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Risk Management Process
A method that identifies loss exposures faced by an organization and selects appropriate techniques to treat those exposures.
Loss Exposure
Any situation where a loss is possible, regardless of whether a loss actually occurs.
Step 1: Identify Loss Exposures
The process of determining what assets need protection and what perils those assets are exposed to.
Sources for Identifying Loss Exposures
Loss history, financial statements, other firms, risk management consultants, surveys, inspections, and contract analysis.
Maximum Possible Loss
The worst loss that could happen to the firm during its lifetime.
Probable Maximum Loss (PML)
The worst loss that is likely to happen.
Risk Control Techniques
Methods that reduce the frequency or severity of losses.
Avoidance
A risk control technique where a certain loss exposure is never acquired or is abandoned.
Loss Prevention
Measures that reduce the frequency of a particular loss, but do not eliminate risk.
Loss Reduction
Measures that reduce the severity of a loss without affecting its frequency.
Duplication
Having backups or copies of important documents or properties in case a loss occurs.
Separation
Dividing assets exposed to loss to minimize harm from a single event.
Diversification
Reducing the chance of loss by spreading loss exposure across different parties, securities, or transactions.
Risk Financing Techniques
Methods of funding losses, which include retention and insurance.
Retention
A method where a firm retains part or all of the losses that can occur from a given risk.
Captive Insurer
An insurer owned by a parent firm to insure the parent firm’s loss exposures.
Self-Insurance
A planned retention method where a firm retains a portion or all of a given loss exposure.
Noninsurance Transfer
Methods, other than insurance, that transfer a risk and its financial consequences to another party.
Deductible
A specified amount subtracted from the loss payment otherwise payable to the insured.
Underwriting Cycle
The fluctuation of insurance market conditions, characterized by hard or soft markets.
Hard Market
A phase in the underwriting cycle marked by declining insurer profitability, tightened standards, and increased premiums.
Soft Market
A phase in the underwriting cycle characterized by improving profitability, loosened standards, and declining premiums.
Risk Management Policy Statement
A document outlining the risk management objectives and policies regarding loss exposure treatment.
Benefits of Risk Management
Enables a firm to attain its objectives more easily, reduces direct and indirect losses, and minimizes the cost of risk.
