1. Risk Management & Insurance
Unit 4
Risk Management
&
Insurance
Information in this unit is derived from Trieschmann, Hoyt, and Sommer’s Risk Management & Insurance, 12th Edition, and Burrow, Kleindl, and Everard’s Business Principles & Management 12th Edition, both from Southwestern Publishing.

2. Today’s Learning Objective What are the basics of risk management & insurance?
Risk Basics
The Risk Management Process
Risk Reduction
Risk Transfer
Risk Retention
Insurance Basics
How Premiums are Determined

3. Risk
The uncertainty that a financial loss will occur due to some event
Peril
The risk for which you are obtaining insurance
Damage to car
Medical expenses due to having cancer
Etc.

4. Hazard The events that can cause a loss Auto accident
Accident in the home resulting in large medical bills
Death due to old age/illness/injury
Someone breaking into your house

5. Exposure Liability The amount of potential loss due to a hazard
Example: If you get into a car accident, it is the amount you might need to repair or replace your car.
Liability
The dollar amount of damages should a hazard occur that would be required to return someone/something to its condition prior to the occurrence of the hazard
Example: You hit someone with your car. The liability is the amount you would need to pay to repair/replace that person’s car.

6. Risk Management The process used to manage risk exposures
The actions you take to deal with the uncertainty of a potential financial loss
Step 1: Identify potential risks
Step 2: Make decisions & take actions on how you will deal with risk

7. Step 1: Risk Identification
Identify all potential risks
Identify every possible event that could happen that could result in a financial loss
Identify loss exposure associated with each risk
The amount you could potentially lose based on that risk
Potential dollar value of that loss

8. Step 2: Decide How to Deal with Risk
Determine what you will do in each of the following methods of risk management to deal with that risk:
Risk reduction
Risk transfer
Risk retention

9. Risk Reduction Actions taken to reduce the:
likelihood of a hazard occurring (called frequency reduction)
severity of loss should hazard occur (called severity reduction)

10. Examples: Hazard: Reduce by: shoplifting
move inventory farther from front door
install security cameras
use electronic loss prevention system
damage to car
drive more slowly
drive safer car
don’t drive as much

11. May choose risk avoidance
Decide not to take on (or no longer take on) risk
Examples:
Hazard: getting hurt or losing car in car accident
Avoid by: don’t drive or get a car
Hazard: someone get food poisoning & sue me after sampling food in my gourmet food store
Avoid by: don’t give out food samples

12. Risk Transfer
Getting someone else to assume the risk of the loss for you
Normally involves payment of money by you to the other person of business to take on the risk that you will suffer a loss
You pay other person money
They assume risk
If loss occurs, they pay for loss so you don’t have to
Example:
INSURANCE

13. Risk Retention
You assume the risk of loss from to an identified hazard yourself
Can assume all of risk associated with potential hazard
Example:
Hazard/Risk: financial loss due medical bills resulting from an accident/injury
Retained by: not getting insurance and paying for medical bills out of your own pocket

14. Can assume part of risk associated with potential hazard
Example:
Hazard/risk: financial loss due to getting sued when you hit someone with your car
Retained by: getting $50,000 in auto liability insurance…if you lose lawsuit for more than $50,000, you will have to pay that out of pocket

15. Risk retention may be planned
You know the risk of a hazard exists
You choose to not reduce/avoid/transfer that risk
Risk retention may be unplanned
You fail to realize that the risk of a hazard exists
You know the risk exists but assume hazard won’t occur

16. Fundamentals of Risk Transfer
Basic terminology
transferor
Person/organization transferring risk to other party
transferee
Person/organization assuming risk from transferor

17. Transferee must be able to predict severity of loss due to hazard
Transferee must be able to predict frequency of hazard occurrence & loss
Based on statistical averages, how often can the transferee expect a specific hazard to occur
Transferee must be able to predict severity of loss due to hazard
Based on statistical averages, how much can the transferee expect to pay when a specific hazard occurs

18. Law of Large Numbers
The larger the number of potential transferors you take on, the more accurately you can predict the frequency & severity of a potential hazard
Based on statistical probability
Transferee can more accurately predict the amount it will have to pay for losses during a given time frame

19. Pooling
The more people a transferee can gather, the better it can utilize the Law of Large Numbers to accurately predict losses for pool
If total amount of losses for pool can be predicted, transferee can spread losses among entire pool
Determine how much to charge each transferor for risk transfer to cover those anticipated losses, other expenses, and profits
Not all of transferors will suffer loss
The money they pay helps cover others’ losses
The money they pay helps cover their losses (if they occur)

20. Transferee must be willing to take on risk of loss
If loss cannot be accurately predicted (cannot employ Law of Large Numbers and risk pooling), or loss will be more frequent or more severe than transferee can afford, they will not take on risk
Not all loss can be transferred
Transferor expected to retain some risk
Transferee will limit exposure
Maximum amount of a loss for which they will pay
Require you to pay part of loss

21. Summary of Risk Transfer Principles
Transferee must be able to pool enough potential transferors to be able to employ Law of Large Numbers to reasonably determine:
Frequency of hazards for which risk is being transferred
Severity of losses for hazards

22. Transferee must be willing to assume risk to be transferred
Can afford risk
Can get transferor to pay enough for risk transfer to help cover loss
Not all risk can be transferred
Transferee will limit its exposure to assumed risk

23. In-Class Assignment Rate the Risk

24. Most Common Method of Risk Transfer
Insurance

25. Insurance
A contract between you (transferor) and the insurance company (transferee)
You transfer risk to insurance company for any financial loss due to the occurrence of the hazard for which you got insurance:
automobile accident
health problems
death
stolen property
They pay so you don’t have to

26. Insurance only pays out the amount of the actual financial loss
for example:
if you have $50,000 coverage for some type of insurance and only suffer $20,000 in financial loss
the insurance company only pays the $20,000 in financial loss you actually suffered
don’t overinsure
if your personal property is only worth $5,000, don’t get $50,000 worth of insurance on it
insurance will only pay you $5,000
Insurance company only gives you money to repair/replace (auto & property only)
They do not repair/replace for you
They do not force you to repair or replace property

27. Insurance Terms insurer - company that sells insurance (transferee)
policyholder - the person or business purchasing insurance (transferor)
insured - the persons or organization covered by the policy
policy - the written agreement, or contract, between the insurer and the policyholder
premium - the payment by a policyholder to the insurer for protection against risk
claim – once loss is suffered by insured, this is submitted to insurance company to pay for loss

28. deductible - a maximum dollar amount you will pay if you file a claim with your insurance company (risk retention)
example: $250 deductible means you will pay up to $250 per claim
$100 claim - you pay all of it
don’t file this claim; it will just raise your premiums
$800 claim - you only pay $250; insurance pays the rest
the higher your deductible, the lower your premium will be
More risk retention on your part

29. co-insurance - you pay a percentage of the total claim (risk retention)
example: $500 claim with 20% coinsurance
you pay $100; insurance pays the rest
the more the claim is to your insurance company, the more you pay
More risk retention on your part

30. How Premiums are Determined
Based on RISK
The riskier the hazard is:
the greater the likelihood that the insurance company will have to pay a claim on your policy
the higher the amount the insurance company will have to pay for a claim

31. The more risk you retain, the lower your premium
The riskier a hazard is to an insurance company, the higher your premium
Risky people:
Bad driver = high auto insurance
Smoker = high health & life insurance
Risky things:
Expensive car = high auto insurance
Expensive stuff = high property insurance
The more risk you retain, the lower your premium
Higher deductibles & co-insurance
Lower coverage amounts (limits of liability) for insurance company