Chapter 3 - Introduction To Risk Management

Question 1

What is the process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating such exposures.

Answer 1

Risk management

Question 2

Define loss exposure

Answer 2

is any situation of circumstance in which a loss is possible, regardless of whether a loss actually occurs.

Question 3

Risk management has two important objectives. these objectives are?

Answer 3

Pre-loss Objectives

Post-loss Objectives

Question 4

Pre-loss objectives- important objectives before a loss occurs include _____, ______, and ________. (3)

Answer 4

Economy, reduction of anxiety, and meeting legal obligations

Question 5

Post-loss objectives- important objectives after a loss occurs include ________, _______,______,______, and _____. (5)

Answer 5

Survival of the firm, continued operations, stability of earnings, continued growth, and social responsibility.

Question 6

What are the four steps in the risk management process?

Answer 6

• identify loss exposures
• measure and analyze the loss exposures
• select the appropriate combination of techniques for treating the loss exposures
• implement and monitor the risk management program

Question 7

What are the NINE important loss exposures? (Mahaha)

Answer 7

• property loss exposures
• liability loss exposures
• business income loss exposures
• human resources loss exposures
• crime loss exposures
• employee benefit loss exposures
• foreign loss exposures
• intangible property loss exposures
• failure to comply with government laws and regulations

Question 8

What are the five sources of information to identify the preceding loss exposures?

Answer 8

• risk analysis questionnaires and checklists
• physical inspection
• flowcharts
• financial statements
• historical loss data

Question 9

What does the loss frequency refer to?

Answer 9

refers to the probable number of losses that may occur during some given time period.

Question 10

What refers to the probable size of the losses that may occur?

Answer 10

Loss severity

Question 11

What refers to techniques that reduce the frequency or severity of losses?

Answer 11

risk control

Question 12

What does risk financing refer to?

Answer 12

refers to techniques that provide for the funding of losses.

Question 13

What are the three major risk-control techniques?

Answer 13

• Avoidance
• Loss prevention
• Loss reduction

Question 14

What are the three major risk financing techniques?

Answer 14

• Retention
• Non-insurance transfers
• Commercial insurance

Question 15

Define retention

Answer 15

means that the firm retains part or all of the losses that can result from a given loss.

Question 16

Retention can be effectively used in a risk management program under the following conditions: (3)

Answer 16

• no other method of treatment is available
• the worst possible loss is not serious
• losses are fairly predicable

Question 17

If retention is used, the risk manager must have some method for paying losses. the following methods are typically used: (4)

Answer 17

• current net income: losses are treated as current expenses
• unfunded reserve: losses are deducted from a bookkeeping account
• funded reserve: losses are deducted from a liquid fund
• credit line: funds are borrowed to pay losses as they occur

Question 18

Define captive insurer

Answer 18

an insurer owned by a parent firm for the purpose of insuring the parent firm’s loss exposures.

Question 19

Define a single parent captive (pure captive)

Answer 19

an insurer owned by only one parent, such as a corporation.

Question 20

Define association or group captive

Answer 20

is an insurer owned by several parents

Question 21

What are the six main reason captive insurers are formed?

Answer 21

• Parent company may have difficulty in obtaining insurance
• To take advantage of favorable regulatory environment
• lower costs
• easier access to a re-insurer
• formation of a profit center
• may be income-tax advantages to the parent under certain circumstances

Question 22

True or False

premiums paid to a single parent captive (pure Captive) are NOT income- tax deductible

Answer 22

True
The IRS argued that there is no substantial transfer of risk from an economic family to an insurer, and that the premiums paid are similar to contributions to a self-insurance reserve.

Question 23

Premiums paid to captives are not income-tax deductible unless some or all of the following factors are present: (4)

Answer 23

• The transaction is a bona fide insurance transaction, and the captive insurer takes some risk under a defensible business plan.
• the captive insure’s owner is organized such that subsidiaries, and not the parent, pay premiums to the captive insurer under a “brother-sister” relationship. (the term brother-sister refers to separate subsidiaries owned by the same parent, such as a captive insurer and an operating subsidiary.)
• The captive insurer writes a substantial amount of unrelated business.
• ownership of the captive insurer is structured so that the insureds are not the same as the shareholders.

Question 24

Define risk retention group (RRG)

Answer 24

is a group captive that can write ant type if liability coverage except employers’ liability, workers compensation, and personal lines.

Question 25

What are the four advantages of the risk retention technique?

Answer 25

- save on loss costs - save on expenses - encourage loss prevention - increase cash flow

Question 26

What are the three disadvantages of the retention technique?

Answer 26

- Possible higher losses - Possible higher expenses - Possible higher taxes

Question 27

Define non-insurance transfers

Answer 27

are methods other than insurance by which a pure risk and its potential financial consequences are transferred to another party. Ex: contracts, leases, and bold-harmless agreements.

Question 28

What are the three advantages of a non-insurance transfers?

Answer 28

- the risk manager can transfer some potential losses that are not commercially insurable - non-insurance transfers often cost less than insurances - the potential loss may be shifted to someone who is in a better position to exercise loss control.

Question 29

What are the three disadvantages of a non-insurance transfers?

Answer 29

- the transfer of potential loss may fail because of the contract language is ambiguous - if the part to whom the potential loss is transferred is unable to pay the loss, the firm is still responsible for the claim - an insurer may not give credit for the transfers, and insurance costs may not be reduced

Question 30

What are the five key areas that must be emphasized when using commercial insurance?

Answer 30

- selection of insurance coverage - selection of an insurer - negotiation of terms - dissemination of information concerning insurance coverages - periodic review of the insurance program

Question 31

What are the four advantages of commercial insurance in a risk management program?

Answer 31

- the firm will be indemnified after a loss occurs. - uncertainty is reduced, which permits the firm to lengthen its planning horizon - insurers can provide valuable risk management services, such as risk-control services, loss exposure analysis, and claims adjusting - insurance premiums are income-tax deductible as a business expense

Question 32

What are the three disadvantages of commercial insurance in a risk management program?

Answer 32

- The payment of premiums is a major cost because the premiums consists of a component to pay losses, an amount to cover the insurer's expenses, and an allowance for profit and contingencies. There is also an opportunity cost. - Considerable time and effort must be spent in negotiating the insurance coverage. - the risk manager may have less incentive to implement loss-control measures because the insurer will pay the claim if a loss occurs.

Question 33

What is the appropriate risk management technique for a low frequency and low severity of loss? Ex: potential theft of office supplies.

Answer 33

Retention because the loss occurs infrequently and, when it does occur, it seldom causes financial harm

Question 34

What is the appropriate risk management technique for a loss occur frequently, but severity is relatively low? Ex: physical damage losses to automobiles, workers compensation claims, shoplifting, and food spoilage.

Answer 34

Loss prevention and retention Loss prevention should be used here to reduce the frequency of losses. loesses occur regularly and are predicable, the retention technique can also be used

Question 35

What is the appropriate risk management technique for a low-frequency, high-severity losses. High severity means that a catastrophic potential is present, while a low probability of loss indicates that the purchase of insurance is economically feasible. Ex: fires, explosions, natural disasters, and liability lawsuits.

Answer 35

Transfer including insurance | The risk manager could also use a combination of retention and commercial insurance to deal with these exposures.

Question 36

What is the appropriate risk management technique for a high frequency and high severity. Ex: harmful side effects of a new drug.

Answer 36

Avoidance. The exposure to liability arising from this drug can be avoided of the drug is not produced and sold.

Question 37

What happens during a period of hard market conditions?

Answer 37

Profitability is declining, or the industry is experiencing underwriting losses. As a result, underwriting standards tighten, premiums increase, and insurance becomes expensive and more difficult to obtain. A risk manager may decide to retain more of a given loss exposure and cut back on the amount of insurance purchased.

Question 38

What happens during a period of soft market conditions?

Answer 38

profitability improving, underwriting standards loosen, premiums decline, and insurance is easier to obtain. Insurance may be viewed as relatively inexpensive. A risk manager may decide to retain less of a given loss exposure and increase the amount of insurance purchased.

Question 39

What are the four benefits of risk management?

Answer 39

- a formal risk management program enables a firm to attain its pre-loss and post-loss objectives more easily - the cost of risk is reduced which may increase the company's profits - the adverse financial impact of pure loss exposures is reduced, a firm may be able to implement an enterprise risk management program that treats both pure and speculative loss exposures - society also benefits since both direct and indirect losses are reduced.

Question 40

Define personal risk management

Answer 40

the identification and analysis of pure risks faced by an individual or family, and to the selection and implementation of the most appropriate technique for treating such risks.

Question 41

What are the four steps that is involved in a personal risk management program?

Answer 41

- identify loss exposures - measure and analyze the loss exposures - select appropriate techniques for treating the loss exposures - implement and review the risk management program periodically.

Question 42

What are the four implementation of a risk management program that involve the risk management policy statement?

Answer 42

- outlines the firm's objectives and polices - educates top-level executives - gives the risk manager great authority - provides standards for judging the risk manager's performance