Risk Management Quiz 4 Mccloskey

Risk Control Options

-Reduce frequency of loss

-Reduce severity of loss

-Improve predictability of loss

Avoidance

-Stop engaging in the activity that causes the loss (Reactive)

-Or never engage in the risk that causes the loss (Proactive) (risk is reduced to zero if done right)

Ex. person won't fly on plane to avoid risk of crashing.

Problems with avoidance as strategy

-Some risks cannot be avoided

Ex. death, weather, natural disasters

-Avoidance may not be feasible or desirable

-Legacy cost

-Trade a risk for another (travel on rail vs. auto if u don't wanna fly)

When is avoidance a good strategy?

-High frequency high severity claims

-when cost of risk is greater than benefit

Loss Prevention

-attempts to reduce the frequency or probability of the loss

-does not completely eliminate it

-goal is to impact frequency

-PRIOR to loss

ex. security guard, training program, safety inspection

Loss Reduction

-assume a loss has or will occur

-reduce severity

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

Pre-loss loss reduction activities

-exit signs

-sprinkler system

-fire drill

Post-loss loss reduction activities

-Salvage operations

-legal defenses (attorney)

-crisis management

-Rehabilitation of injured worker

Separation of exposure units

-break items or activities or assets or responsibilities down into smaller parts to SEPARATE them (eggs in one basket)

-limit the size of loss in any occurrence

ex. one delivery truck vs. two trucks

two suppliers of raw materials

cross-training or job sharing

Duplication of Exposure Units

-key asset or activity is replicated and held in reserve

-critical that replicate is kept in RESERVE - not in use!

ex. key copy, save work, spare parts, back up data, copies of records

Risk Transfer of Control Type

-shift the activity or asset exposed to loss to a 3rd party

-shifts loss exposure

ex. the sale of a building

sell a dangerous product line

loss exposure cannot return to you

Risk Transfer of the Finance Type

-seek external sources from 3rd parties to finance losses

-transfer financial responsibility for the loss, not the asset or activity itself

Insurance

-most common type of risk transfer finance

-transfer the financial responsibility of the loss to the insurer

Non-Insurance risk transfers of the Financing Type

-Leases: tenant is responsible for all property losses

If tenant fails to cover, owner is eventually responsible

Hold Harmless Agreement

-someone contractually accepts risk for you

ex. -contractor doing a project for you

-vendor performing a task

-company promises a firm doing work for them that they'll accept all responsibilities

Retention

-a firm or individual assumes the financial responsibility for losses that do occur

-Retain the exposure to loss

ex. not buying insurance

-insurance with a deductible

Funded

-a firm sets aside funds every period to pay for loss

-better for losses that are predictable and high in severity

ex. say firm believes P* for the year is $1-2M. they set aside $100K/month

Unfunded

-no separate fund to pay for losses

-pay for losses as they occur from money you have or borrow

-better for losses that are low frequency and low severity

Active Retention

deliberate decision to practice retention.

ex. you know about renter's insurance

Passive Retention

retaining the exposure to loss, but you may be unaware (usually results from failure to identify)

ex. you don't know about renter's insurance

Self Insurance

-planned and funded retention

-usually for significant loss exposures where many exposure units exist

Formal Program

not just something that happens -- it's a well thought out strategy (active)

Self Insurance - Ideal Characteristics

-Fairly predictable

-Long payout period

Advantages to Self insurance - Flexibility

-Most insurance contracts are very standardized

-avoid state mandated benefit laws

-ex. mom's cookie - just how you want it. you're not limited if it's self made.

No Loading in Self Insurance

-no administrative expenses

-no marketing expenses

Time Value of Money

-any credits are invested internally which would probably produce a higher rate

-saving from any loss prevention/reduction goes directly into your pocket instead of insurance company

Disadvantages of Self Insurance

-Catastrophic loss possibility

-Firm may have to perform administration functions

-Can be a Public Relations nightmare

-Hard to return to insurance market once you leave

Captive Insurer

-Wholly owned subsidiary of company

-A parent non-insurance company owns an insurance company

-Purpose is to insure the risks of the parent company

Types of Captive Insurers

-Single Parent Captive

-Association/Group Captive: Temple owns an insurance company with 16 other universities (Group Captive)

Captive Insurer Advantages

-Helps during "hard" markets

-Often located in Bermuda or Cayman Islands giving regulatory and income tax advantages

-Tax treatment in the U.S.

-Can write off premium if it is a true risk

True Risk Transfer

Parent risk makes up no more than 30% of the risk portfolio

Captive Insurer Reasons

-Save money on premium

-Freedom to cover or do whatever you want

-Tax reasons