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38 Cards in this Set
- Front
- Back
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Pre - loss objectives |
- survival and growth - compliance with government regulations - efficiency - procedures and principles are implemented and followed |
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Post - loss objectives |
- survival - continue operating - stability of earnings - continued growth of firm - social responsibility- minimize effects that loss has on other people and society |
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Selecting appropriate combo of techniques for treating loss exposures
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- risk control: avoidance, loss prevention, loss reduction - risk financing: retention, non-insurance transfers, insurance |
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Size of firm
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- small- rely more insurance - large- less dependent and wider variety of non-insurance risk handling alternatives
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Low Severity, Low Frequency |
Assume - loss prevention - loss reduction
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Low Severity, High Frequency
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Loss prevention - loss reduction - assume risk |
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High Severity, Low Frequency |
Insure - risk transfer - loss reduction - loss prevention
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High Severity, High Frequency
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Avoid - loss prevention - loss reduction
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Loss/risk control |
- rm activities that help reduce expected losses incurred by organization |
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Loss prevention |
- reduces frequency with which losses occur - when frequency high and/or severity - measure only cost-effective if cost lower than benefits realized from fewer loss occurrences - make decisions to reduce or eliminate chance of death or injury to people (putting value to human life is complicated and involves ethics
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Avoidance |
- simply not engaging in risky activity - certain loss exposure never acquired or undertaken, or existing loss exposure is abandoned
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Advantages and Disadvantages of Avoidance |
- Advantages: chance of loss is reduced to zero - Disadvantages: may not be able to avoid all losses; abandonment may leave company with residual liability or without critical revenue stream; ex.: not introducing new product, not doing business in some locations, etc. |
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Loss Reduction |
- decreases severity of loss if it does occur, since some are unavoidable - aim to minimize impact when loss occurs, reduce before and after loss - most appropriate when severity is high; must be cost-effective - ex.: installation of automatic sprinkler systems, segregation of exposure units so that single loss cannot simultaneously damage all exposure units |
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Duplication, Separation, Diversification
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- duplication: individual or firm reduces exposure to risk by holding multiple copies of key asset or resource - separation: practice in which firm designs operations around multiple locations that are physically far from each other, reducing chance that single adverse event like fire could disrupt operations -diversification: use to limit severity and variability of losses by selling variety of products to diversify sources of revenue to reduce chance of revenues simultaneously decreasing |
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Examples that prevent and reduce losses simultaneously |
- worker training - hiring security - preventative maintenance of machinery - warning labels on dangerous products - quality-control checks |
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What do we measure? (evaluation) |
- maximum possible loss: absolute maximum dollar amount of damage - maximum probable loss: conservative estimate of what is likely to occur in worst case scenario - relative frequency: estimate (numerical or verbal) as to number of times loss occurs
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Risk Transfer- Non-insurance methods |
- Risk- bearing financial institutions - Contractual transfer agreements - Hold harmless agreements - Limited liability
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Risk-bearing financial institutions |
- take on financial risk in exchange for fee - customers transfer risk but can also finance cost their loss |
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Contractual transfer agreements |
- transfers risk to another party but does not reduce underlying risk
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Hold harmless agreements |
- transfer of risk through contract prior to loss where one party agree to assume second party's financial responsibility should loss occur |
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Limited liability |
- provided to owners of certain types of business organizational forms, where personal assets of owner of business cannot be attached to any lawsuit against business - by laws, claims are limited to assets of firms |
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Advantages of Non-insurance risk transfers |
- can transfer some risk not commercially insurable - can cost less compared to insurance - potential loss may be shifted to someone who is in better position to exercise loss control |
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Disadvantages of Non-insurance |
- may fail b/c language is ambiguous - if party risk is transferred to is unable to pay losses |
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Loss Financing- External and internal methods |
- pay for losses; insurance and hedging are most common methods to finance costs externally, and internal options are risk retention, self-insurance, captive insurance |
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Insurance |
- transfer of risk to insurer for premium payment - appropriate when loss frequency low, but potential severity high - low frequency- not enough data to forecast losses - high severity- some companies may not be able to financially bear losses internally - sometimes required by law to purchase
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Deductibles |
- deductible- contractual provision stating that policy holder must deduct specific dollar amount from any insurance claim that he/she is requesting insurer to pay - consumer financially responsible for portion of insured loss - discounts in premiums for higher deductibles |
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Moral Hazard |
- less incentive to prevent losses when insured - moral hazard- behavior that increases expected loss payouts of insurer |
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Steps for getting insurance |
- selection of insurance coverage - selection of insurer - negotiation of terms - dissemination of information - periodic review of program (make sure company does not violate terms of agreement) |
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Advantages of Insurance
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- premiums income tax deductible as business expense - firm indemnified after loss occurs and can continue operating; fluctuations in earnings reduced - uncertainty reduced, firm can lengthen planning horizon - insurers provide valuable rm services - can buy guaranteed cost insurance to fix price for duration of policy, leading to more stable rm budget |
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Disadvantages of insurance
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- premiums are major cost- loading charge covers 1/3 of premium - cost high for consumers, reflecting high prob. of suffering losses in future - time in negotiating coverage - moral hazard
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Hedging |
- combines financing risk with risk transfer - typical deals with speculative risks which can result in either financial gain or financial loss |
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Risk Assumption/Retention |
- deliberate decision- full understanding of consequences of potential loss and knowing they will bear these consequences - depends on size of firm; not always choice - works well if no other method available, worst possible loss not serious, losses fairly predictable - requires more attention and time from rm department (carrying out support functions that insurance would do otherwise) |
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Funded Risk Assumption |
- set aside funds to use when losses occur or setting up agreements with banks; extra margin of safety |
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Ignorance |
- failing to identify loss before it occurs or failing to carry out proper rm techniques
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Self-insurance |
- special form of planned retention- firm retains and finances its losses internally based on forecasts generated from pooling of losses within organization - usually protected by some form of stop-loss limit |
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Why do companies self-insure?
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- save money - better control over loss prevention incentives, improved claims settlement, profitability and investment earnings |
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Captive Insurance Companies |
- method of self-insuring - company formed to write insurance for parent company
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Motives for starting captive |
- good when difficulty obtaining insurance - favorable regulatory environment - save overhead and profits of insurance company - easier access to reinsurance - earn investment income on premium - tax advantages - become profit center- invest premiums |
