2. Introduction to Risk Management

1. 2. Introduction to Risk Management Bus 200 Introduction to Risk Management and Insurance Fall 2008 Prof. Jin Park

2. Overview • Definition & Objectives • Process • Risk Management Technique • Control vs. Finance • More on Risk Finance • Retention, Captive, Insurance, Transfer

3. Definition and Objectives • Risk Management • A systematic process for managing (pure) risks faced by an individual or organization. • Pre-loss vs. Post-loss risk management • Loss Exposure • Ay situation or circumstance in which a loss is possible regardless of whether a loss occurs. • Objectives • Why? • Management’s job • Reduce earnings volatility • Maximize shareholder’s value • Promote job and financial security

4. Risk and Relative Return Zone 2 Optimal Risk Taking Zone 3 Excessive Risk Taking Zone 1 Insufficient Risk Taking Risk- Adjusted Return Risk

5. Risk Management Process

6. Risk Management Process

7. Risk Management Process

8. The Process • Step 1 - Identification • Loss exposures • Methods • Step 2 – Evaluation • Frequency • Severity • Step 3 – Risk Management Selection • Control vs. Finance • Prevention vs. Reduction • Step 4 – Implementation and Monitor

9. Evaluation Tools • Risk mapping • A graphical presentation of potential frequencies and severities of identified loss exposures faced by individual/organization • Critical issue tolerance boundary or risk-tolerance boundary • Prioritize risks • Risk management matrix

10. Risk Mapping EE’s petty theft Auto liability Job related injuries Vandalism System failure Frequency Owner’s disability Robbery Fire on warehouse Default on payment Tornado Flood on warehouse Severity

11. Risk Management Matrix Prevention Retention High Avoidance Frequency Reduction Insurance Low Retention Low High Severity

12. Risk Control Goals Risk control options Avoidance Loss control Prevention Reduction Pre-loss risk control Post-loss risk control Risk Financing Goals Risk financing options Retention How? Transfer Insurance Non-insurance Risk Management Techniques

13. Risk Financing - Retention • A method of funding losses using internal money • No purchase of insurance • Retention with insurance • What determines the retentiondecision? • Frequency & severity of expected losses • No other effective method available • Costs and availability of insurance • MMP, Health care insurance • Highly predictable losses • Self-confidence or degree of risk aversion • Failure to identify

14. Risk Financing - Retention • What determines the retentionlevel? • Degree of risk aversion • Financial condition • Ability to diversify the retained risk • Potential cost/benefit • Costs and availability of insurance • Ability to administer a retention program in a cost effective manner

15. Risk Financing - Retention • Self-Insurance, Captive, RRG • Self-Insurance • Captive • A form of self-insurance through a wholly owned subsidiary (insurance company) created to provide insurance to the parent companies • Pure captive, Group captive, Risk Retention Group • Which one? • UPS vs. IRS

16. Advantages Less uncertainty Loss control services. Eligible expenses Non-taxable insurance proceeds. Disadvantages High insurance premium. Moral and morale hazards. Time and effort. Insurance may not be available. Dependable No benefit of loss control Transfer - Insurance

17. Non-Insurance Transfer • Methods of transferring risk to another party other than by insurance • Contracts • Hold harmless agreements • Leases

18. Advantages May be able to transfer losses that are otherwise not commercially insurable. Noninsurance transfers may cost less than insurance. May be able to shift loss to someone who is in a better position to exercise loss control. Disadvantages Transfer may fail for legal reasons Transferee may be unable to pay the loss May not reduce insurance costs if insurer does not give credit for the transferred risk Non-Insurance Transfer