RISK MANAGEMENT AND INSURANCE

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RISK MANAGEMENT AND INSURANCE
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RISK Speculative Risk vs. Pure
Risk Insurable vs. Uninsurable Risk Why are
some exposures not insurable? To be
commercially insurable 1. there must be a
large number of similar exposure units 2.
losses must be accidental 3. losses
must be definite in time and place
4. the premium must be economically feasible

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Examples of uninsurable exposures flood, sewer
backup earthquake or earth movement war,
rebellion, etc. nuclear action, radiation, and
contamination normal wear and tear
(depreciation) damage from domestic
animals Insurance Management vs. Risk Management
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THE RISK MANAGEMENT PROCESS Steps in
the RM process 1. Identification of loss
exposure 2. Risk analysis 3. Selection
of appropriate risk management tool
4. Implementation and monitoring
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1. IDENTIFICATION OF LOSS EXPOSURES There are
four general categories of identifiable loss
exposures PHYSICAL a) Propertyhome,
auto, personal property b) Loss of income or
profit (indirect) FINANCIALLiability due to
intentional act or negligence of the client or
others CONTRACTUALLoss assumed under a
contract or through an association with
others HUMANValue of human life Loss of
life Financial needs associated with an accident
or illness
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2. RISK ANALYSIS Loss frequencyhow often
does it occur? Loss severity A relative
concept A special problem for
liability Property values are not always easy
to determine (especially indirect
losses) Severe, important, optional coverages
Which is more importantfrequency or severity?
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• SELECTION OF APPROPRIATE RISK
• MANAGEMENT TECHNIQUE
• a) Risk avoidance
• b) Risk retention
• c) Loss control
• d) Noninsurance transfers
• Hold harmless agreements, using
• subcontractors, requiring lessees
  to retain certain risks, surety bonds
• e) Insurance
• A method of paying for losses.
• 4. Implementation and monitoring

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MAJOR TYPES OF PERSONAL INSURANCE Homeowners A
uto Personal umbrella Professional
liability Health Life Disability Long-term
care
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BASIC STRUCTURE OF HOMEOWNERS POLICIES HO-2 BROA
D FORM Named peril coverage HO-3 SPECIAL
FORM Open peril on building and named peril on
personal property. H0-4 CONTENTS BROAD
FORM Covers only personal property on named
peril basis. H0-5 COMPREHENSIVE FORM Open
perils coverage on both the buildings and
personal property. H0-6 UNIT OWNERS FORM For
condominium owners. HO-8 MODIFIED COVERAGE
FORM Do not meet underwriting requirements.
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HOMEOWNER COVERAGES AMOUNTS ARE TIED TO BASIC
DWELLING AMOUNT BUT MAY BE INCREASED (NORMAL
LIMITS SHOWN). COVERAGE A DWELLING COVERAGE
B OTHER STRUCTURES (10) COVERAGE C UNSCHEDULED
PERSONAL PROPERTY (50) AND PERSONAL PROPERTY
LOCATED ELSEWHERE (10) COVERAGE D LOSS OF USE
(30) COVERAGE E PERSONAL LIABILITY
(300,000) COVERAGE F MEDICAL PAYMENTS (1,000)
AND DAMAGE TO PROPERTY OF OTHERS (250)
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AUTOMOBILE INSURANCE Basic components of the PAP
are Part A liability coverage Part B
medical payments Part C uninsured
(underinsured) motorist Part D physical
damage to the insureds vehicle POLICY LIMITS
Traditional approach is split limits, but
single limits are available
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INSURED PERSONS (PART A) 1. The named
insured and resident family members.
Includes coverage for 90 days for a spouse who no
longer resides in the insureds
household or until the spouse obtains a
separate PAP or the policy period ends, whichever
occurs first. 2. Any other person
using the named insureds covered auto (if
there is a reasonable belief that permission has
been given). 3. Any person or party for
liability arising out of the use of a
covered auto. (Using a car for a charitythe
charity would be covered). 4. Any
person or organization legally responsible for
the acts of a covered person while
using a covered auto. (Person on
errand for employerthe employer would be
covered)
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PART D COVERAGE FOR DAMAGE TO YOUR AUTO
COLLISION COVERAGE Collision is defined as the
upset of a covered auto or its impact with
another vehicle or object. Collision with a
bird or animal is not a collision loss.
These payments are made regardless of fault.
OTHER-THAN-COLLISION COVERAGE
(Comprehensive) Covers theft, falling objects,
glass breakage, etc. In fact, it covers
everything that is not collision. Together, the
two provide all-risk coverage. Why does the
PAP divide the physical damage coverage this
way? Some people do not want to pay for
collision coverage. Other-than-collision
coverage often has a lower deductible.
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PERSONAL UMBRELLA LIABILITY Supplements the
underlying homeowner and auto liability coverage
(which are required) Reaches down when there
is no underlying other coverage. High
limits Higher limits are not that much more
expensive. Needed by individuals with
substantial assets.
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HEALTH (MEDICAL EXPENSE) INSURANCE Frequency
typically varies with age Losses can be very
severe TYPES OF PLANS 1. Indemnity
plans Generally provide for reimbursement of
covered medical expenses by paying the allowed
expense directly to the service provider
(physician or hospital). Expenses usually have
a minimal deductible and a coinsurance
clause. Emphasis is on patient choice.
Often are more expensive than other types of
plans.
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• Managed care plans
• a) Health maintenance organizations (HMOs)
• Charges a set fee for which it provides health
  care during the membership period.
• Emphasizes preventive care.
• The insured must use the HMOs doctors and
  facilities.
• Doctors are usually salaried employees.
• b) Preferred provider organization (PPO)
• A health care delivery system that contracts
  with medical
• care providers to offer services to
  members.
• Participants are allowed to choose between
  in-network
• and out-of-network providers, paying
  a higher cost for the
• latter.

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3. HEALTH SAVINGS ACCOUNTS (HSAs) These are
also known as Consumer-Driven Health Plans
(CDHPs) and also known as high deductible
health plans). One of the major problems
with managed care plans is that they
provide broad coverage with minimal copayments.
To qualify for a HSA you cannot be covered by
another health insurance policy or entitled
to Medicare. HIGH DEDUCTIBLE Generally
1,000 (individual) and 2,000 (family) but may
be 5,000 or more. The deductible engages
the insured as an active consumer.
The insured must pay the deductible either
out-of-pocket or from a health account.
This account can be used for health care
expenses, including copayment, deductibles,
health care items or services not covered by the
plan.
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Contributions to a HSA account are tax deductible
and can be made by the employee, employer, or
both. Money contributed but not used can be
rolled over and used next year. After a client
has a year or two of contributions in the account
and has reached more than the out-of-pocket
maximum, many financial planners advise
investing the HSA money in a variety of CDs,
stocks, bonds, mutual funds, etc. The account
grows tax-free and distributions for qualified
medical expenses are tax-free.
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LIFE INSURANCE All forms of life insurance
consist of 3 basic elements 1. Mortality
cost 2. Administrative cost
3. Investment performance Life insurance death
proceeds are normally received income tax
free. TERM INSURANCE Simplest form.
Provides only protectionno cash values.
Most are renewable. Can be 1 year, 5 year, 10
year, etc. Renewable policies can be
renewed without evidence of insurabililty.
The premium will be level during the policy
term, but will increase upon renewal.
Cost will become prohibitive at older ages.
Thats why it is called temporary
insurance. Can be appropriate for
temporary needs, e.g. mortgage protection.
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THE LEVEL PREMIUM TECHNIQUE The policy is based
on the assumption that the policy will be in
force until the insured diesno matter how long
that might be. That is, it provides whole life
protection. Premiums are level over the policy
period while the mortality curve is increasing at
an increasing rate. This creates an overcharge
in the early policy years and an undercharge in
later years. The overcharge is invested and
creates a cash value. Traditional whole life
insurance Provides a guaranteed cash value
that is known in advance. The year-to-year
increase in cash values is not taxable.
Provides cash values that can be borrowed for any
reason (and the policy will remain in force)
Provides cash values that can be taken in
various forms at retirement. Provides
protection from creditors. Provides
guaranteed premiums.
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EVALUATION OF TRADITIONAL WHOLE LIFE
INSURANCE Is there any major disadvantage of
this type of insurance? The buy term and invest
the difference argument. MODERN POLICIES
(Variable Life, for example) Like traditional
whole life, has a fixed premium and a minimum
guaranteed death benefit. The cash value is
maintained in a segregated investment account
(much like a mutual fund) and the policyholder,
not the insurance company) determines how the
funds will be invested. Policyowner has a choice
of types of mutual funds. Policyowner can
periodically change the mix of investments.
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DISABILITY INCOME INSURANCE Covers the loss of
income when the insured is unable to
work. Greatly under-insured (mostly provided by
employers) Frequency and severity is
high Coverage is provided by 1. Sick leave
plans Typically one or two weeks of income
(uninsured) per year. May be cumulative.
2. Short-term disability income policies
Often only 6 months or 1 year of benefits.
3. Long-term disability income policies
Important provisions are a) Definition of
disability b) Length of
benefit period c)
Rehabilitation benefits 4. Social security
program Very strict definition of
disability 12 month waiting period
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LONG-TERM CARE INSURANCE What kind of insurance
or program pays when a person is healthy but
cannot take care of himself? (bathe, eat, get in
and out of bed, use the toilet, etc.activities
of daily living) Frequency and severity are
both pretty high. Who has this kind of exposure
(ie who needs this type of coverage?)
Coverage Most are group policies. May
be per diem or reimbursement of actual
expenses Premiums increase with age May
have inflation protection May have cash values