1. Chapter 17 Risk Management and Insurance
Small Business Management
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2. 1. Meaning and nature of business risk
For business owners - risk is real likelihood - business may not succeed – lose part – lose all
Some – seek risk - most entrepreneurs - risk adverse.
If they cannot reduce level of risk, they are likely to:
Insure
Share
17-2

3. Business risk
Level of probability that the future economic state of the business will be worse than expected.
E.g.
Sales projections are not met
Products do not meet spec.
Investments* go bad.

4. Most Commonly Identified Sources of Risk
Financial risk
Nonpayment of debts
Changes in technology
Injury and illnesses suffered by employees
Injury from accidents incurred by customers
Misbehavior by employees
Loss or harm – use – product or service
Theft of business property
Violation of laws
Natural events
(storms, floods, fire,
earthquakes)
There are many things that can go wrong: just ask the victims of 2005 hurricane Katrina in New Orleans.
Other risks may be special to certain industries such as tools stolen off a construction job site, customer injury in a rock climbing gym, or illnesses from hospital employees.

5. 2. Risks Associated with Specific Business Operations
3 general events:
Property of the business
Personnel
Customers and others

6. a. Events Related to Property
Every business owns thing of value
A retail – inventory
A manufacturing business – production machinery
Other businesses – furniture, office equipment, vehicles, buildings, land, intellectual properties.

7. Each of these types of property involves specific forms of risk
Inventory - be stolen
Machinery - break
Buildings - be damaged / destroyed
Land - become contaminated
Patents - be infringed upon

8. b. Events Related to Personnel
i. Theft ii. Violation of governmental regulations ii. Loss of key employees

9. i. Employee theft – a fact of life May be a direct act of removing property from a business e.g. small items or an illegal act that provide personal benefit at a cost to the business e.g. embezzlement or fraud

10. ii. Loss of key employees occurs if someone
quits, retires, dies or becomes disabled.
In some cases - could lead to bankruptcy and business dissolution.
Competition – constant risk
Especially – understand business – skilled – tempted to become competitors

11. iii. Law and governmental rules - limit the freedom of business owners to manage their businesses as they please. It has become a source of significant business risk over the last 30 years.

12. Given the complex, ambiguous and sometimes contradictory nature of the regulations - violation could occur (inevitable) .
LHDN (Inland Revenue Board of Malaysia) and Labor Department are known as agencies - to cause most headaches for small businesses

13. FOUR strategies regarding compliance:
To stay small - regulations do not kick in.
Some owners try indifference – not to spend time on compliance, when the face government action, close the business.
***The riskiest – government agencies can come after the owner

14. Others – proactive - seeking help from the professional do assessments to check for compliance.
Fight for what you believe is right. It is not suitable for a faint of heart – short of cash.

15. iii. Events Related to Customers and Others
Events related to customer and others
(vendors and even trespassers) occur in
several ways:
Injuries may be suffered while upon business property.
May or may not be your fault.
Even - a customer does something unreasonable – like climbing on shelves to reach something – can be liable.

16. Injuries / damaged by the use of products or services.
***product liability.
Magnitude of losses has increased greatly – manufacturer
Lawsuits may be individual or class action suits (a large group of people) - the latter being more common.

17. Risk of nonpayment by customers - experienced by all businesses that offer credit
Must balance:
giving credit to customers - increase your sales
offering credit - guarantees sooner or later some customers will not pay as promised.

18. 3. Techniques to Manage Risks?
Limit both the possibility the risk will occur and the damage that will occur if it does.
Think of it this way:
In a car you drive defensively to prevent and accident.
But you also wear your seatbelt to minimize the risk of injury should you be in an accident despite your preventive measures.

19. Best strategy - develop a business environment that MINIMIZES:
Cannot be avoided –
they can be managed.
Best strategy - develop a business environment
that MINIMIZES:
Probability of the event occuring
Amount of loss - can be experienced if the event does occur
Limit both the possibility the risk will occur and the damage that will occur if it does.
Think of it this way:
In a car you drive defensively to prevent and accident.
But you also wear your seatbelt to minimize the risk of injury should you be in an accident despite your preventive measures.

20. How?
Making specific plans and arrangements to deal with foreseeable events
Creating and enforcing an appropriate code of conduct
Ensuring valuable assets are physically secured
Actively working to get rid of any physical hazards (chemicals, poisons etc)

21. a. Managing risks to tangible property - depends on nature of asset.
Buildings and land:
Protect from fire with smoke alarms, sprinkler systems and being near a fireplug.
Protect from flood by not locating on a flood area - inspecting plumbing systems.
Protection from storms by rigorously enforcing building codes. E.g. choice of materials

22. Computers and data: Firewalls, Anti-virus, Anti-spyware programs
Encryption
Taking care of the human element:
Train employees - only safe surfing.
Download from trusted sources.
Passwords should be complex - hidden away if written.
Automatically lock down when inactive for a period of time.
Back up data daily

23. Intellectual property can be done through patents, copyrights and other registration procedures.
Intellectual Property Corporation (myipo.gov.my)
Responsible to regulate and supervise issues or matters relating to Intellectual Property
Must be prepared to make immediate written objections to the infringement.

24. Intellectual property rights comprise - legal rights to use unique features of products or services - competitive advantage.

25. Guarding against obsolescence - watching what is going on in the industry.
Protection – property - from theft can occur in several ways:
Adverse possession – legal way - allowing a non-owner to use property as if it were his own – period of time.
Institute separation of duties – to make it difficult for an employee to steal.

26. Managing Risk Resulting from Events Involving Personnel
Starts by careful screening and hiring practices.
PREVENT tempting employees by instituting business practices - make theft difficult:
Internal control - a set of rules and procedures to limit opportunity for employee theft.
Separation of duties - a form of internal control - separates physical control of an asset from the person accounting for that asset.
Keeping valuable property in a secured location - reduces temptation.

27. Sources of Business Theft
Figure 17.2

28. Percentage of Frauds by Method of Detection
Figure 17.3

29. Risk of losing key personnel can be done through employee contracts:
Limit the employee’s freedom to go into competition (e.g. non-compete agreement).
Contain employee’s specific promise to not disclose sensitive or confidential information.
Provide rewards for providing adequate time termination notice - replacement.
Cross training of employees - reduces shock to the business should a key employee leave unexpectedly.

30. An internal audit – a way to keep risks at a manageable level.
Should consider outsourcing to an expert.
A properly conducted audit - give business owner valuable information - various risks and recommendations for more effective and efficient use of resources.
Once it’s determined to use an external company, steps should be taken to carefully describe his role.

31. A properly conducted, ‘independent internal audit’ –
benefits:
An evaluation of overall level of business risk.
An objective evaluation of risk control structure.
A systematic analysis of business processes and controls.
Information on irregularities detected during the audit process.

32. Managing Risk from Violations of Tax Regulations
Keep complete, accurate accounting records
Establish a relationship - an accountant and a lawyer who are expert in tax issues
Make paying taxes the first financial priority

33. Managing Risk from Employee Violation of
Government Regulations:
Ignorance of employee actions is not a defense.
The only defense to ever hold an employer
harmless is:
Having a written policy provided to each employee.
Conducting training to each employee.
Having immediately and consistently acted upon receipt of any complaint.

34. 4. How to Use Insurance ?
Insurance - tool to minimize the loss from potential risks.
Key - buying enough coverage, but not wasting money by buying too much.
Not every loss is insurable.

35. Insurance
A contract between two or more parties in which one party agrees, for a fee, to assume the risk of another.
Takaful - a mutual assistance scheme based on the spirit of brotherhood and solidarity, where participants agree to assist each other financially in case of predefined events taking place. With this intention in mind, participants pay contribution on the basis of ‘tabarru’ (donation) to the General Takaful Fund managed by Takaful company (e.g. Etiqa Takaful Berhad).

36. Developing a comprehensive insurance policy means: E.g. car insurance
Understanding risks to which your business is vulnerable.
Amount of loss you could suffer.
Finding competitive rates for this coverage.

37. Determining which risks to cover:
Mandatory coverages :
Vehicle liability – Property, Injury
Unemployment insurances*
Desired coverages :
Product liability – harmed by product
Malpractice – harm caused – during performance by professionals
Credit – only applicable for manufacturers*

38. Theft insurance
For most assets - covered under property insurance.
Cash cannot be insured.
Two types of ‘insurance’ bonds – Fidelity and Surety.

39. Fidelity bonds
Bonds - called dishonesty bonds - repay employers for losses caused by dishonest or negligent employees.
Cover losses from employee fraud, theft, forgery, and embezzlement

40. Surety bonds e.g. bank guarantee
A surety bond - a promise to pay one party (the obligee) a certain amount if a second party (the principal) fails to meet some obligation, such as fulfilling the terms of a contract.
Surety bond protects the obligee against losses resulting from the principal's failure to meet the obligation.

41. Property insurance - cost is determined by:
Insurable value
Amount of an asset for which a company will write an insurance policy
Amount of deductible loss
An amount of loss that will not be paid by an insurance company
E.g. Pay amount of loss – a deductible

42. Property insurance (continued…)
Amount of co-insurance
A contract requirement that works to prevent property owners from deliberately underinsuring

43. A math formula:
A building actually valued at RM1,000,000 has an 80% coinsurance clause but insured for only RM750,000.
Since the insured value < 80% of its actual value, when suffers a loss - insurance payout will be subject to the underreporting penalty.
E.g. It suffers a RM 200,000 loss.
The insured would recover 750,000 ÷ (.80 × 1,000,000) × 200,000 = RM 187,500.

44. Credit insurance - manufacturer
Covers abnormal losses from credit customers not paying their bills
Buyout insurance
Insurance that provides money to owners of a business to buy the shares of any deceased owner from that owner’s heirs.

45. Personnel insurance
Key person insurance (SOCSO)
protects you in the event that a key employee dies or is disabled and cannot work
Life insurances
provided to employees to provide security for their families
Medical coverage

46. Thank You