Chapter 3: Hazard Risk - Review

Question 1

The Casualty Actuarial Society describes hazard as these six risks

Answer 1

• Fire and other property damage
• Windstorm and other natural perils
• Theft and other crime, personal injury
• Business interruption
• Disease and disability
• Liability claims

Question 2

How does the Basel Committee define operational risk?

Answer 2

“The risk of loss resulting from inadequate or failed internal processes, people and systems or from external events.”

Question 3

Three categories of hazard risk

Answer 3

• Personnel risk: death, incapacity, loss of health or unexpected departure of key employees
• Property risk: Loss fo wealth due to damage or destruction of property
• Liability risk: Financial resonsibility for bodily injury or loss of wealth that the entity causes to another

Question 4

Two measures traditionally used for hazard risk exposures

Answer 4

• Frequency
• Severity

Typically based on several years of measurement, such as three to five years before the current year, for each line of coverage

Question 5

Six techniques risk managers use to prevent loss or reduce their frequency / severity

Answer 5

• Avoidance: eliminates possiblity of loss because the organization does not assume the risk
• Separation: dispersing activity over several locations
• Duplication: relying on backups if primary assets are lost
• Diversification: providing a range of products or services used by a variety of customers
• Prevention: techniques to reduce frequency of loss
• Reduction: techniques to reduce severity of loss

Question 6

What are the most common techniques used by risk managers and why?

Answer 6

Prevention and reduction, often in combination.

Avoidance, separation, duplication, and diversification can only be used in certain circumstances (ex. a business can avoid purchasing a property if it was contaminated by a pollutant, but can’t avoid making investments forever)

Question 7

The role of insurance in risk management

Answer 7

• Losses cannot be eliminated, so organizations must either retain or transfer its loss exposures
• Losses with low frequency and severity can be retained, while higher frequency or higher severity losses can be transferred
• Insurance is most common method of risk transfer

Question 8

Advantages and disadvantages of insurance for risk transfer

Answer 8

Advantages
* Provides an offset to exposure for large losses
* Lessons variability of cash flows for organizations

Disadvantages
* Deductibles and self-insured retentions
* Limits of coverage for most lines
* Policies exlude certain types of exposure

Roughly 20-30% of operational risk losses are covered by insurance

Question 9

What are loss exposures and the three circumstances that lead to them?

Answer 9

Loss exposures are the invidiual pieces that form the risk an organization faces. They arise from the intersection of:

• An asset exposued to loss (ex. property, investments)
• A cause of loss or peril (ex. fire, theft)
• A financial consequence (ex. value of building damaged by fire)

Question 10

Four main categories of loss exposures

Answer 10

Property loss
Liability loss
Personnel loss
Net income loss

Question 11

Property loss exposures

Answer 11

• Possibility that a loss will result from damage to property in which an entity has a financial interest
• Damage to property can 1) reduce its value and 2) result in a loss of income for the owner

Question 12

Liability loss exposures

Answer 12

Results from the claim itself, not necessarily the payment of damages. Even if the claim is successfully defended, defence costs, claims-related expenses, and adverse publicity could result.

Question 13

Personnel loss exposures

Answer 13

Possibility of loss caused by a key person’s death, disability, reitrement or resignation resulting in loss of that person’s expertise (ex. the resignation or death of a CEO)

Question 14

Net income loss exposures

Answer 14

• Possibility of loss caused by reduction in net income (revenues minus expenses and tax in a given period)
• Ex. a fire at a production facility not only damages the facility but results in a loss of operations and revneus
• Can result from property, liability, or personnel loss and is considered an indirect loss
• Indirect losses are difficult to estimate since its hard to project the effects that a direct loss will have on operations or expenses

Question 15

Three other potential net income losses that may affect an organization

Answer 15

• Loss of goodwill: poor service or mismanaged operations can damage reputatoin
• Failure to perform: can include a pro=duct’s failure to perform as promised, a contractor’s failure to complete a project as scheduled etc.
• Missed opportunities: a company that takes too long to roll out a new product may miss out on profits it could have generated

Question 16

Two major categories of property-casualty insurance

Answer 16

Property
Liability

Question 17

Types of coverage provided under commercial property insurance policies

Answer 17

• Monoline or package policies
• Named perils or all-risks coverage
• Endorsements available for keeping a customer’s personal property, also known as bailee’s customers policy
• Replacement cost or actual cash value

Question 18

Purpose of business income insurance

Answer 18

Designed to provide coverage for loss of business income and extra expenses incurred while repairs are made after a covered loss

Question 19

Builder’s risk coverage addresses the following exposures not faced by standard organizations

Answer 19

• Value of building increases as construction progresses
• Different insured interests involved in a building under construction (ex. the owner, the contractor, subcontractors)
• Additional exposures to a building under construction (ex. theft since materials are left in the open)

Question 20

Equipment breakdown coverage provides protection for the following five types of property

Answer 20

• Boilers and pressure vessels
• Electrical equipment
• Mechanical equipment
• Air conditioning and refrigeration equipment
• Business equipment and systems

Question 21

Five examples of fidelity and crime insurance coverages

Answer 21

• Employee dishonesty
• Computer fraud
• Extortion
• Forgery or alteration
• Theft and robbery

Question 22

What is a surety bond and what are the typically used for?

Answer 22

• Three-party agreements involving the principal, the surety, and the obligee
• If principal defaults, the surety is answerable to the obligee
• Most common surety bonds are for construction operations to certify the contractor (the principal) will complete the project within a specified period of time

Question 23

Overall purpose of a general liability insurance policy

Answer 23

• Coverage for when the insured becomes obligated to pay for damages as a result of a legal wrong (ex. tort or breach of contract)
• Only provides cover if the claim is within the scope of the insuring agreement and not excluded
• Provides additional coverage to defend the insured against an allegation of liability
• Auto liability, indirect expense, environmental liability, and cyber liability are typically excluded

Question 24

Auto insurance

Answer 24

• Many nations require individuals to carry liability coverage for using vehicles on public roads
• Commercial auto policies exclude coverage for vehicles that solely perform off-road operations (ex. excavators or forklifts)

Question 25

Workers compensation and employer's liability insurance

Answer 25

* **Worker's compensation:** provides medical and wage replacement benefits as specified by law when a worker is injrued on the job **Employers liability insurance:** coverage for rare instances where employees are permitted to sue their employer (ex. if employer also manufactured the product that injured their employee)

Question 26

Purpose of Professional Liability (E&O) insurance

Answer 26

* Professionals have a duty to perform services for which they were hired * Provides coverage for failure to perform or failure to meet appropriate standards * Typically issued on a claims-made form since claims may arise years after the incident which gave rise to the loss

Question 27

Three major types of Management Liability

Answer 27

* Directors and officers (D&O) liability * Employment practices liability * Fiduciary liability

Question 28

Directors and Officers Liability Insurance

Answer 28

* Protects leadership of organziations against lawsuits arising from management of the organization * "Side A" - insures individual directors and officers * "Side B" - insures organization for the amounts they are legally required to pay as a result of a lawsuit against a director or officer

Question 29

Employment practices liability

Answer 29

EPL loss exposures arise from laws that protect employees against discrimination, sexual harassment, unfair wage practices, and other prohibited employer practices

Question 30

Fiduciary Liability

Answer 30

* Similar to D&O and EPL policies * Fiduciaries have a duty to act in the best interests of their clients and beneficiaries

Question 31

Three elements of aviation that distinguish it from other types of loss exposure

Answer 31

* Potential for catastrophic loss * Limited spread of risk * Diversifying factors that distinguish the loss exposures of each indivudal aircraft and pilot Aviation loss exposures are excluded from general liability policies, and few insurers have capacity and expertise to provide this type of coverage

Question 32

Ocian marine insurance (Hull and P&I)

Answer 32

* Three categories of coverage in marine insurance: vessel, liability, and cargo * Hull insurance covers vessel plus collision liability, usually on named perils basis for perils of the sea * Protection and Indemnity (P&I) insurance can be written to cover liability loss exposures. May also include cargo, but not all do.

Question 33

Environmental insurance

Answer 33

* Environmetnal liability is excluded from most general liability and auto policies * Various environmental policies provide coverage for these exposures