Chapter 3: Risk Management

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Chapter 3Risk Management
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Risk Management

• What is Risk Management (RM)?
• Making pre-loss arrangements for post-loss
  resources
• The logical approach to financing and controlling
  loss exposures

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The RM Function

• The staff varies based on size and responsibility
• All firms and people engage in risk management
• Career opportunities in profit and non-profit
  organizations
• Occupation is professionally recognized RIMS
  Risk and Insurance Management Society

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RM Statement of Objectives and Principles

• Distinguish between pre-loss and post-loss
  objectives
• Pre-loss objectives
• Survival and growth
• Compliance with government regulations
• Efficiency
• Procedures and principles are implemented and
  followed

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RM Statement of Objectives and Principles

• Post-loss objectives
• Survive the loss
• Provide a foundation to grow and prosper
• Behave responsibly as a good corporate citizen
• Risk Management Manual
• Written to articulate goals, standards, how to
  measure results and provide benchmarks

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Steps in the Pre-loss Risk Management Process

• Identify Measure (evaluate)
• Choose most efficient tool(s) for
• Loss Control
• Loss Financing
• Implement and review

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Step 1 - Identify

• What to identify
• Direct losses
• Indirect losses
• Key personnel
• Operations

• How to identify
• Balance sheet
• Income statement
• Other records
• Checklists
• Flow charts
• Questionnaires

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Measure (evaluation)

• Maximum possible loss
• The absolute maximum dollar amount of damage
• Maximum probable loss
• A conservative estimate of what is likely to
  occur in a worst case loss
• Relative Frequency
• An estimate (numerical or verbal) as to the
  number of times the loss will occur

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Valuing Property

• Replacement value versus book value versus actual
  cash value versus market value
• International operations and exchange rate
  problems
• The impact of inflation on values

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Loss of Income

• Definition
• Sources of Loss
• Problems
• Can be seasonal in nature
• Difficult to measure
• Best measurement still can only be an estimate

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Liability Losses

• Examples of loss sources
• Bodily injury or personal injury
• Property damage to real or personal property
• Intentional damage to reputation
• Wrongful hiring, firing, sexual harassment,
  invasion of privacy, age discrimination
• Vicarious liability
• Products, environmental, workers compensation

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Losses to Key or other Personnel

• Death
• Disability physical (medical) or mental
• Short or long term
• Permanent or temporary
• Loss of health
• Unplanned retirement
• Results in loss of income, business continuation
  problems, replacement and training issues

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Step 2 -Decide How to Handle

• A ---- Avoid
• R ---- Retain
• T ---- Transfer
• Insurance
• Non-insurance

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Selecting the Risk ManagementTechnique
Frequency
High
Low
Assume loss prevention loss reduction
Loss Prevention loss reduction assume risk
Low
Severity
High
Insure risk transfer loss reduction loss
prevention
Avoid loss prevention loss reduction
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Loss Control - Prevention
Always engage in, if beneficial

• Loss Prevention
• Take various steps to reduce the probability of
  losses occurring
• How do you value the loss of life in the cost /
  benefit equation?

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Government and Loss Prevention

• Occupational Safety and Health Act of 1970 (OSHA)
• Consumer Product Safety Act of 1972 (CPSA)
• Comprehensive Environmental Response,
  Compensation Liability Act of 1980 (CERCLA)
  (Superfund)
• Food and Drug Administration (FDA)
• The Clean Air Act
• The Water Pollution Control Act

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Loss Control - Reduction
Always engage in, if beneficial

• Loss Reduction
• Steps designed to reduce the severity
• Take steps to reduce the damage before and after
  a loss

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Self-insurance - loss financing

• What is self-insurance?
• Why do companies self-insure?
• Save money
• Better control
• Loss prevention incentives
• Improved claims settlement
• Profitability and investment earnings
• Difference between self-insurance and risk
  assumption

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Captive Insurance Companies

• A method of self-insuring
• A company formed to write insurance for a parent
  company
• Motives for starting a captive
• Save the overhead and profits of the insurance
  company
• Earn investment income on the premium
• Tax advantages

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Other Risk Management Concepts

• Finite risk programs
• Multiple year insurance contract
• Premiums equal to the aggregate policy limit paid
  in installments over the contracts years.
• If losses exceed aggregate limit, loans are made
  for excess and future premiums repay loans
• If losses are less than aggregate, there is a
  refund.

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Other Risk Management Tools

• Risk Transfer
• Hold harmless agreements - transfer of risk
  through a contract
• Hedging - take equal but opposite position on an
  even based on chance
• Financial risk management - techniques to deal
  with interest rate, currency value, and crop
  price changes
• Leases - transfers risk of obsolescence

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Step 3 Review and Update

• Regularly review and update the process
• New assets or disposal of assets
• Valuation changes
• New products and processes, materials
• New personnel
• Law changes
• Currency fluctuations
• New contractual relationships