Chapter 3:Risk Management

Risk Management

• What is Risk Management (RM)?• Making pre-loss arrangements for post-loss

resources• The logical approach to financing and

controlling loss exposures

The RM Function

• The staff varies based on size and responsibility

• All firms and people engage in risk management

• Career opportunities in profit and non-profit organizations

• Occupation is professionally recognized – RIMS – Risk and Insurance Management Society

RM Statement of Objectives and Principles

• Distinguish between pre-loss and post-loss objectives

• Pre-loss objectives– Survival and growth– Compliance with government regulations– Efficiency– Procedures and principles are implemented and

followed

RM Statement of Objectives and Principles

• Post-loss objectives– Survive the loss– Provide a foundation to grow and prosper– Behave responsibly as a good corporate citizen

• Risk Management Manual– Written to articulate goals, standards, how to

measure results and provide benchmarks

Steps in the Pre-loss Risk Management Process

• Identify & Measure (evaluate)• Choose most efficient tool(s) for– Loss Control– Loss Financing

• Implement and review

Step 1 - Identify

• What to identify:– Direct losses– Indirect losses– Key personnel– Operations

• How to identify– Balance sheet– Income statement– Other records– Checklists– Flow charts– Questionnaires

Measure (evaluation)

• Maximum possible loss– The absolute maximum dollar amount of damage

• Maximum probable loss– A conservative estimate of what is likely to occur in a

worst case loss

• Relative Frequency– An estimate (numerical or verbal) as to the number of

times the loss will occur

Valuing Property

• Replacement value versus book value versus actual cash value versus market value

• International operations and exchange rate problems

• The impact of inflation on values

Loss of Income

• Definition• Sources of Loss• Problems– Can be seasonal in nature– Difficult to measure– Best measurement still can only be an estimate

Liability Losses

• Examples of loss sources– Bodily injury or personal injury– Property damage to real or personal property– Intentional damage to reputation– Wrongful hiring, firing, sexual harassment,

invasion of privacy, age discrimination– Vicarious liability– Products, environmental, workers’ compensation

Losses to Key or other Personnel

• Death• Disability – physical (medical) or mental

– Short or long term– Permanent or temporary

• Loss of health• Unplanned retirement• Results in loss of income, business continuation

problems, replacement and training issues

Step 2 -Decide How to Handle

• A ---- Avoid• R ---- Retain• T ---- Transfer– Insurance– Non-insurance

Selecting the Risk ManagementTechnique

• Frequency Low High

• S L Assume Loss Prevention• e o Loss prevention loss reduction• v w Loss reduction assume risk• e• r h Insure Avoid• i i risk transfer loss prevention• t g loss reduction loss reduction• y h loss prevention•

Loss Control - Prevention

• Loss Prevention– Take various steps to reduce the probability of

losses occurring

• How do you value the loss of life in the cost / benefit equation?

Government and Loss Prevention• Occupational Safety and Health Act of 1970

(OSHA)• Consumer Product Safety Act of 1972 (CPSA)• Comprehensive Environmental Response,

Compensation Liability Act of 1980 (CERCLA) (Superfund)

• Food and Drug Administration (FDA)• The Clean Air Act• The Water Pollution Control Act

Loss Control - Reduction

• Loss Reduction– Steps designed to reduce the severity– Take steps to reduce the damage before and after

a loss

Self-insurance - loss financing

• What is self-insurance?– Why do companies self-insure?

• Save money• Better control

– Loss prevention incentives– Improved claims settlement– Profitability and investment earnings

– Difference between self-insurance and risk assumption

Captive Insurance Companies

• A method of self-insuring• A company formed to write insurance for a

parent company• Motives for starting a captive– Save the overhead and profits of the insurance

company– Earn investment income on the premium– Tax advantages

Other Risk Management Tools

• Risk Transfer– Hold harmless agreements - transfer of risk

through a contract– Hedging - take equal but opposite position on an

even based on chance– Financial risk management - techniques to deal

with interest rate, currency value, and crop price changes

– Leases - transfers risk of obsolescence

Step 3 – Review and Update

• Regularly review and update the process– New assets or disposal of assets– Valuation changes– New products and processes, materials– New personnel– Law changes– Currency fluctuations– New contractual relationships