Analysis Tools Used in Corporate Risk

Management

Chapter Five

Risk Management Tools• For small businesses and individuals, risk management

decisions depend largely on judgment, and commonly they are influenced by the advice of insurance agents and brokers

• For large firms, the value of information provided by statistical analysis is much more likely to exceed the cost of understanding the analysis (the cost of data collection, analysis and interpretation)

• The information provided is likely to be more meaningful and reliable, and large firms can spread the fixed costs of analysis over a larger number of exposures

• The chapter presents some tools used by risk managers to analyze their risk and improve decision making

Calculating Frequency and Severity of Losses from Historical Data

• Table 26.1 resents data on medical payments resulting from workplace accidents at two restaurants owned by Klare corporation

• The restaurants are of similar size and design, employ the same number of people, conduct similar amounts of business (revenue) and are located in areas with similar health care costs

• The table provides the data of the accident and the amount of the loss for the year 2002

• The loss payments are matched to the date of the accident, not when the payments were actually made

• The risk manager for Klare Corporation would like to examine the frequency and severity of losses during the year at the two restaurants

• Using the data in the top, total loss payments for the year, the frequency (number) of losses per year, and the average severity (the total loss payments divided by the frequency) are calculated and reported

• The data indicate that restaurant B had greater frequency and severity of losses in 2002 than restaurant A

• Since one year of data is insufficient to conclude that restaurant B has a worse safety record, the manager collects loss data for the two restaurants for the past eight years

• He adjusts the historical data to take into account health care costs inflation

• He multiplies each loss payment by one plus the rate of inflation from the year of the loss to 2002

• If the health care costs increased by 4% from 2000 to 2001 and by 5% from 2001 to 2002, then the manager multiplies the 2001 losses by 1.05 to put them in 2002 dollars

• He multiplies the 2000 losses by (1.04)x(1.05)= 1.092 to put them in 2002 dollars

• On average, restaurant A has about 20 losses per year compared to about 22 for restaurant B

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