Risk management chapter 4/6

post loss reduction (activities)

• salvage operations

• legal defenses

• crisis management

• rehabilitation of injured worker

Public protection( pre loss reduction)

• public fire department

• fire hydrant within 1000 feet

building construction( pre loss reduction)

• some construction holding up better

• steel vs wood

• fire resistance protection vs none ( steel building)

• fire resistance build don’t collapse

sprinklers( pre loss reduction)

• activated by heat

• individually activate

• job is to contain the fire

• most fire are contained by 1 or 2 sprinklers

Fire pumps ( pre loss reduction)

• supplemental water supply

• used when public water supply cannot be effectively supply an automatic sprinkler to increase water pressure and flow

• commonly in high rise buildings

• strongly linked to standpipes and sprinklers

Stand pipes ( pre loss reduction)

• water pipe system built into buildings to fight fires

• types

  • dry stand pipe

  • wet stand pipe

forms of Private protection( pre loss reduction)

• suppression

• portable fire extinguisher

• stand pipe

• fire pump

• sprinkling

• building construction

Forms of detection( loss reduction)

• smoke or heat detection

• alarm system

Pre loss reduction activities( must be set up prior to loss)

• detection

• private protection

• public protection

Loss reduction

• assume a loss will occur

• what can be done to prior to or after the loss to lessen the amount of loss

• reduce severity

Examples of loss prevention

• training program

• safety inspection

• quality control checks

• security guards

Loss prevention

• attempt to reduce the frequency or probability of the loss

• does not completely eliminate loss

• activates that attempt to interrupt or break the chain of events that lead to loss

• activities must take place before loss

When avoidance is a good strategy

• usually high, frequency, high severity losses

• conduct cost benefit analysis

• recall the cost of risk

• when “cost of risk” is greater than benefit (proift) from the activity

legacy cost (problem with avoidance)

• May avoid future losses by avoidance

• might not avoid costs from the past

Problems with avoidance

• some risks cannot be avoided

• death/illness

• natural disaster

• weather

• avoidance may not be feasible or desirable

• less profits associate with the activity( opportunity costs)

Avoidance

-stop engaging in the activity that causes loss (reactive)

-never engaging in the risk that causes the loss ( proactive)

• risk is reduced to zero if properly implemented (except legacy costs)

Risk control options

• Activities or attempts to “ control” risk

• reduce the frequency of the loss

• reduce the severity of the loss

• improve predictability of the loss

  • less variable

  • decrease in coefficient in variation

insurance

is a device

-pools exposure to loss of individuals into a group

• uses fund paid by member of the group to pay losses as they occur

• group engaged or involved in risk sharing arrangement

Homogenous risk pool

(Income/ wealth transfers )

• income transfer is from those who do not have a loss to those who do have a loss

heterogenous risk pool

-risk transfer is also from those who don’t have a loss to those who do

-income transfer is from those who are low risk to those who are high risk

social security

• is the largest risk pool in the us this has an intergenerational risk/wealth transfer is is very heterogenous

Why do firms + individuals purchase insurance

• certainty peace of mind

• - serve other contracts

• enhances credit worthiness/ protect assets

• regulation/comply with law

premium

• trade unknown/ uncertain loss without insurance for unknown loss with insurance

• premium can be view as know loss

• certainty in loss occurs

• individuals risk still exist (just financial risk gets reduced)

What If PI >mac (demand)

• pi is to high

• expected losses are to high

• risk charges is to high

• P max is to low

• invidual underestimate the severity or frequency of loss

• moral hazard created by disaster relief(flood) where insurance like benefits exists

insurance demand

-will individuals pay for insurance at stated premium

-pmax= most an individual pay for insurance for risk

• risk is insurable if pi<pmax- a market exists

insurance supply

insures are willing to sell insurable at particular rate

-gp(gross premium)= price of insurance

• gp= expected ;psses +risk charges+admin +loading

purpose of indeminfication

• control moral hazard

• prevent the insured for making a profit from the loss

• violation to the Principe

Life insurance/ rare items (indeminficaiton)

-ACV has no meaning

-one factor

• specify the amount of potential before costs

Principe of indemnity

• in the event of property loss, insured should not collect more than actual cash value of loss ACV

• ACV is simple way to value or measure a loss

• limit amount of recovery to no more than ACv

• ACv= replacment -depreciation based on replacment costs

types of indemnification

replace or repair assets

cash, reimburse or pay dollar

paid for services such as attorney

partial indemification

cost sharing

• coinsurance deductible copay =, auto home owner health insurance

full indeminficaiton

• all losses are paid for weather large or small