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Introduction to Risk Management

Bus 200 Introduction to Risk Management and Insurance

Fall 2008 Prof. Jin Park

Overview

Definition & Objectives Process Risk Management Technique

Control vs. Finance More on Risk Finance

Retention, Captive, Insurance, Transfer

Definition and Objectives

Risk Management

A systematic process for managing (pure) risks faced by an individual or organization.

Pre-loss vs. Post-loss risk management

Loss Exposure

Objectives Why?

Ay situation or circumstance in which a loss is possible regardless of whether a loss occurs.

Managements job Reduce earnings volatility Maximize shareholders value Promote job and financial security

Risk and Relative Return

Zone 1
Insufficient Risk Taking

Zone 2

Optimal Risk Taking

Zone 3

Excessive Risk Taking

RiskAdjusted Return

Risk

Risk Management Process

Risk Management Process

Risk Management Process

The Process

Step 1 - Identification

Step 2 Evaluation

Loss exposures Methods

Frequency Severity

Step 3 Risk Management Selection

Step 4 Implementation and Monitor

Control vs. Finance Prevention vs. Reduction

Evaluation Tools

Risk mapping

Risk management matrix

A graphical presentation of potential frequencies and severities of identified loss exposures faced by individual/organization Critical issue tolerance boundary or risktolerance boundary Prioritize risks

Risk Mapping
EEs petty theft
Auto liability Vandalism System failure Robbery Job related injuries

Frequency

Owners disability
Fire on warehouse Tornado Flood on warehouse

Default on payment

Severity

Risk Management Matrix

High Low Prevention Retention Retention

Frequency

Avoidance Reduction Insurance

Low

Severity

High

Risk Management Techniques

Risk Control

Risk Financing

Goals Risk control options

Goals Risk financing options

Avoidance Loss control

Retention

Prevention Reduction

Transfer

How?

Pre-loss risk control Post-loss risk control

Insurance Non-insurance

Risk Financing - Retention

A method of funding losses using internal money

What determines the retention decision?

No purchase of insurance Retention with insurance

Frequency & severity of expected losses No other effective method available Costs and availability of insurance

Highly predictable losses Self-confidence or degree of risk aversion Failure to identify

MMP, Health care insurance

Risk Financing - Retention

What determines the retention level?

Degree of risk aversion Financial condition Ability to diversify the retained risk Potential cost/benefit Costs and availability of insurance Ability to administer a retention program in a cost effective manner

Risk Financing - Retention

Self-Insurance, Captive, RRG

Self-Insurance Captive

A form of self-insurance through a wholly owned subsidiary (insurance company) created to provide insurance to the parent companies

Which one? UPS vs. IRS

Pure captive, Group captive, Risk Retention Group

Transfer - Insurance

Advantages

Disadvantages

Less uncertainty Loss control services. Eligible expenses Non-taxable insurance proceeds.

High insurance premium. Moral and morale hazards. Time and effort. Insurance may not be available. Dependable No benefit of loss control

Non-Insurance Transfer

Methods of transferring risk to another party other than by insurance

Contracts Hold harmless agreements Leases

Non-Insurance Transfer

Advantages

May be able to transfer losses that are otherwise not commercially insurable. Noninsurance transfers may cost less than insurance. May be able to shift loss to someone who is in a better position to exercise loss control.

Disadvantages

Transfer may fail for legal reasons Transferee may be unable to pay the loss May not reduce insurance costs if insurer does not give credit for the transferred risk