Managing Risk Bonus Chapter C McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

Understanding Business Risks Companies adopt risk management procedures to minimize the chance of business failure due to unplanned events such as security breaches, terrorist attacks, and natural disasters. Goals of enterprise risk management (ERM): 1) Defining which risks the program will manage. 2) What risk management processes, technologies, and investments will be required. 3) How risk management efforts will be coordinated across the firm. WHAT’S ENTERPRISE RISK MANAGEMENT? LG1 C-2

Managing Risk Risk -- The chance of loss, the degree of probability of loss, and the amount of possible loss. WHAT’S RISK? LG2 C-3 Two kinds: Speculative Risk -- A chance of either profit or loss…entrepreneur takes speculative risk when starting a business Pure Risk -- The threat of loss with no chance for profit…chance of fire, accident or theft…most concerns business people

1) Reduce the risk 2) Avoid the risk 3) Self-insure against the risk 4) Buy insurance against the risk HOW to DEAL with PURE RISK…once identified LG2 Managing Risk C-4

MOST COSTLY DISASTERS DisasterYearLosses Hurricane Katrina2005$122 Billion Kobe, Japan Earthquake1995$100 Billion Northridge California Earthquake1994$40 Billion Hurricane Ike2008$35 Billion Chilean Earthquake and Tsunami2010$30 Billion Hurricane Andrew1991$28 Billion 9-11 Terrorist Attacks2001$21.37 Billion Source: Fortune Magazine, April 11, LG2 Managing Risk C-5

Self Insurance Self-Insurance -- The practice of setting aside money to cover routine claims and buying only “catastrophe” insurance policies to cover big losses. WHAT’S SELF INSURANCE? LG2 Companies that self-insure can “go bare” and pay claims from their operating budgets or set up special funds to pay for claims…could go bankrupt C-6 When is it best for companies to self-insure?

Buying Insurance to Cover Risk Uninsurable Risk -- A risk that no insurance company will cover. Risks can include:  Market risks – market styles and new products  Political risks – war and government leaders  Personal risks – loss of job  Operational risks – strikes or inefficient machinery WHAT RISKS are UNINSURABLE? LG2 C-7

Insurable Risk -- A risk that the typical insurance company will cover, using the following guidelines: 1) The policyholder must have an insurable interest. 2) The loss must be measurable. 3) The chance of loss must be measureable. 4) The loss must be accidental. 5) The insurance company’s risk should be dispersed among different areas…one of the reasons for high price of earthquake insurance 6) The insurance company can set standards for accepting risks. WHAT RISKS are INSURABLE? LG2 Buying Insurance to Cover Risk C-8

PROGRESS ASSESSMENT What is the difference between pure risk and speculative risk? Progress Assessment C-9 What are some examples of uninsurable risk? Pure risk is the threat of loss with no chance for profit, such as the threat from a fire. If your house burns to the ground you lose money, but if it does not you gain nothing. Speculative risk can result in either profit or loss. An entrepreneur’s chance to make a profit is considered speculative risk. Market risk, political risk, personal risk and some risk of operation.

Understanding Insurance Policies Insurance Policy -- A written contract between the insured and an insurance company that promises to pay for all or part of the loss by the insured. Premium -- The fee the insurance company charges… the cost of the policy to the insured. Claim -- A statement of loss that the insured sends to the insurance company to request payment. INSURANCE POLICIES LG3 C-10

Law of Large Numbers -- If a large number of people or organizations are exposed to the same risk, a predictable number of losses will occur during a given period of time. BASICS of INSURANCE POLICIES Rule of Indemnity -- An insured person or organization can’t collect more than the actual loss from an insurable risk. LG3 Understanding Insurance Policies C-11

Types of Insurance Companies Stock Insurance Company -- Owned by stockholders, just like any other investor-owned company. TYPES of INSURANCE COMPANIES Mutual Insurance Company -- An organization owned by its policyholders…nonprofit. Like AAA. Discounts passed on in the form of dividends or premium savings LG3 C-12

Health Insurance Health Maintenance Organizations (HMOs) -- Offer a full range of healthcare benefits, members do not receive bills and do not have to fill out claim forms but must obtain the HMO's approval before medical treatment is provided Preferred Provider Organizations (PPOs) -- Contract with hospitals and physicians, members usually pay some part of the bill; choose physician. Health Savings Accounts (HSAs) -- are tax- deferred accounts that allow people to save money for medical costs such as prescription drugs, office visits, and routine medical procedures. EMPLOYER HEALTH INSURANCE OPTIONS LG4 C-13

Disability Insurance and Workers’ Compensation Disability insurance replaces part of your income if you become disabled and can’t work. Important for younger people because they are more likely to be disabled by accident or disease than death. OTHER TYPES of INSURANCE LG4 C-14

Liability Insurance Professional liability insurance covers people found liable for professional negligence; also known as malpractice insurance…stock brokers, doctors, real estate agents Product liability insurance covers liability arising out of products sold. LIABILITY INSURANCE LG4 Photo Courtesy of: Paul Wilson C-15

Insurance Coverage for Home-Based Businesses Homeowners’ policies usually don’t provide protection for home- based businesses. For more coverage, you may need to add a rider to your homeowner’s policy. HOME-BASED BUSINESSES LG4 C-16

PROGRESS ASSESSMENT Why should younger workers buy disability insurance? Progress Assessment C-17 How many different kinds of private insurance can you name? A young person is more likely to become disabled than to die. Life insurance (Whole and Term), medical insurance (PPO and HMO), property insurance, renter’s insurance, professional liability insurance, disability insurance.