Topic 2: Risk Management

TRM Loss exposures + ERM Risk

TRM Loss Exposure

• property

• Net Income

• Personnel

• Liability

Property Loss Exposure

• Ownership of Financial or Physical Assets

• Theft/Damage-
  - Direct losses, Cost of replacing the asset Cost of Repair

Legal Interest in Property

• Financial interests or stake in the property

• if there is a loss to the property, you also suffer a loss

Situations giving rise to interest in property

1. Ownership Interest

2. Secured Creditors

3. Buyers & Sellers Interest

4. Bailee Interest

5. Tenants Interests

Ownership Interest

• most common type of interest

• can have present or future ownership interest
  - Future, when you have a car loan or mortgage

Secured Creditors

• The bank or lender when you take a loan for a house/car

• They actually hold title- i.e they own it your ownership interest is future

Buyers & Sellers

• Shipping Products

Bailee Interest

• A bailor is the owner of the property

• A —— is an entity who receives property from another for a business purpose

• interest for the bailee is a legal liability to return or cost to replace the property — if something happens before returning it to bailor

Tenants interests

• continued use interest
  - For a specified period of time
  - For a specified purpose
  - For a specific rental rate

• Responsible for returning property in reasonable conditions

• May have a leasehold interest

Leasehold Interest

• 10 year property lease

• $1,000 a month

• by year 5 fair mkt value of rent is $1500

• can be lost due to external factors

Net Income loss Exposure

• Aka Business > interuption

• Net Income = Revenue - Expenses

• A firm sufferes a primary (usually property) loss — as the results suffer a secondary loss that results indirect exposure
  - Inderect losses
  - Extra Expenses
  - Loss of Income

• The normal prodcutive process of a firm is interupted
  - a decrease in revenue
  -an increase in exposure

• Impacts your bottom line (Net Income)

Events Causing Net Income Loss

• Damage to property owned by the firm

• Delivery truck is stolen (property Loss)
  
  

• Extra Costs
  - Rent another truck causing an increase in expenses
  -orders are not filled causing a decrease in revenue
  
  

• Damage to property owned by others

• key supplier has a property loss
  - Unable to produce goods causing a decrease in revenue

• Power or telephone outage
  -Could cause a decrease in revenue

Personal Loss Exposure

• risks the oganization will suffer losses due to key employee suffering a loss

• Employees suffer illness, death, disability, retirement, resignation

• Human capitol Risk — for the employee suffering loss

• Employee benefits and personal finance Handles

• Due to loss of key employee — the firm may also suffer
  - REvenue decreases
  - Sales are down
  - Decisions are not made

• Expenses increases
  - cost of replacing the person

• Personal issue for employee becomes a business issue for employer

Negligence & Legal Liability

• Wealth losses from liability Exposure
  -Money loss from being sued
  -Legal Fees

• Bad behavior or breaking a contract can lead to a lawsuit

• Behavior commonly classified as either:
  - intentional (assault, Libel, slander)
  -Unintentional (Negligence or carelessness

• Legal Liability (LL) is established when:
  - There was Negligence
  - There was actual damage or loss

What Constitutes Negligence

• Failure of a person to exercise the proper degree of care
  - The burden of proof is on the injured party

• Absolute/ Strict Liability

Absolute/ Strict Liability

• LL is established because accidents happen

• Imposed whether anyone’s was at fault

• situation w/children, workers compensation

Measurement issue

• Usually easier to establish injury or damage occured

• establishing the amount of damage is usually difficult

• Property losses (PD)
  - Relatively simple to calculate- value of items

• Bodily Injury (BI)
  - special damages
  - compensation for measurable losses
  -medical expense
  - loss of income
  - Moderately difficult to calculate

Bodily Injury (BI)

• special damages

• compensation for measurable losses

• medical expense

• loss of income

• Moderately difficult to calculate

Measuring Bodily Injuries & Damages

• General damages

• Punitive Damages

General Damages

• compensate for intangible losses

• pain & Suffering

• Mental Anguish

• very difficult to estimate & measure - why?

Punitive Damages

• Amounts assessed as a form of punishment

• gross negligence is involved

• very difficult to estimate & manage- why?

Defense to Liability

• Assumption of Risk defense (by the injured party)

• One recognizes the danger involved in an activity

• Voluntarily chooses to encounter it
  - attending a hockey game
  -going sky diving

• Comparative/ contributory Negligence
  - plaintiff was partially to blame for, what happened

Res Ipsa Laquitur

• “The Thing speaks for itself” - A modification to law of negligence

• presumption of negligence on part of Defendant

• Requirements:
  - Normally would not occur unless negligence
  - Defendant exclusively controls the tool/equipment
  -Injured party does not contribute to loss
  —EX. Dentist removes wrong tooth

Vicarious Liability

• One person becomes L.L for the negligent behavior of another

• Employers are held responsible for actions of their employees acting within the capacity as employers.

Joint & several Liability

• Negligence of two or more parties contributes to the injury or damage

• Injured party may recover the entire amount of compensation from any negligent party who is able to pay — regardless of the degree of the party’s negligence

• “Search for Deep Pockets”

Product Liability

• Manufactures of a faulty product that injures someone or damages property may be held L.L

• Negligence:
  - product is negligently made or improperly designed
  -Proper warning is not given to the consumer

Product Liability Losses

• Cost of defending & paying claims for injury

• cost of recalling any batches of products suspected of being defective

• damage to your name

Premises Liability

• Owner or tenant may be held liable for damages if someone is injured

• If the property of others is damaged as a result of a condition in or arising out of the premises

• Trespasser

• Licensee

• Social Guest/ Invitee

Trespasser

• someone comes without right & consent only obligated to abstain from doing intentional harm

Licensee

• comes onto property with knowledge of owner

• no purpose of or benefit to owner

• must warn of any hiden danger

Social guest/ invitee

• Been invited for some purpose

• customer in store

• must keep premises safe so no harm comes

Liquor Liability

• Businesses that manufacture, sell & serve alcohol
  - Injuries resulting to patron/ guests selling alcohol
  - Dram shop laws — can hold businesses liable if they ever serve someone
  - 30 states have dram shops
  - the rest have social host liability: Liability only resides with the serving of someone who is underage

Animal Liability

• Exotic Animal
  - strict Liability

• Dogs
  - some states have strict liability
  - some states — if dog never bit before — could escape liability (1st Time)

Traditional Risk Management (TRM)

• 4 loss exposures (Property, Net income, Personnel, Liability)

• Sile Approach: focusses on mostly pure insurable Risks

Enterprise Risk Management (ERM)

• Manage Risk & Seize opportunity
  - Risk based approach to managing entire enterprise
  - very strategic & scientific approach
  -evaluates Risk throughout an orginzation & impacts as a whole to the entire function of the firm
  - breaks it down to 4 quadrants of risk

#1 Hazard Risk

• Fire/floods

• issues with key employees- personnel

• Lawsuits (liability)

• Net income losses
  Typically pure risks

• essential risk management

#2 Financial Risks

• inflation

• stock market

• liquidity

• debt rating

• foreign currency rate

• interest Rates

• Credit

• Mostly speculative Risks- Not net Income losses!

• Ex. — what does mortgage interest rates going up mean to
  - builders, bankers, credit card companies, realtors & money managers

#3 Operational Risks

Risk that arise out of business —— - combo of pure and speculative risks

• Manufacture Products
  - supply chain issues
  - service provider failures
  - product recall
  - chips for cars post covid - who did that impact?

• Regulatory issues- commerce bank ex.

• Employee pratices/ company policies/ procedures
  - Discrimination - workplace violence/ Sexual harm

#4 Strategic or Business Risk

(SWOT)- strength, Weakness, Opportunities, Threats

• Customer service issues

• competition/ bad business decisions

• intellectual property

• Ethics

• Public relations/ Reputation risk

• business trends
  - Alcohol, Marijuana, & gambling

• Union Issues

Typically Speculative Risks

TRM Vs ERM (TRM)

• TRM has Silo/ Departmentalizaed approaach

• TRM focuses mainly on Hazard type Risks (Flood, Fire, etc) - handled by the risk managerial areas

• other risks maybe handled by their specific areas

• Not much effort to make relative comparisons among various risks to understand the cumulative impact on firm

TRM Vs ERM (ERM)

ERM has Integrated Approach

• Occurs at enterprise level instead of individual departments

• Risk management activities heavily impact business decision

• designed to facilitate comparison & evaluation

• identify Risks and determine if Risks are correlated or independent

• individual vs team

• department vs entire organization

CRO is in charge

CRO is in charge

• change business strategy

• seize opportunities

• —- is crucial

How to Identify Exposure

1. Inspection of plant/facility/location- “walk around”

2. Contract analysis

• leases

• hold harmless agreements

3. Look at past information

4. share loss information with other similar organization

5. safety checklist from insurance companies

6. flow chart approach

7. ask employees/manager in the firm

8. financial statement approach

• balance sheets

• assets, (physical: building) (non physical- trademark, patent, copywrite, goodwill