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Rmin 4000 ch 3
| Term | Definition |
|---|---|
| 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 actually occurs |
| Risk Management Process: | 1. Identify loss exposures. 2. Measure and analyze the loss exposures. 3. Consider and select the appropriate risk management techniques. 4. Implement and monitor the chosen techniques. |
| 1. Identify loss exposures. | What assets need to be protected? What perils are those assets exposed to? Sources: loss history, financial statements, other firms/competitors, risk management consultants, surveys/questionnaires, inspections, contract analysis, flowcharts |
| 2. Measure and analyze the loss exposures. | Estimate the frequency and severity of loss exposures. Rank loss exposures according to relative importance. Severity is more important. |
| Maximum Possible Loss | the worst loss that could happen to the firm during its lifetime. |
| Probable Maximum Loss | the worst loss that is likely to happen. |
| Risk Control: | techniques that reduce the frequency or severity of losses. - Avoidance, loss prevention, loss reduction, duplication, separation, diversification |
| Risk financing: | techniques that provide for the funding of losses. - Retention, noninsurance transfer, insurance |
| 4. Implement and monitor the chosen techniques. | Risk management policy statement: Outlines: risk management objectives of the firm, company policy with respect to treatment of loss exposures. Provides standards, requires active cooperation from other departments in the firm |
| Avoidance | loss exposure is never acquired (proactive), or an existing loss exposure is abandoned (reactive). Advantage: frequency is reduced to 0. Disadvantage: may not be possible, has an opportunity cost, avoiding one loss exposure may create another |
| Loss prevention | measures that reduce the frequency of a particular loss. Does not completely eliminate risk |
| Loss reduction | measures that reduce the severity of a loss. No effect on the frequency of a loss |
| Duplication | having back-ups or copies of important documents or property available in case a loss occurs. Can affect severity and frequency |
| Separation | physically dividing the assets exposed to loss to minimize the harm from a single event. Ex: firewalls in buildings, companies with multiple warehouses |
| Diversification | reducing the chance of loss by spreading the loss exposure across parties (customers, suppliers), securities (stocks, bonds), or transactions. Ex: Multiple suppliers, sources, products, stocks |
| Retention (Deductible) | a firm or individual retains part or all of losses that can occur from a given risk (keep the loss to yourself) |
| Retention level | the dollar amount of losses that the individual/firm will retain (have to pay) |
| When should risk be retained? | it is difficult to insure, Worst possible losses are not serious (low severity), Losses are predictable (high frequency) |
| Retention Advantages: | Save on loss costs, Save on expenses, Encourage loss prevention, Increase cash flow, |
| Retention Disadvantages: | Possible higher losses, Possible higher expenses, Possible higher taxes |
| Unfunded Retention: | unplanned, low cost and frequency, don’t have money set aside |
| Funded Reserve | insurance, high frequency low severity, have money set aside for it |
| Captive Insurer: | insurer owned by a parent firm for the purpose of insuring the parent firm's loss exposures (only purpose is to insures the main company's loss, keep in-house insurance). Single-parent captive is owned by only one parent. |
| Captive Insurer Advantages: | help when insurance is expensive or difficult to obtain. Lower costs: No agent or broker commissions, Interest earned on invested premium. Easier access to reinsurance market, lower tax rate, favorable regulatory environment |
| Self-Insurance: | a special form of planned retention by which part or all of a given loss exposure is retained by the firm, up to a certain amount (funded reserve) |
| Risk Retention Group | group captive that can write any type of specific liability coverage except employers' liability, workers compensation. Collect money from a group of people, and pays out if someone needs it Ex: medical liability from doctors being sued |
| Noninsurance Transfer | methods other than insurance by which a pure risk and its potential financial consequences are transferred to another party. Ex: contracts, leases, hold-harmless agreements Ex: bungee jumping life waver, housing contracts |
| Noninsurance Transfer Advantages: | Can transfer some losses that are not insurable. Less expensive, Can transfer loss to someone who is in a better position to control losses, Sometimes insurance don't cover certain losses |
| Noninsurance Transfer Disadvantages: | Contract language may be ambiguous, so transfer may fail. If the other party fails to pay, firm is still responsible for the loss. Insurers may not give credit for transfers |
| Insurance | appropriate for low-frequency, high-severity loss exposures. 1. Selection of insurance coverages and an insurer. 2. Negotiation of terms. 3. Dissemination of information concerning insurance coverages. 4. Periodic review of the insurance program |
| Excess insurance: | A plan in which the insurer pays only if the actual loss exceeds the amount a firm has decided to retain (coverage beyond the umbrella max insurance payout) |
| Manuscript policy | A policy specially tailored for the firm |
| Insurance Advantages: | Firm is indemnified for losses; can continue to operate. Uncertainty is reduced. Firm may receive valuable risk management services. Premiums are income-tax deductible |
| Insurance Disadvantages: | Premiums may be costly. Negotiation of contracts take time and effort. The risk manager may become lax in exercising loss control because of the existence of insurance |
| Hard Market | insurer profitability is declining, underwriting standards are tightened, premiums increase, and insurance is hard to obtain. Might have to increase retention, less coverage |
| Soft Market | Profitability is improving, standards are loosened, premiums decline, and insurance become easier to obtain. Extra coverage, more funded reserve, lower retention. |
Created by:
aychan
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