Chapter 3, Lecture 3

Front 1

What is Risk Management?

Back 1

Risk management is a process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating such exposures.

Front 2

What forms of risk does new RM consider?

Back 2

Both speculative and pure risks

Front 3

What are the two categories of objectives Risk Management has?

Back 3

Risk Management has Pre-loss and Post-loss objectives

Front 4

What are some examples of Pre-Loss objectives?

Back 4

*Prepare for potential losses in the most economical way

*Reduce anxiety

*Meet any obligations

Front 5

What are some examples of Post-loss objectives?

Back 5

*Ensure survival of the firm

*Continue operations

*stabilize earnings

*Maintain growth

*Minimize the effects a loss have on other persons and society

Front 6

What are the steps of the Risk Management Process?

Back 6

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

Front 7

What are some examples of potential loss exposures?

Back 7

*Property loss exposures

*Personal loss exposure

*Liability loss exposure

*Loss of business income exposure

*HR Loss exposure

*Foreign loss exposures

Front 8

What are the sources of information Risk Managers use to identify loss exposure?

Back 8

*Questionnaires
*Physical inspection

*Flowcharts
*Financial statements
*Historic loss data

Note: Industry trends and market changes can create new loss exposures

Front 9

What is the process of Measuring and Analyzing risk as it pertains to the Risk Management Process?

Back 9

At this stage the Risk Manager estimates the frequency and severity of loss for each type of loss exposure.

Once the exposures are analyzed, they can be ranked according to their relative importance.

Front 10

What is Loss Frequency?

Back 10

Loss frequency refers to the probable number of losses that may occur over a given time period

Front 11

What is Loss Severity?

Back 11

Loss severity refers to the probable size of the losses that may occur

Front 12

Which is more important, loss frequency or loss severity?

Back 12

Loss severity is more important than loss frequency.

Front 13

What is maximum possible loss?

Back 13

MPL is the worst loss that could happen to the firm during its lifetime

Front 14

What is probable maximum loss?

Back 14

PBL is the worst loss that is likely to happen

Front 15

What is the main objective of selecting an appropriate combination of techniques?

Back 15

Risk control: The techniques that reduce the frequency and severity of losses

Front 16

What are some methods of risk control?

Back 16

*Avoidance

*Loss prevention

*Loss reduction

(Risk financing?)

Front 17

What is avoidance?

Back 17

Avoidance means a loss exposure is never acquired, or an existing loss exposure is abandoned

*Chance of loss is reduced to zero
*It is not always possible, or practical, to avoid all losses

Front 18

What is loss prevention?

Back 18

Measures that reduce the frequency of a particular loss

*installing safety feature on hazardous products

Front 19

What is loss reduction?

Back 19

measures that reduce the severity of a particular loss after it occurs

*installing an automatic sprinkler system

Front 20

Another technique is Risk Financing. What is risk financing?

Back 20

Risk financing are techniques that provide for the funding of losses

Front 21

What are the methods of risk financing?

Back 21

*Retention

*Non-insurance Transfers

*Commercial Insurance

Front 22

Risk Financing Methods: What is the retention level?

Back 22

The retention level is the dollar amount of losses that the firm will retain

*financially strong firm will have higher retention level
*Calculated as a percentage of firm's net working capital or annual earnings from current operations

Front 23

What are the methods a risk manager has for paying retained losses?

Back 23

Current net income: Losses are treated as a current expense

Unfunded reserve: Losses are deducted from a bookkeeping account

Credit line: funds are borrowed to pay losses as they occur

Front 24

When is retention effective used?

Back 24

*No other method of treatment is available

*The worst possible loss is not serious

*Losses are highly predictable

Front 25

What is the difference between active and passive risk retention?

Back 25

Active risk retention means that the firm is aware of loss and plans to retain all or part of it while passive risk retention is the failure to identify a loss exposure, failure to act, or forgetting to act

Front 26

Risk financing methods: Retention: what is a captive insurer?

Back 26

A captive insurer is an insurer owned by a parent firm for the purpose of insuring the parent firm's loss exposures

Front 27

What is a single-parent captive insurer?

Back 27

A captive insurer owned by only one parent

Front 28

What is an association captive insurer (group)?

Back 28

An insurer owned by several parents

Front 29

Why are captive insurers formed?

Back 29

* parent firm may have difficulty obtaining insurance

*take advantage of a favorable regulatory environment

*costs may be lower than purchasing commercial insurance

*Captive insurer has easier access to a reinsurer

*A captive insurer can become a source of profit

(premiums may be tax-deductible under certain conditions)

Front 30

Risk Financing methods: Retention: What is self-insurance?

Back 30

Self-insurance also known as self-funding is a special form of planned retention, all or part of a given loss is retained by the firm.

*widely used for workers comp and group health benefits

Front 31

What is a risk retention group?

Back 31

A risk retention group is a group captive that can write any type of liability coverage except employer liability, workers comp, and personal lines.

-employers, trade groups, and gov units etc can form risk retention groups

-exempt from many state insurance laws

Front 32

What are the advantages and disadvantages of the risk financing method: Retention?

Back 32

Advantages:
-Save on loss costs
-Save on expenses
-Encourage loss prevention

-increase cash flow

Disadvantages

-Possible higher losses
-Possible higher expenses

-Possible higher taxes

Front 33

What is the risk financing method: Non-insurance transfer?

Back 33

Non-insurance transfer is a method other than insurance by which a pure risk and its potential financial consequences are transferred to another party

ex. contracts, leases, hold-harmless agreements

Front 34

What are the benefits and cons of non-insurance transfers?

Back 34

Advantages:
-Can transfer some losses that are not insurable

-Save money

-Can transfer loss to someone who is in a better position to control losses


Disadvantages:

-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

Front 35

Risk financing method: insurance

Back 35

Insurance is appropriate for loss exposures that have a low probability of loss but for which the severity of loss is high

The risk manager picks the coverages needed and policy provisions

Front 36

What is a deductible?

Back 36

A provision by which a specified amount is subtracted from the loss payment otherwise payable to the insured

Front 37

What is an excess insurance policy?

Back 37

One in which the insurer does not participate in the loss until the actual loss exceeds the amount a firm has decided to retain

Front 38

What is the risk managers duty in regards to insurance?

Back 38

The risk manager selects the insurer(s) the coverages, and policy provisions.

RMs also negotiates the terms of the insurance contract

Periodically review insurance program

ensure insurance coverage info is disseminated

Front 39

What is a manuscript policy?

Back 39

A policy specially tailored for the firm.

-The language in the policy must be clear to both parties and they must agree on provisions, endorsements, forms, and premiums

Front 40

What are the advantages/disadvantages of risk financing: insurance?

Back 40

Advantages:

-Firm is indemnified for losses

-uncertainty is reduced

-insurers may provide other RM services

-premiums are tax deductible

Disadvantages:
-premiums may be costly (opp cost)

-negotiation of contracts takes time and effort

-risk manager may become lax in exercising loss control

Front 41

How do market conditions affect the selection of risk management techniques?

Back 41

Risk managers may have to modify their choice of techniques depending on market conditions in the insurance markets and underwriting cycle

Front 42

What is a "hard market" ?

Back 42

A "hard" market is characterized by declining profitability, tightened underwriting standards, increase in premiums and difficulty obtaining insurance

Front 43

What is a "soft market"?

Back 43

A "soft" market is characterized by improving profitability, loosened standards, declining premiums, and ease of obtaining insurance

Front 44

What does implementation of a risk management program start with?

Back 44

Implementation of a risk management program begins with a risk management policy statement

Front 45

What does the risk management policy statement do?

Back 45

A risk management policy statement:

-Outlines the firm's risk management objectives

-Outlines the firm's policy on loss control

-Educates top-level executives in regard to the risk management process

-gives the risk manager greater authority

-Provides standards for judging the risk manager's performance

Front 46

What is a risk management manual?

Back 46

A tool used to describe the risk management program and train new employees (non-execs)

Front 47

What is necessary for a successful risk management program?

Back 47

*A successful risk management program requires active cooperation from other departments in the firm

*Risk management program should be periodically reviewed and evaluated to determine whether objectives are being attained

Front 48

What are the activities of a typical risk manager?

Back 48

-Assisting with risk identification

-implementing loss prevention and control

-reviewing contracts and related documents

-providing training and safety education

-assuring governmental compliance

-arranging no-insurance financing

-claims management and defense

Front 49

What are the benefits of risk management?

Back 49

*Pre-loss and post-loss objectives are attainable

*a risk management program can reduce a firm's cost of risk

*Reduction in pure loss exposure allows a firm to enact an ERM program to treat both pure and speculative loss exposures

*society benefits because both direct and indirect losses are reduced

Front 50

What is personal risk management?

Back 50

The identification of pure risks faced by an individual or family, and to the selection of the most appropriate technique for treating such risks

(same process as the risk management process)

Front 51

What is the cost of risk?

Back 51

The cost of risk includes premiums paid, retained losses, outside risk management services, financial guarantees, internal administrative costs, taxes, fees, and other expenses

Front 52

What is the risk management matrix?

Back 52

Freq low, Sev low = Retention

Freq high, sev low = prevention and retention

Feq low, sev high = reduction and insurance

freq high, sev high = avoidance

Front 53

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Back 53

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