Managing Risk

Bonus Chapter C

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

1. Identify the environmental changes that have made risk management important.

2. Explain the four ways of managing risk, and distinguish between insurable and uninsurable risk.

3. Define insurance policies, and explain the law of large numbers and the rule of indemnity.

4. Discuss the various types of insurance businesses can buy to manage risk.

LEARNING GOALSBonus Chapter C

C-2

• Oechslin is chief risk officer of Munich Re; the world’s largest reinsurer.

• Damage caused by a disaster is not limited to the immediate damage, but spreads throughout the supply chain.

• Oechslin and his team predict what those events will mean and how much insurance companies will have to pay.

ProfileJOACHIM OECHSLIN

Munich Re

C-3

NAME that COMPANYBonus Chapter C

Every business faces risks that can affect the health of the company. When the government suspected some of our hens had been exposed to bird flu, we killed and buried some 15,000 hens in northwestern Arkansas.

Name that company!

C-4

Understanding Business Risks

• 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-5

Managing Risk

• Risk -- The chance of loss, the degree of probability of loss, and the amount of possible loss.

• Speculative Risk -- A chance of either profit or loss.

• Pure Risk -- The threat of loss with no chance for profit.

WHAT’S RISK?LG2

C-6

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 RISKLG2

Managing Risk

C-7

MOST COSTLY DISASTERS

Disaster Year Losses

Hurricane Katrina 2005 $122 Billion

Kobe, Japan Earthquake 1995 $100 Billion

Northridge California Earthquake 1994 $40 Billion

Hurricane Ike 2008 $35 Billion

Chilean Earthquake and Tsunami 2010 $30 Billion

Hurricane Andrew 1991 $28 Billion

9-11 Terrorist Attacks 2001 $21.37 Billion

Source: Fortune Magazine, April 11, 2011.

LG2

Managing Risk

C-8

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.

C-9

Buying Insurance to Cover Risk

• Uninsurable Risk -- A risk that no insurance company will cover. Risks can include:

- Market risks

- Political risks

- Personal risks

- Operational risks

WHAT RISKS are UNINSURABLE?LG2

C-10

• 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.

6) The insurance company can set standards for accepting risks.

WHAT RISKS are INSURABLE?LG2

Buying Insurance to Cover Risk

C-11

PROGRESS ASSESSMENT

• Why are companies more aware now of the need to manage risk?

• What is the difference between pure risk and speculative risk?

• What are the four major options for handling risk?

• What are some examples of uninsurable risk?

Progress Assessment

C-12

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 POLICIESLG3

C-13

• 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-14

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.

LG3

C-15

STOCK and MUTUAL INSURANCE COMPANIES

Stock Insurance Companies

Hartford Life

Metropolitan Life

Prudential Life

Mutual Insurance Companies

Mass Mutual

New York Life

Northwestern Mutual

LG3

Types of Insurance Companies

C-16

PROGRESS ASSESSMENT

• What is the law of large numbers?

• What is the rule of indemnity?

Progress Assessment

C-17

Health Insurance

• The U.S. is going through major changes in health insurance.

• The debate of government involvement is ongoing.

• We are likely to see many variations of health coverage in the future.

HEALTH INSURANCE CHANGESLG4

C-18

Health Insurance

• Health Maintenance Organizations (HMOs) -- Offer a full range of healthcare benefits, with emphasis on helping members stay healthy through preventative care; restricted list of doctors.

• Preferred Provider Organizations (PPOs) -- Contract with hospitals and physicians, members usually pay some part of the bill; choose physician.

• Health Savings Accounts (HSAs) -- Tax-deferred savings accounts linked to low cost, high-deductible health insurance policies.

EMPLOYER HEALTH INSURANCE OPTIONSLG4

C-19

Disability Insurance and Workers’ Compensation

• Disability insurance replaces part of your income if you become disabled and can’t work.

• Worker’s compensation insurance guarantees payment of wages, medical care and rehabilitation for employees injured on the job.

OTHER TYPES of INSURANCELG4

C-20

GETTING the MOST out of LIFE INSURANCELG4

Disability Insurance and Workers’ Compensation

1. Quit smoking, lose weight and go to the gym!

2. Figure out how much insurance you need.

3. Pick a good insurance company.

4. Find a good financial planner.

Source: Entrepreneur, March 2010.

C-21

Liability Insurance

• Professional liability insurance covers people found liable for professional negligence; also known as malpractice insurance.

• Product liability insurance covers liability arising out of products sold.

LIABILITY INSURANCELG4

Photo Courtesy of: Paul Wilson

C-22

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 BUSINESSESLG4

C-23

HOME MATTERSWhat You Need to Know About Home InsuranceLG4

1. Not all policies cover home-based businesses.

2. Don’t buy too much coverage.

3. Small claims can add up.

4. The home’s history matters.

Source: Money, September 2010.

Insurance Coverage for Home-Based Businesses

C-24

PROGRESS ASSESSMENT

• Why should someone buy disability insurance?

• How many different kinds of private insurance can you name?

Progress Assessment

C-25