hazard
- A condition that either increases the probability that a peril will occur or that tends to increase the los when a peril has struck
(A-1C) Risk and Employee Benefits
Peril and Hazard Distinguished from Risk
3 Types of Hazards
1 - Physical Hazards
2 - Moral Hazards
3 - Morale Hazards
(A-1D) Risk and Employee Benefits
Peril and Hazard Distinguished from Risk
Define Physical Hazard
- Physical conditions that fit within the definition of hazard.
- Examples in the workplace; presences of flammable materials and absence of fire extinguishing equipment, machines without appropriate safety devices, faulty heating and air conditioning units.
(A-1E) Risk and Employee Benefits
Peril and Hazard Distinguished from Risk
Define Moral Hazard
- Dishonest, unethical, and immoral people
- Examples; those who steal from the employer, purposely damage employer property, file fraudulent medical claims, abuse sick leave and PTO, file false overtime and expense statements
(A-1F) Risk and Employee Benefits
Peril and Hazard Distinguished from Risk
Define Morale Hazard
- Exist when people act with carelessness or indifference
- Examples; individuals who appear to be accident prone or disaster prone, failure to lock rooms, vaults, or areas from which valuable items are stolen, forgetting to notify the ER of faulty materials that cause personal injuries, ignoring the fact that a number of employees all experience the same symptoms of physical discomfort, which ultimately can be traced to a job-related cause.
(A2) Risk and Employee Benefits
Types of Risk - 2 Types
1 - Pure Risk
2 - Speculative Risk
(A2) Risk and Employee Benefits
Types of Risk - PURE RISK
Pure risk is risk in which only two alternatives are possible
1 - either the risk will not happen (no financial loss)
2 - it will happen (financial loss)
Example - Illness, loss from fire, auto accident, unemployment, disability, theft of property, earthquake
Pure risk for the most part can be insured
(A2) Risk and Employee Benefits
Types of Risk - SPECULATIVE RISK
The possibility of gain.
Three potential outcomes -
1 - loss
2 - no loss
3 - gain
Example - purchase of a share of common stock, acquiring a new business, gambling
(A3) Risk and Employee Benefits
Pure Risk - 3 Classifications
1 - Personal Risk
2 - Property Risk
3 - Legal Liability Risk
(A-3A) Risk and Employee Benefits
Personal Risk
- The most important classification of pure risk from an employee benefit standpoint
- Losses that have a direct impact on an individuals life or health
- Death, illness, accidents, unemployment, and old age are all considered to be personal losses
- Measured with some degree of accuracy
- By estimating potential lost income from a particular loss or medical expense associated with it, one can approximate the potential loss.
- With that information, one can estimate needed protection and seek insurance appropriately.
(A-3B) Risk and Employee Benefits
Property Risk
- The uncertainty (possible loss) that decreases the value of one’s real or personal property.
- Examples; fire, flood, earthquake, wind, theft, and automobile collisions
- The home, furniture, jewelry, cars would be the types of property losses
(A-3C) Risk and Employee Benefits
Legal Liability Risk
- A loss resulting from negligent actions of a person that result in injury to another person.
- Stems from lawsuits by the injured party seeking damages from the negligent party
- Common sources; negligent behavior associated with automobiles, ones home or business, sale of products, professional misconduct (malpractice)
- UNLIMITED POTENTIAL LOSS
(A4) Risk and Employee Benefits
Methods of Handling Risk - 5 Types
1 - Avoidance 2 - Control 3 - Retention 4 - Transfer 5 - Insurance
(A-4A) Risk and Employee Benefits
Methods of Handling Risk
Type 1 - AVOIDANCE
- One does not acquire the risk to begin with and hence wold not be subject to risk
- One is unable to avoid some risks and attention to them must be focused on the alternatives
- it is almost impossible to use the avoidance technique in employee benefits - how does one avoid death or illness?
(A-4B) Risk and Employee Benefits
Methods of Handling Risk
Type 2 - CONTROL
- A mechanism by which one attempts either to prevent or reduce the probability of a los taking place, or to reduce the severity of the los after it has taken place
- Examples; smoke detectors, fire-resistant building materials, seats belts, air bags, etc.
- Employee Benefits use control in conjunction with insurance as any procedure used to reduce or prevent accidents, illnesses, or premature death would help in lowering the cost of most benefit plans.
- Employers adopt accident prevention programs with intent of lowering workers comp and other EB costs as well as improving employees health and welfare
(A-4C) Risk and Employee Benefits
Methods of Handling Risk
Type 3 - RETENTION
- The risk is assumed and paid for by the person suffering the loss.
- Used with losses that are small in terms of financial impact on a person or company
- Sometimes more economical to retain the risk that it is to insure it - CAR example
(A-4D) Risk and Employee Benefits
Methods of Handling Risk
Type 4 - TRANSFER
Two Forms of Transfer
- One switches or shifts the financial burden of risk to another party
- Example; landlord charges a security deposit, travel agent having client sign a waiver if they are visiting a place of war
- Non-insurance transfers do not typically serve as risk handling measures in EBP
1 - Insurance
2 - Non-Insurance
(A-4E) Risk and Employee Benefits
Methods of Handling Risk
Type 5 - INSURANCE
-The Pooling of fortuitous losses by transfer of such risks to insurers who agree to indemnify insures for such losses or to render services connected with the risk
- A common method of financing employee benefits
- Important to clarify the difference between insurance and gambling
- Insurance is a mechanism for handling an existing risk; based on a mutual sharing of any losses that occur; pure risk
- Gambling creates a risk where one did not previously exist; involves a gain for one party (winner) and the expense or another (loser - remains in a negative situation); speculative risk
(A5) Risk and Employee Benefits
Summary of Risk-Handling Alternatives
- Long Term Care Techniques
- Insurance = Transfer
- Proper Health Care and Living Conditions = Control
- Finding a way to pay for the loss out of savings or income = Retention
(B1) Insurance and Insurable Risk
Advantages of Insurance
- Known Premium (cost); set in advanced by the insurance company
- Outside administrator can be an advantage to the employer - employer does not have to be involved with employee coverage
- More economical for an employer to use insurance rather than other alternatives as the insurance company may be more efficient and able to do the job for a lower cost
(B2) Insurance and Insurable Risk
Disadvantages of Insurance
- Insurance companies charge administrative expenses that are added to the premium to compensate for their overhead expenses
- Employer satisfaction is directly impacted by the insurers ability to handle claims and solve problems; slow payment or restrictive claim practices can have an adverse effect on employees
