Risk Management: Definitions and Concepts, Exams of Risk Analysis

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RMIN 4000 Test 1 Brown UGA with

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Exposures - ANSWER-things of value (assets) that could be lost Perils - ANSWER-things that cause injury or loss risk - ANSWER-a calculated possibility of a negative outcome Frequency - ANSWER-the number of losses (such as fire or theft) that occur within a specified time period. aka the probability of a loss Severity - ANSWER-the dollar amount of a loss for a specific peril (fire, theft, collision) aka How much does it cost when the loss does occur? Hazard - ANSWER-a condition that creates or increases the frequency or severity of loss but does NOT cause the loss. Physical Hazard - ANSWER-a physical condition that increases the frequency or severity of loss Moral Hazard - ANSWER-the presence of insurance changes the behavior of the insured. ex: making hail damage to get a check Morale hazard (attitudinal hazard) - ANSWER-A condition of carelessness or indifference that increases the frequency or severity of loss. Legal Hazard - ANSWER-characteristics of the legal system or regulatory environment that increase the frequency or severity of losses Georgia's Diminution in value is an example of a - ANSWER-legal hazard because it increases the severity on property losses Pure Risk - ANSWER-A chance of loss or no loss, but no chance of gain. Insurance can be bought for this Speculative Risk - ANSWER-A chance of loss, no loss, or gain. Diversifiable risk - ANSWER-a risk that affects only individuals or small groups and not the entire economy. It can be eliminated/ reduced through diversification. the risks are not correlated

Developing cancer or your house being caught on fire are two examples of what kind of risk? - ANSWER-Pure Risk diversifiable risk - ANSWER-A risk that affects only some individuals, businesses, or small groups. they can be reduced/eliminated through diversification. the risks are not correlated Non-Diversifiable Risk - ANSWER-affects the entire economy or large numbers of persons or groups within the economy (hurricane, flood), risks are correlated (inflation, unemployment) cannot be eliminated through diversification Enterprise Risk - ANSWER-encompasses all major risks faced by a business firm, which include: pure risk, speculative risk, strategic risk, operational risk, and financial risk systemic risk - ANSWER-the risk that the failure of one financial institution can bring down other institutions as well. instability in the financial system due to the interdependency between the players in the market Types of Pure Risk - ANSWER-personal risks, property risks, liability risks, loss of business income, cyber-security risks Personal risk - ANSWER-a risk that can directly affect an individual or a family; loss of income, extra expenses, and depletion of financial assets Property Risk - ANSWER-a risk that can lead to destruction or theft and loss of personal or business property including money, vehicles, and buildings; 2 types (direct and indirect) Direct Loss - ANSWER-cost to replace a loss that is a direct result of a peril, such as fire. Indirect Loss - ANSWER-Loss that is a result or consequence of a direct loss Liability Risk - ANSWER-a risk that relates to harm or injury to other people or their property because of your actions; no upper limit; Defense costs; liens may be placed on income or assets may be siezed Loss of business income - ANSWER-Financial loss when the firm must shut down for some time after a physical damage loss Grease fire in the kitchen causes a restaurant to close down for 4 weeks while repairs are made. The restaurant has no income while closed. this is an example of: - ANSWER-Loss of business income 2 techniques for managing risk - ANSWER-risk control, risk financing

Risk Control - ANSWER-techniques that reduce the frequency or severity of losses Risk Financing - ANSWER-techniques that provide for the funding of losses Loss Prevention is a _____ _________ technique that reduces the frequency of a loss. an example would be airport security - ANSWER-risk control _______ _____________ is a risk control technique that reduces the severity of a loss. it can occur pre-loss or post-loss. examples are duplication, diversification, and separation - ANSWER-Loss reduction which avoidance technique is practiced when a certain loss exposure is never acquired? - ANSWER-proactive avoidance which avoidance technique is practiced when an existing exposure is abandoned? - ANSWER-Reactive avoidance Retention is a ___ _____________ technique in which you retain part or all of losses that can occur from a given risk. - ANSWER-Risk Financing Active Retention - ANSWER-an individual is aware of the risk and deliberately plans to retain all or part of it; ex: high deductible Passive Retention - ANSWER-means risks may be unknowingly retained because of ignorance, indifference, or laziness __________________ _____________ is a risk financing technique in which you transfer liability by contract, hedging, or incorporation. - ANSWER-Non-Insurance transfer. insurance is a type of _______ _____________ - ANSWER-risk financing technique Risk Management - ANSWER-a process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating such exposures Loss Exposure - ANSWER-any situation or circumstance in which a loss is possible, regardless of whether a loss occurs 4 Steps in Risk Management Process - ANSWER-1. Identify potential losses

2. Evaluate potential losses
3. Select the appropriate risk management techniques
4. Implement and monitor the risk management program

the most important step in the risk management process - ANSWER-identifying loss exposures (which assets need to be covered and which perils are associated with those assets) When measuring and analyzing the loss exposures (step 2) you rank the loss exposures according to - ANSWER-relative importance with severity being more important. maximum possible loss - ANSWER-the worst loss that could happen to the firm during its lifetime Probable Maximum Loss (PML) - ANSWER-the worst loss that is likely to happen Step 3: consider and select the appropriate form of risk management technique from - ANSWER-risk control techniques and risk financing techniques Risk Control Techniques (6) - ANSWER-avoidance; loss prevention; loss reduction; separation; duplication; diversification Risk Financing Techniques - ANSWER-retention and transfer Types of retention - ANSWER-unfunded retention, funded reserve, deductible, captive insurer, self insurance, risk retention group when should risk be retained? - ANSWER-when it is difficult to insure when the worst possible losses are not serious (low severity ) losses are predictable (high frequency) captive insurer - ANSWER-an insurer owned by a parent firm for the purpose of insuring the parent firm's loss exposures single parent captive - ANSWER-owned by only one parent Group Captive - ANSWER-A captive insurer owned by a group of companies, usually operating similar businesses, rather than a single parent. Advantages of a Captive - ANSWER-can help a firm when insurance is expensive and difficult to obtain lower costs lower tax rate easier access to reinsurance market possibility of favorable regulatory enviornment Self-insurance - ANSWER-a special form of planned retention by which part or all of a given loss exposure is retained by the firm

Risk Retention Group - ANSWER-a group captive that can write any type of liability coverage except employers' liability, workers compensation, and personal lines exempt from many state insurance laws Advantages of Retention - ANSWER--save on loss costs -save on expenses -encourage loss prevention -increase cash flow disadvantages of retention - ANSWER-Possible higher losses Possible higher expenses Possible higher taxes non-insurance transfer (risk financing technique) - ANSWER-a method other than insurance by which a pure risk and its potential financial consequences are transferred to another party ex: contracts, leases, waivers advantages of non-insurance transfer - ANSWER-Can transfer some losses that are not insurable Less expensive Can transfer loss to someone who is in a better position to control losses disadvantages of non insurance transfer - ANSWER-Contract language may be ambiguous, so transfer may fail If the other party fails to pay, firm is still responsible for the loss Insurers may not give credit for transfers Commercial Insurance - ANSWER-appropriate for low-frequency, high-severity loss exposures areas of emphasis for commercial insurance - ANSWER-1.selection of insurance coverage's 2.selection of an insurer. 3.Negotiation of terms. 4.Dissemination of information concerning insurance coverages. 5.Periodic review of the insurance program deductible - ANSWER-a specified amount of money that the insured must pay before an insurance company will pay a claim Excess Insurance - ANSWER-a 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 - ANSWER-a policy specially tailored for the firm

advantages of commercial insurance - ANSWER-firm is indemnified for losses;can continue to operate •Uncertainty is reduced• Firm may receive valuable risk management services Premiums are income-tax deductible disadvantages of commercial insurance - ANSWER-premiums are costly negotiation of contracts takes time and effort risk manager may become lax in exercising loss control low frequency, high severity - ANSWER-Insurance and loss control low frequency, low severity - ANSWER-unfunded retention high frequency, low severity - ANSWER-funded reserve, loss prevention high frequency, high severity - ANSWER-avoidance captive or risk retention group loss prevention/reduction Hard Market - ANSWER-tight standards, high premiums, unfavorable insurance terms, more retention, insurance is hard to obtain soft market - ANSWER-profitability is improving, standards are loosened, premiums decline, and insurance become easier to obtain step 4 implementing and monitoring chose techniques - ANSWER-risk management policy statement periodic review and evaluation compare costs and benefits Benefits of Risk Management - ANSWER--Enables firm to attain its pre-loss and post- loss objectives more easily -A risk management program can reduce a firm's cost of risk -Reduction in pure loss exposures allows a firm to enact an enterprise risk management program to treat both pure and speculative loss exposures -Society benefits because both direct and indirect losses are reduced purpose of pooling losses - ANSWER-reduce variation which reduces uncertainty (risk) Risk Transfer - ANSWER-A pure risk is transferred from the insured to the insurer, who typically is in a stronger financial position Indemnification - ANSWER-The insured is restored to his or her approximate financial position prior to the occurrence of the loss

Characteristics of an ideally insurable risk - ANSWER-1. Large number of exposure units

2. Accidental and unintentional loss
3. Determinable and measurable loss
4. No catastrophic loss
5. Calculable chance of loss
6. Economically feasible premium Large number of exposure units - ANSWER-to predict average loss based on the law of large numbers the loss must be determinable and measurable. - ANSWER-can you determine that a loss has occurred and can you measure the amount of loss that has occurred Loss must be accidental & unintentional - ANSWER-loss should be outside of the insured's control Loss should not be catastrophic to insurer - ANSWER-allows the pooling technique to work ex: flood, earthquake, hurricane what is a solution for insurers when the loss might potentially be catastrophic - ANSWER-reinsurance and diversification Chance of Loss Must be Calculable - ANSWER-must be able to calculate the frequency and severity premium must be economically feasible - ANSWER-insured must be able to afford it adverse selection - ANSWER-the situation in which one party to a transaction takes advantage of knowing more than the other party to the transaction asymmetric information - ANSWER-a situation in which one side of the market has more reliable information than the other side credit-based insurance scores - ANSWER-The majority of insurers use the applicant's credit record for purposes of underwriting and rating in auto and homeowners insurance; used to predict the likelihood of future insurance losses introduced in the early 1990s not the same as the credit score Types of Private Insurance - ANSWER-Life Health Property Liability Casualty

life insurance - ANSWER-pays death benefits to beneficiaries when the insured dies health insurance - ANSWER-Insurance that covers medical illness or injury. Property Insurance - ANSWER-indemnifies property owners against the loss or damage of real or personal property liability insurance - ANSWER-covers the insured's legal liability arising out of property damage or bodily injury to others Casualty Insurance - ANSWER-refers to insurance that covers whatever is not covered by fire, marine, and life insurance