Chapter 4 Risk Management BCN 4772 Summer 2007

Risk Management What is Risk? What is Risk? Specific types of Risk Specific types of Risk Inflation Inflation Market Market Principal Principal Liquidity Liquidity Credit Credit Two categories of risk Two categories of risk Speculative Risk Speculative Risk Pure Risk Pure Risk What is Risk Management? What is Risk Management?

Risk Management Types of losses Types of losses Property Property Financial Financial Liabilities Liabilities Losses involving personnel Losses involving personnel

Risk Management Risk Management Process Risk Management Process Identify and analyze loss exposure Identify and analyze loss exposure Evaluate alternatives Evaluate alternatives Select the best techniques Select the best techniques Implement Implement Monitor and adjust Monitor and adjust

Risk Management Return Risk Risk / Return Tradeoff

Risk Management Transfer risk exposure Transfer risk exposure Insurance Insurance Required Required Covers specific risk Covers specific risk Selection is important Selection is important Disclosure Disclosure Best’s Rating Guide Best’s Rating Guide

Risk Management Property insurance Property insurance Covers losses due to destruction of personal or company property Covers losses due to destruction of personal or company property Replacement cost Replacement cost Value Value Coinsurance Coinsurance Specific perils Specific perils Exclusions Exclusions

Risk Management Financial Loss Exposure Financial Loss Exposure Loss of net income Loss of net income Decrease in revenues and increase in expenses Decrease in revenues and increase in expenses Business interruption insurance Business interruption insurance Covers rental equipment costs Covers rental equipment costs Work stoppage costs Work stoppage costs Temporary relocation costs Temporary relocation costs

Risk Management Business Liability Exposures Business Liability Exposures Legal liability losses Legal liability losses Bodily injury Bodily injury Property damage Property damage Other injury Other injury Caused by employees or subcontractors Caused by employees or subcontractors Third party agreement Third party agreement

Risk Management Contract Liability Exposure Contract Liability Exposure Exculpatory Clauses Exculpatory Clauses Hold-harmless Hold-harmless Indemnification Indemnification Contract Liability exclusion Contract Liability exclusion

Risk Management Other types of coverage Other types of coverage Business Automobile Policy Business Automobile Policy Workers Compensation Insurance Workers Compensation Insurance Employee Benefits Liability Coverage Employee Benefits Liability Coverage Employment Practices Liability Employment Practices Liability Umbrella Liability Policy Umbrella Liability Policy Personnel Loss Exposures Personnel Loss Exposures

Risk Management Premium Rates Premium Rates Property Property Full value Full value Fire rate Fire rate Flood rate Flood rate Wind rate Wind rate Etc Etc Maximum values at risk Maximum values at risk Credits for certain amenities Credits for certain amenities Payroll or gross sales Payroll or gross sales Location Location Reputation Reputation

Risk Management Bond Obligation Bond Obligation Guarantee by third party Guarantee by third party Insures that the work will be done Insures that the work will be done Not insurance Not insurance Surety bond Surety bond Three party agreement Three party agreement Contractor Contractor Guarantor Guarantor Owner Owner Protects the taxpayer Protects the taxpayer

Risk Management Types of Bonds Types of Bonds Bid Bond Bid Bond Forfeiture Obligation Forfeiture Obligation Difference in Bid Difference in Bid Performance Bonds Performance Bonds Payment Bonds Payment Bonds

Risk Management Important People in Bonding process Important People in Bonding process CPA CPA Banker Banker Attorney Attorney Bonding agent Bonding agent Professional bond team Professional bond team

Risk Management Bond issuers Bond issuers Treasury Department Treasury Department T-list T-list Max amounts Max amounts A.M. Best A.M. Best Private rating Private rating A+ - C- A+ - C- Gives insight to condition of company Gives insight to condition of company

Risk Management Florida Statute Florida Statute Allows smaller surety companies to provide bonds Allows smaller surety companies to provide bonds Must have a treasury listing Must have a treasury listing Projects under $500,000 Projects under $500,000 This provision allows smaller companies to develop a reputation This provision allows smaller companies to develop a reputation

Risk Management Underwriting Underwriting Capital Capital Character Character Capacity Capacity Default options Default options Bank roll the contractor until completion Bank roll the contractor until completion Dissolve the contract pay the difference for new contract Dissolve the contract pay the difference for new contract Leave it to the owner to negotiate Leave it to the owner to negotiate Use own contract Use own contract

Risk Management Information needed by the Surety Information needed by the Surety 3 yrs of financials 3 yrs of financials Personal financial statements of all stockholders Personal financial statements of all stockholders Schedule of equipment available Schedule of equipment available Schedule of contracts in progress Schedule of contracts in progress Resumes on key people Resumes on key people History of business History of business Letter of credit from bank Letter of credit from bank Reference letters Reference letters Surety questionnaire Surety questionnaire Organization chart Organization chart

Risk Management Indemnity Indemnity Legal right of surety Legal right of surety Prevents non compliance by principal Prevents non compliance by principal Agreement requires signatures of all corporate stockholders and spouses Agreement requires signatures of all corporate stockholders and spouses Continuity Continuity

Risk Management Other surety interests Other surety interests Financial Statements Financial Statements Audit Audit Review Review Compilation Compilation Income recognition Income recognition Cash Cash Completed Contract Completed Contract Accrual Accrual Percentage of completion Percentage of completion Ratios Ratios Net quick Net quick Actual contract Actual contract

Risk Management Bond Costs Bond Costs Premium based on contract price Premium based on contract price Multiplied by a rate per thousand Multiplied by a rate per thousand May very from firm to firm May very from firm to firm All premiums are subject to change All premiums are subject to change Standards set for certain classes of contract ratings Standards set for certain classes of contract ratings

Risk Management Small Business Administration Guaranty Small Business Administration Guaranty Guaranties a portion 70%-90% Guaranties a portion 70%-90% Allows for newly stated contractors to get bonded Allows for newly stated contractors to get bonded Max $1,250,000 Max $1,250,000 Contractor must be under $5,000,000 annual Contractor must be under $5,000,000 annual Charges to contractor of additional $6 per thousand Charges to contractor of additional $6 per thousand May require collateral, escrow agent and updates of project May require collateral, escrow agent and updates of project

Risk Management Dealing with risk Dealing with risk Identify Identify Plan Plan Monitor Monitor Anticipate Anticipate Improve company Improve company