UGA RMIN 4000 Edmunds Exam 1

risk

uncertainty concerning the occurrence of a loss (or calculated possibility of a negative outcome)

loss exposure

any situation where a loss is possible (does not have to occur)

loss frequency

how often a loss occurs within a specific period (probability)

formula to find frequency

# of losses/# of exposures

loss severity

how much does a loss cost when it occurs (a house fire costs $x)

formula to find severity

total losses in dollars/# of losses

Peril

cause of loss (fire, windstorm, flood)

Hazard

an event that creates or increases the frequency or severity of a loss

At what probability is risk highest?

0.5

Do risk and chance of loss mean the same?

No, chance of loss is the probability that an event will occur

What are the four types of hazards?

Physical, Moral, Morale, and Legal

Physical hazard

a physical condition that increases the frequency or severity of loss

moral hazard

dishonesty or character defects in an individual that increase the frequency or severity of loss (using a hammer to create "hail" damage to your roof to get a claim)

Morale (Attitudinal) Hazard

carelessness or indifference to a loss, which increases the frequency or severity of a loss (leaving car unlocked leading to theft)

Legal Hazard

characteristics of the legal system or regulatory environment that increase the frequency or severity of losses (a jury in one district may be more sympathetic than others)

pure risk

a risk with a possibility of loss or no loss; no gain occurs

speculative risk

A chance of loss, no loss, or gain

diversifiable risk

a risk that affects only individuals or small groups and not the entire economy

nondiversifiable risk

a risk that affects the entire economy or large numbers of persons or groups within the economy (war, inflation, business recession)

what makes a risk diversifiable or not?

it is diversifiable if it can be reduced or eliminated by diversification

enterprise risk

encompasses all major risks faced by a business firm

systemic risk

the risk that the failure of one financial institution can bring down other institutions as well

What are the major types of pure risk?

personal, property, and liability

personal risk

A risk that directly affects an individual or family (peril, like unemployment, causes loss of income)

property risk

possibility of losses associated with the destruction or theft of property (can be direct or indirect-financial loss result of direct loss)

legal liability risk

financial consequences from injuries or damages you caused to someone else (defense costs; liens on income or assets seized as punishment)

What are the techniques of managing risks?

risk control and risk financing

risk control

techniques that reduce the frequency or severity of losses

risk financing

techniques for funding losses

what are some risk control tactics?

loss prevention (employee training or safety equipment to reduce frequency), loss reduction (sprinkler heads for fires to reduce severity) , duplication, separation, diversification, and avoidance (never acquire loss exposure (proactive) or abandon loss (reactive))

what are some risk financing tactics?

retention (retaining part or all of losses from a risk), noninsurance risk transfer (risk is given to party other than insurance company), and insurance (transfer risk to insurer in exchange for a premium cost)

insurance

pooling of accidental losses by transfer of risks to insurers, who agree to compensate insureds for such losses, to provide monetary benefits on their occurrence, or to render services connected to the risks

basic characteristics of insurance

pooling of losses, payment of fortuitous losses, risk transfer, and indemnification

pooling of losses

spreading the losses of a few over an entire group (reduces variation which reduces uncertainty)

payment of fortuitous losses

insurance pays for losses that are unforeseen, unexpected, and occur from chance

risk transfer

A pure risk is transferred from the insured to the insurer, who typically is in a stronger financial position

indemnification

The insured is restored to his or her approximate financial position prior to the occurrence of the loss

What are characteristics of an ideally insurable risk?

Large # of exposure units, must be accidental and unintentional, determinable and measurable, should not be catastrophic, have a calculable chance, and have a economically feasible premium

Large # of exposure units

enables insurer to predict average loss based on law of large numbers

Loss must be accidental & unintentional

Loss should be outside of insured's control

the loss must be determinable and measurable.

definite cause, time, place, and amount of loss.

adverse selection

the tendency of persons with a higher-than-average chance of loss to seek insurance at standard rates (can lead to higher loss levels than expected)

(typically results from asymmetric info where one party only has relevant transaction info)

underwriting risks

process of selecting and classifying applicants for insurance (standards met, coverage items, and rates)

types of insurance

private and government

private insurance includes:

life & health and property & liability and casualty

casualty insurance

covers whatever is not covered by fire, marine, and life insurance (usually includes auto and workers' compensation)

government social programs

financed all or mostly by contributions from employees and/or employers. benefits are weighted in favor of low income groups

risk management

a process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treatment

Pre-Loss objectives of risk management

efficient cost of risk, permits better decision making, and meet legal obligations

Post-Loss objectives of risk management

survival of the firm, business continuity, earnings, & growth, and societal responsibility

What are the steps in the risk management process?

1) Identify loss exposures, 2) measure and analyze the loss exposure, 3) consider and select appropriate treatment techniques, and 4) implement and monitor the chosen techniques

What are some important loss exposures

property, liability, income loss, human resource loss, crime loss, employee benefit, foreign, and intangible and regulatory

What are some ways of identifying loss exposures?

analyzing statements, past losses, staff meetings with RM, inspections, surveys, and flowcharts

What is a good way to analyze loss exposure

rank loss exposures by importance (severity)

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

What techniques would we use for loss exposure treatment?

Risk control and/or risk financing

What are some methods used for paying losses when financing risks?

Current net income, unfunded reserve, funded reserve, and credit line

current net income

losses are treated as current expenses (if a loss is too big, firm may have to liquidate assets)

unfunded reserve

bookkeeping account that is charged with actual or expected losses from a given exposure

funded reserve

funds set aside for losses

Why could a funded reserve not be ideal?

because it is not tax deductible and money could be used elsewhere in the firm

captive insurer

an insurer owned by a parent firm for the purpose of insuring the parent firm's loss exposures (lower costs, easy to obtain insurance, and possible tax advantages)

Can a captive insurer have more than one parent?

yes

self-insurance

planned retention by which part or all of a given loss exposure is retained by the firm

Risk Retention Group (RRG)

a group captive that can write any type of liability coverage except employers' liability, workers compensation, and personal lines (could save or have possible higher costs)

noninsurance transfers

methods other than insurance by which a pure risk and its potential financial consequences are transferred to another party (apartment lease or contracts)

emphasized areas of commercial insurance

selection of insurance coverages, selection of insurer, negotiation of terms, dissemination of info of coverages, periodic review of insurance program

deductible

amount you must pay before you begin receiving any benefits from your insurance company

excess insurance

plan in which the insurer does not participate in the loss until the actual loss exceeds the amount a firm has decided to retain

manuscript

policy specially tailored for a firm

what are advantages of commercial insurance?

firm indemnified for loss and continue operation, uncertainty is reduced, firm may receive valuable RM services, and premiums are tax deductible

what are disadvantages of commercial insurance?

premiums may be more costly, negotiations of policies takes time and effort, most policies are annual, and the RM might be lax in exercising loss control

underwriting cycles

Hard market - insurer profitability is declining, underwriting standards are tightened, premiums increase, and insurance is hard to obtain.

Soft market - profitability is improving, standards are loosened, premiums decline, and insurance become easier to obtain.

What are some benefits of risk management?

enables a firm to attain its pre/post loss objectives easier, society benefits because both direct and indirect losses are reduced, and can reduce a firm's total cost of risk

Enterprise Risk Management (ERM)

strategic business discipline that supports the achievement of an organization's business objectives by addressing the full spectrum of its risks and managing the combined impact of those risks as an integrated risk portfolio (typically headed by CRO)

what was the biggest category of insurance loss in 9/11?

Business interruption (33% with $15.6 B)

What are the types of risks within ERM?

Hazard, operational, financial, and strategic

Hazard risks (ERM)

traditional "pure" risks from regular RM

operational risk

results from the firm's day to day business operations (ex: supply chain, cybersecurity, customer service)

financial risk

arise from changing conditions in financial markets (ex: interest rates, exchange rates, credit risk, commodity and liquidity availability)

strategic risk

external risks that a firm has no control over; must be in ready position to respond (ex: brick and mortar stores able to convert to online)

Some other ERM risks include:

reputational, regulatory/compliance (OSHA, taxes), terrorism, COVID, and climate change

risk register

table with risk, category, responsible party, maximum possible and probable loss, comments, and risk score if treated or left untreated

risk map

graph of risks with axes of frequency and severity

What are some advantages of an ERM program?

increase awareness of risk, integrated response to full range of risks, alignment with org.'s risk tolerance and its strategies, fewer operational surprises and loses which increase value of org., and greater compliance with regulations and improved accountability

Challenges/Barriers of an ERM Programs

dynamic, lack of commitment from senior leadership, resistance to change / disagreement over responsibilities / turf war, and communication

Why use ERM?

by combining all risks into a single risk management program, the organization may be able to offset one risk against another, and reduce its overall risk

insurer combined ratio

ratio of paid losses and loss adjustment + underwriting expenses (if >100%, underwriting is unprofitable by paying out more than received, and vice versa)

insurer investment returns

issuing lower premiums with expected loss in hope to offset with investment income

Funded reserve, Loss prevention

High frequency, low severity

Unfunded reserve

Low frequency, low severity

Avoidance, Captive or risk retention group, Loss prevention/reduction

High frequency, high severity

Insurance, Loss reduction

low frequency, high severity