Risk Management Chapter 3

Risk Management
process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating such exposures
loss exposure
any situation or circumstance in which a loss is possible, regardless of whether a loss occurs
objectives of risk management
pre-loss objectives
post-lost objectives
pre-loss objective
1. prepare for potential losses in the most economic way
2. reduction of anxiety
3. meet any legal obligations
post-loss objective
1. survival of the firm
2. continue operating
3. stability of earnings
4. growth of firm
5. social responsibility is to minimize the effects that a loss will have on other people and on society
steps in the risk management process
1. identify loss exposures
2. measure and analyze the loss exposures
3. select the appropriate combination of techniques for trading the loss exposures
4. implement and monitor the risk management program
Step 1: Identify/Classify loss exposures
I. property
II. human resources (people, who they are)
III. liability loss exposure
IV. net income (how you make money, components of it)
Types of property loss exposure
-real
-other tangible
-intangible –> cash, property
Classifying buildings/structures -knowing your risk
** COPE **
1. construction (wood, metal)
2. occupancy (who’s in it)
3. protection (sprinklers, burglar alarm)
4. exposure (buildings around it and near it)
types of human resource exposures
-circumstances with employees which could lead to a loss?
-laying off
-anything an employee does
-doing something wrong
-injuries
-death of a key employee
-retirement
types of liability exposures (arise out of other classifications)
-circumstances which could lead to a liability related loss
-copyright infringement, defective products made from employees, sexual harassment, pollution, mismanagement of company
types of net income exposure
-lead to net income loss
-damage to certain property, legal, political change, environmental factors (if they rely on wheat for example)
loss exposure identification methods
-physical inspections
-check-list, questionnaires
-consult with people
***-financial statements, flowcharts, historical loss data
***-review insurance policies
—9 times out of 10 they are in writing
5 checklist types
1. list of assets (account for all assets)
2. activity/situation list
3. perils analysis (understand human, economic, natural perils)
4. insurance checklist (know exclusions)
5. industry list (specific to industry)
Step 2: Measure and analyze the the loss exposure
Frequency and Severity
Important because…
1. rank relative to importance/risk tolerance
2. allows risk manager to choose best RM technique
***if regular + predictable–can retain
Step 3: selecting the best RM techniques
1. risk control
—1. avoidance –> dont do it
—2. loss prevention –>reduce FREQUENCY ex. safe driving course
—3. loss reduction –> reduce SEVERITY ex. air bags

2. risk financing
—1. retention–>decision to retain, active and passive
—2. non insurance transfer –> entity type + identity agreement/contract
RETENTION:
-captive
-self-insurance (SIR or deductible)
-risk retention groups

advantages of retaining
1. save on lost costs
-x losses premium (do better save money)
2. save on insurer expenses
3. encourage loss prevention
4. increase cash flow –> pay as you go
disadvantages of retaining
1. worse on loss costs
2. possible higher expenses
3. possible higher taxes
non-insurance advantages
1. can transfer risk to someone you can’t buy insurance from
2. often costs nothing
3. intent can be shifted to someone better suited
non-insurance disadvantages
1. fails if you don’t write contract right way
2. transfer is transferred to someone who can’t pay the loss, firm still responsible
3. may not give credit for the transfers, and insurance costs may not be reduced
insurance
1. selection of insurance coverage
2. selection of insurer
3. negotiation of terms
4. dissemination of information concerning insurance coverage
5. periodic review of the program
selecting insurer
1. policy holder surplus (Assets-liabilities)
2. reserves for outstanding liabilities
—1 and 2: financial strength
3. types of insurance they write
4. quality of management
advantages of insurance
1. indemnified after loss occurs
2. worry and fear are reduced
3. can provide valuable risk management such as loss control services, loss exposure
4. insurance premiums are income tax deductible
disadvantages of insurance
1. payment of premiums is a major cost
2. considerable time and effort must be spent in negotiating the insurance coverage
3. the risk manager may have less incentive to follow a loss control program because the insurer will pay the claim if a loss occurs
underwriting problems
hard market: prices going up, profitability is declining, premiums increase, insurance is expensive

soft market: profitability is improving, premiums decline, insurance is easier to obtain

step 4: implement and monitor RM program
1. risk management policy statement
2. risk management manual
3. cooperate with other departments
4. periodic review and evaluation
benefits of risk management
1. attain its pre-loss and post-loss objectives easily
2. cost of risk is reduced, increase company’s profits
3. enact an enterprise risk management program that treats both pure and speculative loss exposures
4. pain and suffering reduce–> society benefits