Exam 1 (Ch 1, 2, 3, 6) Risk mgmt

Explain the historical definition of risk

What is a loss exposure?

How does objective risk differ from subjective risk?

Define chance of loss

What is the difference between objective probability and subjective probability?

What is the difference between peril and hazard?

Define physical hazard, moral hazard, attitudinal hazard, and legal hazard

Explain the difference between pure risk and speculative risk

How does diversifiable risk differ from nondiversifiable risk?

Explain the meaning of enterprise risk.

What is financial risk?

What is systemic risk?

What is enterprise risk management?

How does enterprise risk management differ from traditional risk management?

Identify the major types of personal risks that are associated with economic insecurity

Describe the major social and economic burdens of risk on society.

Explain the difference between a direct loss and an indirect or consequential loss

Identify the major risks faced by business firms

Risk control

1. avoidance

2. loss prevention

3. loss reduction

4. duplication

5. separation

6. diversification

Avoidance

Loss prevention

Loss reduction

Duplication

Separation

Diversification

Risk-financing techniques for managing risk

1. retention

2. noninsurance transfer

3. insurance

Assume that the chance of loss is 3% for two different fleets of trucks. Explain how it is possible that objective risk for both fleets can be different even though the chance of loss is identical.

Identify the type of risk

The Department of Homeland alerts the nation of a possible attack by terrorists

Identify the type of risk

A house may be severely damaged in a fire

Identify the type of risk

A family head may be totally disabled in a plant explosion

Identify the type of risk

An investor purchases 100 shares of Microsoft stocks

Identify the type of risk

A river that periodically overflows may cause substantial property damage to thousands of homes in the floodplain

Identify the type of risk

Home buyers may be faced with higher mortgage payments if the Federal Reserve raises interest rates at its next meeting

Identify the type of risk

A worker on vacation plays the slot machines in a casino

Identify an appropriate technique/s that would be appropriate for dealing with the risk

A family head may die prematurely because of a heart attack

Identify an appropriate technique/s that would be appropriate for dealing with the risk

An individual’s home may be totally destroyed in a hurricane

Identify an appropriate technique/s that would be appropriate for dealing with the risk

A new car may be severely damaged in an auto accident

Identify an appropriate technique/s that would be appropriate for dealing with the risk

A surgeon may be sued for medical malpractice

Andrew owns a gun shop in a high-crime area. The store does not have a camera surveillance system. The high cost of burglary and theft insurance has substantially reduced his profits. A risk management consultant points out that several methods other than insurance can be used to handle the burglary and theft exposure. Identify and explain two noninsurance methods that could be used to deal with the burglary and theft exposure.

For each of the following, what method for handling risk is used?

The decision not to carry earthquake insurance on a firm’s manufacturing plant

For each of the following, what method for handling risk is used?

The installation of an automatic sprinkler system in a hotel

For each of the following, what method for handling risk is used?

The decision not to produce a product that might result in a product liability lawsuit

For each of the following, what method for handling risk is used?

Requiring retailers who sell the firm’s product to sign an agreement releasing the form form liability if the product injures someone

What is the meaning of risk management?

Explain the objective of risk management both before and after a loss exposures

What is the meaning of risk management?

Explain the objectives of risk management both before and after a loss occurs

Describe the steps in the risk management process

Identify the sources of information that a risk manager can use to identify loss exposures.

What is the difference between the maximum possible loss and probable maximum loss?

Explain the meaning of risk control

Explain the meaning of risk financing

What conditions should be fulfilled before retention is used in a risk management program?

What is self-insurance?

Explain the advantages of using insurance in a risk management program

Explain the disadvantages of using insurance in a risk management program.

Scaffold Equipment manufactures and sells scaffolds and ladders that are used by construction firms. The products are sold directly to independent retailers in the United States. The company’s risk manager knows that the company could be sued if a scaffold or ladder is defective, and someone is injured. Because the cost of products liability insurance has increased, the risk manager is considering other technique to treat the company’s loss exposures.

Describe the steps in the risk management process.

Scaffold Equipment manufactures and sells scaffolds and ladders that are used by construction firms. The products are sold directly to independent retailers in the United States. The company’s risk manager knows that the company could be sued if a scaffold or ladder is defective, and someone is injured. Because the cost of products liability insurance has increased, the risk manager is considering other technique to treat the company’s loss exposures.

For each of the following risk management techniques, describe a specific action using that technique that might be helpful in dealing with the company’s products liability exposure.
1. Avoidance
2. Loss prevention
3. Loss reduction
4. Noninsurance transfers

The Swift Corporation has 5,000 sales representatives and employees in the United States who drive company cars. The company’s risk manager has recommended to the firm’s management that the company should implement a partial retention program for physical damage losses to company cars.

Explain the advantages and disadvantages of a partial retention program to the Swift Corporation.

The Swift Corporation has 5,000 sales representatives and employees in the United States who drive company cars. The company’s risk manager has recommended to the firm’s management that the company should implement a partial retention program for physical damage losses to company cars.

Identify the factors that the Swift Corporation should consider before it adopts a partial retention program for physical damage losses to company cars

The Swift Corporation has 5,000 sales representatives and employees in the United States who drive company cars. The company’s risk manager has recommended to the firm’s management that the company should implement a partial retention program for physical damage losses to company cars.

If a partial retention program is adopted, what are the various methods the Swift Corporation can use to pay for physical damage losses to company cars?

The Swift Corporation has 5,000 sales representatives and employees in the United States who drive company cars. The company’s risk manager has recommended to the firm’s management that the company should implement a partial retention program for physical damage losses to company cars.

Identify two risk-control measures that could be used in the company’s partial retention program for physical damage losses

What is the major advantage of using the technique of avoidance in a risk management program?

Is it possible or practical for a firm to avoid all potential losses?

Chris and Karen are married and own a three-bedroom home in a large midwestern city. Their son, Christian, attends college away from home and lives in a fraternity house. Their daughter, Kelly, is a
senior in high school. Chris is an accountant who works for a local accounting firm. Karen is a marketing analyst and is often away from home several days at a time. Kelly earns extra cash by babysitting on a regular basis. The family’s home contains household furniture, personal property, a computer that Chris uses to prepare business tax returns on weekends, and a laptop computer that Karen uses while traveling. The family owns three cars. Christian drives a 2010 Ford; Chris drives a 2015 Honda for both business and personal use; and Karen drives a 2017 Toyota and a rental car when she is traveling. Although the family has owned their home for several years, they are considering moving because of the recent increase in
violent crime in their neighborhood.

Describe briefly the steps in the personal risk management process

Chris and Karen are married and own a three-bedroom home in a large midwestern city. Their son, Christian, attends college away from home and lives in a fraternity house. Their daughter, Kelly, is a
senior in high school. Chris is an accountant who works for a local accounting firm. Karen is a marketing analyst and is often away from home several days at a time. Kelly earns extra cash by babysitting on a regular basis. The family’s home contains household furniture, personal property, a computer that Chris uses to prepare business tax returns on weekends, and a laptop computer that Karen uses while traveling. The family owns three cars. Christian drives a 2010 Ford; Chris drives a 2015 Honda for both business and personal use; and Karen drives a 2017 Toyota and a rental car when she is traveling. Although the family has owned their home for several years, they are considering moving because of the recent increase in
violent crime in their neighborhood.

Identify the major pure risks/pure loss to which Chris and Karen are exposed with respect to each other

Personal loss exposures
Property loss exposures
Liability loss exposures

Chris and Karen are married and own a three-bedroom home in a large midwestern city. Their son, Christian, attends college away from home and lives in a fraternity house. Their daughter, Kelly, is a
senior in high school. Chris is an accountant who works for a local accounting firm. Karen is a marketing analyst and is often away from home several days at a time. Kelly earns extra cash by babysitting on a regular basis. The family’s home contains household furniture, personal property, a computer that Chris uses to prepare business tax returns on weekends, and a laptop computer that Karen uses while traveling. The family owns three cars. Christian drives a 2010 Ford; Chris drives a 2015 Honda for both business and personal use; and Karen drives a 2017 Toyota and a rental car when she is traveling. Although the family has owned their home for several years, they are considering moving because of the recent increase in
violent crime in their neighborhood.

With respect to each of the aformentioned loss exposures, identify an appropriate personal risk management technique that could be used to treat the exposure

Pooling of losses

Payment of fortuitous losses

Risk transfer

Indemnification

Explain the law of large numbers

List the six characteristics of an ideally insurable risk

What is the meaning of adverse selection?

the tendency for persons with a higher-than-average chance of loss to seek insurance at standard (average) rates, which, if not controlled by underwriting, results in higher-than- expected loss levels

Identify some methods that insurers use to control for adverse selection

ccareful underwriting, by charging higher premiums to substandard applicants for insurance, and by certain policy provisions

Identify the major fields of private insurance

life insurance, health insurance, and property and liability insurance (also called property and casualty insurance)

Identify several property and casualty insurance coverages

Personal lines include private passenger auto insurance, homeowners insurance, personal umbrella liability

insurance, earthquake insurance, and flood insurance
Commercial lines include fire and allied lines insurance, commercial multiple peril insurance, general liability insurance, products liability insurance, workers compensation insurance, commercial auto insurance, accident and health insurance, inland marine and ocean marine insurance, professional iability insurance, directors and officers liability insurance, boiler and machinery insurance (also known as equipment breakdown insurance), fidelity and surety bonds, and crime insurance

Explain the basic characteristics of social insurance programs

Social insurance programs are government insurance programs with certain characteristics. The programs are enacted into law to deal with social and economic problems. The programs generally are compulsory and financed by contributions from covered employers and employees; benefits are paid from specifically earmarked funds; benefits are skewed or weighted in favor of lower income groups; benefit amounts generally are related to the covered individual’s earnings; and eligibility requirements and benefit rights are prescribed by statute.

Identify the major social insurance program in the United States

Social Security, Medicare, Unemployment insurance, Workers compensation

Compare the risk of fire with the risk of war in terms of how well they meet the requirements of an ideally insurable risk

	Risk of Fire	Risk of War
Large # of exposure unites	Met	Not met Based on the law of large numbers, it is difficult to estimate accurately the number of wars that will occur
Accidental and unintentional loss	Met	Not met
Determinable and measurable loss	Met	Although a war loss can be determined, the measurement of loss would be difficult.
No catastrophic loss	Met Since most homes do not burn at the same time.	Not meet
Calculable chance of loss	Insurers can estimate within ranges the probability of a fire loss	Not easily meet
Economically feasible premium	Met	Because of the catastrophic potential of war, the premiums would not be economically feasible

Indemnification for loss

insureds are restored to their former financial position after a loss occurs, either partly or wholly. As a result, individuals and families can maintain their economic security and are less likely to apply for public assistance or welfare, or seek financial assistance from relatives and friends.

Enhancement of credit

it guarantees the value of the borrower’s collateral, or gives greater assurance that the loan will be repaid

Source of funds for capital accumulation

Premiums are collected in advance, and funds not needed to pay immediate losses and expenses can be invested in financial securities, such as stocks, bonds, and loans, issued by business firms and government units. These funds typically are invested in capital goods, such as housing developments, shopping centers, new plants, machinery and equipment, and local government projects, such as water treatment plants. Since the stock of capital goods is increased, economic growth and full employment are promoted. In addition, since the supply of loanable funds is increased, the cost of capital to business firms is lower than it would be in the absence of insurance

Explain the major costs of insurance to society

 Cost of doing business

 Fraudulent claims

 Inflated claims

Buildings in flood zones are difficult to insure by private insurers because the ideal requirements of an insurable risk are difficult to meet

Identify the ideal requirements of an insurable risk

 Large number of exposure units

 Accidental and unintentional loss

 Determinable and measurable loss

 No catastrophic losses

 Calculable chance of loss

 Economically feasible premium

Buildings in flood zones are difficult to insure by private insurers because the ideal requirements of an insurable risk are difficult to meet

Which of the requirements of an insurable risk are not met by the flood peril?

The requirement of not having a catastrophic loss is not met because large numbers of exposure units in a flood zone would be incurring losses at the same time. Also, the requirement of an economically feasible premium generally is not met. Without a government backup, premiums for flood insurance in major flood zones generally would be unaffordable for many insureds.

Identify a private insurance coverage that would provide the desired

protection

Emily, age 28, is a single parent with two dependent children. She wants to make certain that funds are available for her children’s education if she dies before her youngest child finishes college

Life insurance can provide the needed funds for a college education

Identify a private insurance coverage that would provide the desired

protection

Danielle, age 16, recently obtained her driver’s license. Her parents want to make certain they are protected if Danielle negligently injures another motorist while driving a family car.

Auto liability insurance will protect the parents if Danielle negligently injures someone while driving a family car.

Identify a private insurance coverage that would provide the desired

protection

Jacob, age 30, is married with two dependents. He wants his income to continue if he becomes totally disabled and unable to work

An individual or group disability income policy will provide periodic income payments if Jacob becomes totally disabled

Identify a private insurance coverage that would provide the desired

protection

Tyler, age 35, recently purchased a house for $200,000 that is located in an area where tornadoes frequently occur. He wants to make certain that funds are available if the house is damaged or destroyed by a tornado.

A homeowners policy will provide the desired protection. Windstorm and hurricanes are covered perils

Identify a private insurance coverage that would provide the desired

protection

Nathan, age 40, owns an upscale furniture store. He wants to be protected if a customer is injured while shopping in the store and sues him for the bodily injury

A commercial general liability insurance policy will cover Nathan if a customer is injured in his store

How does rate making, or the pricing of insurance, differ from the pricing of other products?

Ratemaking differs from the pricing of other products. When other products are sold, the company generally knows in advance what its costs of production are, so that a price can be established to cover all costs and yield a profit. However, an insurer does not know in advance what its actual costs are going to be. The premium may be inadequate for paying all claims and expenses during the policy period. It is only after the period of protection has expired that an insurer can determine its actual losses and expenses.

Define the meaning of underwriting

is the process of selecting and classifying applicants for insurance

The basic principles of underwriting

(1) Attaining an underwriting profit

(2) Selecting insureds according to the company’s underwriting standards

(3) Providing equity among policyholders

Identify the major sources of information available to underwriters

In determining whether to accept or reject an applicant for insurance, underwriters have several sources of information. They include the application, agent’s report, inspection report, physical inspection, physical examination, attending physician’s report, and a Medical Information Bureau (MIB) report.

Briefly describe the sales and marketing activities of insurers

Production refers to the sales and marketing activities of insurers. Agents who sell insurance are frequently referred to as producers. The key to the insurer’s financial success is an effective sales force. Marketing activities include the development of a marketing philosophy and strategy, identification of short- and long-run production goals, marketing research, developing new products, and advertising the insurer’s products

Explain the basic objectives in the settlement of claims

a) Verification of a covered loss

(b) Fair and prompt payment of claims

(c) Personal assistance to the insured

Describe the steps involved in the settlement of a claim

(a) Notice of loss must be given to the company.

(b) The claim is investigated by the company.

(c) A proof of loss may be required.

(d) A decision is made concerning payment.

What is the meaning of reinsurance?

an arrangement by which the primary insurer that initially writes the insurance transfers to another insurer (called the reinsurer) part or all of the potential losses associated with such insurance

Briefly explain the reasons for reinsurance

(1) To increase the company’s underwriting capacity

(2) To stabilize profits

(3) To reduce the unearned premium reserve

(4) To provide protection against a catastrophic loss

(5) To retire from the insurance business or from a line or territory

(6) To obtain underwriting advice or assistance