Unit 4

1. Unit 4 Risk Management & Insurance

2. 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.

3. 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

4. Exposure • 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.

5. 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

6. 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

7. 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

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

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

10. 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

11. 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 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

12. 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

13. 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

14. 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

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

16. 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

17. 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 amountit will have to pay for losses during a given time frame

18. 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)

19. Transferee must be willing to take on risk of loss • If loss cannot be accurately predicted (cannot employ Law of Large Numbers or 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

20. 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

21. 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

22. In-Class AssignmentRate the Risk

23. Most Common Method of Risk Transfer Insurance

24. 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

25. 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

26. 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 transferee, this is submitted to insurance company to pay for loss

27. deductible - a maximum dollaramount 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

28. co-insurance - you pay a percentageof 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

29. 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

30. 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

31. Insurance Institute for Highway Safety (IIHS) Highway Loss Data Institute (HLDI)

32. Automobile Insurance

33. Automobile Liability Insurance • required by all states • covers damages to other people and their property caused by you driving your vehicle (i.e. accident is your fault) • normally stated in terms of coverage: • for bodily injury per other injured party • for bodily injury per accident, regardless of the number of other injured parties and • property damage

34. for example, coverage of $100,000/$300,000/$50,000 would be: • $100,000 coverage for bodily injury to each injured party • if you cause bodily injury to someone that totals $200,000, your insurance only pays $100,000 • $300,000 for bodily injury per accident, regardless of the number of injured parties • if you cause bodily injury to 5 people that totals $450,000 in medical bills, your insurance will only pay $300,000 • $50,000 for property damage per accident • this is what pays for the damage you cause to someone else’s car • if you crash into and total a Dodge Viper, your insurance would only pay $50,000

35. You are personally liable for any damages above the maximum amounts of your coverage • that means you pay the rest • YOU must ensure you have adequate coverage • minimums required by your state • enough to cover any damage you might cause in your local area

36. Collision Insurance • protects against direct or accidental damage to your car due to: • colliding with another object (car, tree, etc.) • upset, such as overturn • only pays out if accident is your fault • most common type of damage caused to your car • most expensive portion of your policy

37. not required if you own your car • requiredif you have a loan on your car • You will set your deductible for this coverage • Insurance company will base this portion of your premium off of fair market value of vehicle

38. Comprehensive Insurance • protects against all damage to your car by anything else other than collision • storm • theft • vandalism • You set the deductible for this coverage • Insurance company will base this portion of your premium off of fair market value of vehicle

39. Other Coverage • Uninsured/underinsured motorist • covers you in case you are hit by someone who either: • has no coverage • does not have enough coverage • required in most states • get enough to pay for you and your car • Medical expenses • pays certain medical or funeral expenses for anyone in your car, regardless of fault • optional

40. Income loss coverage • if you cannot work due to an automobile accident that is your fault, it pays for your lost income up at a rate specified in your policy • Towing coverage • covers towing expenses for your car should it break down • Rental coverage • pays for a rental car for you should your car become disabled due to an event covered by your collision or comprehensive coverage

41. Risk Management for Auto Insurance • Risk Reduction • Be a good driver/maintain good driving record • Drive a vehicle with better risk category • Risk Transfer • Obtain insurance for risks you wish to transfer: • Liability & uninsured/underinsured motorist (required) • Collision • Comprehensive • Medical, towing, rental, etc. • Risk Retention • Deductibles • Coverage limits • Risks you choose not to transfer

42. Summary of types of Insurance • Bodily Injury Liability Coverage - when other people are injured by your car and you or another insured person are at fault. Other people include pedestrians, passengers, and people in other vehicles. • Collision - Pays for cost (less your deductible) of repairs when your car is damaged in a collision with another vehicle or object up to your policy limits, or the actual cash value of your car, whichever is less. • For un-repairable vehicles ("totaled"), it covers actual cash value (industry bluebook). Normally covers costs above your deductible. In some cases, the deductible will be waived. (This will be required coverage if you are making loan payments.)

43. Comprehensive (other than collision) - i.e., fire, theft and other non-collision damage, covers fire damage to your vehicle, break-ins, vandalism or theft, as well as natural disasters (earthquake, hail, hurricane, flood, etc.). (This will be required coverage if you are making loan payments.) • Property - Damage Protection - covers damage you may cause to other people's property in the operation of your car. • Personal Injury Protection (P.I.P.) insurance - usually in the range of $10,000 to $35,000, covers medical expenses for injuries. • This "good-faith" coverage guarantees immediate medical payments for you, your passengers and other parties, regardless of who is at fault. It also covers you and members of your household in any accident involving an automobile, whether you are on foot, on a bicycle, in a friend's car, etc.

44. Property - Damage Liability - Applies if you damage someone else's property such as a vehicle, lamp post, telephone pole or building with your car and you are at fault. • Rental Reimbursement - Pays for a rental car if the insured's vehicle is undergoing repairs for covered damage up to policy limits. • Uninsured Motorist (UM) and underinsured motorist (UIM) coverage - protects you if you are injured in an accident with others who carry insufficient or no liability insurance. • Extra Coverage - include expenses for towing, labor, temporary replacement vehicles, road-side assistance, etc. These are generally defined as add-ons or endorsements to your policy.

45. Why and how are policies priced for different Drivers?

46. Drivers are grouped • according to the level of risk each one poses, i.e., the amount of loss incurred by insurers within various categories of policy holders. For various reasons, drivers are categorized by:

47. Sex • Men pay more because they have more accidents on the road than women.

48. Age • Drivers under 25 (and, for some insurers, under 30) pay more are considered at higher risk of having an accident.

49. Marital Status • Married drivers pay less because they tend to have fewer accidents than single drivers.

50. Personal Driving Record Years of driving experience, accidents, speeding tickets and drunk- driving offenses are all factorsin determining how much of a risk you are as a driver.