Risk Management Topics 7 8 Topic 7 Selecting The Appropriate Risk Management Techniques 1 Loss Matrix 2 Risk Management Alternatives a Full Insurance b Retention Retain Risk c Retention Safety fire suppression etc 3 Selecting Risk Management Alternatives Loss Matrix Firm A Revenue 2 000 Insurance 0 Taxable Income 2 000 Tax Bill of 40 Tax 800 Firm B Revenue 2 000 Insurance Premium 400 Taxable Income 1 600 Tax 640 The Following Will Be On Exam Building worth 254 000 is provided 1 Possible Risk Management Alternatives for Insuring Building a Retention Fund Loss Internally 254 000 b Retention Safety 254 400 7 200 261 600 c Insurance 12 000 2 Loss Fire OR No Loss No Fire a All or nothing no partial loss Probabilities Without Safety Probability of fire 3 Probability of No fire 97 With Safety Probability of Fire 1 Probability of No Fire 99 Expected Losses for Each Option 1 Retention a 2 Retention Safety 3 Full Insurance 254 000 0 03 0 0 97 7 632 a 261 000 0 01 7 200 0 99 9 744 a 12 000 Known Cost 12 000 If the decision is to chose among Risk Management Alternatives in this case o Choose the lowest priced option Retention 2 Types of Cost o Monetary Cost o Non Monetary Cost Worry Value Expected Loss Cost of Uncertainty Worry Value Professor will provide us with the Worry Value Cost associated with decision making Cost of Anxiety Loss of Sleep Unique to the decision maker Estimate Worry Value for Retention Loss Probability 254 000 0 03 0 0 97 Offer Key decision maker a choice between Retention that has a P 7 632 or buy full insurance for a fair premium P 7 632 10 10 10 When do you stop o Buying insurance at a fair premium Pmax Maximum premium that a person or firm is willing to pay for particular risk or insurance o Formula Pmax P Worry Value o Worry Value Maximum amount over above P that a person or a firm is willing to pay to reduce uncertainty Insurance Reducing Uncertainty Premium Known Maximum Amount Pay Loss No Loss Partial Loss 1 No Loss 2 Partial Loss 3 Total Loss 0 1 000 10 000 100 000 Probability 0 90 0 07 0 029 0 001 Partial Insurance in Face Amount FA 10 000 Full Insurance in Face Amount FA 100 000 Deductible Insurance Face Amount FA 100 000 o Premium 550 o Premium 700 o Deductible 1 000 o Premium 550 This kind of info will be given to us on an Exam or Quiz Matrix No Loss 0 Partial Loss 1 000 Total Loss 10 000 100 000 1 000 550 10 000 550 100 000 90 000 550 90 550 700 700 700 1 000 550 1 550 1 000 550 1 550 1 000 550 1 550 Retention Partial Insurance Full Insurance Deductible 0 550 700 550 Retention Partial Insurance Full Insurance o 700 Deductible Insurance o 0 0 90 1 000 0 07 10 000 0 029 100 000 0 001 460 o 550 0 90 5500 0 07 550 0 029 90 550 0 001 640 o 550 0 90 1 550 0 07 1 550 0 029 1 550 0 001 650 1 Worry Value for retention Highest 2 Worry Value for Full Insurance Always 0 3 Total Loss Loss Worry Value 1 What makes Worry Value go up increase a Economic Financial Change b Uncertainty c Location d Experience Prior Loss e Maximum Potential Loss f Level of confidence in P is not good unsure Options Risk Control Avoidance Loss Reduction Loss Prevention you plan budget Risk Financing Retention Funded Unfunded O K if Insurance Topic 8 Definition Characteristics of Insurance Use of Insurance as a Risk Management tool Why Firms people buy insurance What commodity are you buying o Peace of Mind o Certainty o Safety o Protection of assets on a Balance Sheet o Tax Benefits 1 Premise of Insurance uses funds that are paid into a group Group combination of Loss exposures of individuals a b Members of the group pay for losses of anyone who is a member of the c group Insurance Trading an unknown loss For a known Loss Premium Trading uncertainty for certainty the insurer e Pooling Sharing losses among a group i Insurance A contract 2 Indemnification d Transfers Financial responsibility for payment of Loss from the insured to a Where the insurer agrees to indemnify compensate the insured b Fully Indemnified Insurance coverage will put the insured in the same financial position as before the loss 3 Forms of Indemnification a Repair the asset before replace i Fair Market Value Depreciation Value b Cash up front OR Reimburse you Insurance companies may have preferred body shop i Or they may pay a 3rd party ii iii Pay Shop directly No out of pocket for you iv Or 2 3 estimates from non approved shops 1 Pay lowest estimate v Insurance Companies paying amount determined after a loss c Services i Additional Costs expenses 1 Rental Car d Provide an Attorney Legal Fees Insurance Defense Panel Counsel i ii Settlement Verdict Award iii Loss Settlement Rule In the contract 1 Determine if there is a loss 2 Pay you actual cash value 3 Replace 4 Pay you Market Value Blue Book Depreciated Value iv Can the Loss amount be determined prior to a Loss 1 Pre determined Value a Life Insurance Policy for a specific amount i Total Loss 2 Unique Items Irreplaceable a Want to Predetermine the Value before the Loss Occurs i Antiques ii Art iii Collectables 3 Insurable Interest If you have Insurable Interest you can insure anything 4 50 000 Antique Reassess Reappraise 5 Constantly Reappraise agree to a pre loss value How and why is insurer able to accept Risk Financial Loss Transfer o Transferred Risk for payment to insurance company o Premium Ability to predict the future o Actuary Rates Predictions o Law of Large Number s As Number gets bigger Fairer Know Experience o Captive One client No numbers o Higher Increased Premium Best Industry practices Consultant Experience o Insurers have many clients in Risk Pool reflects losses for whole group NOT o With the Law of Large Numbers Insurance Company is able to accept the for one particular individual risk financial transfer Invest premium until they have to pay Accurate predictions Risk is still present for the insured Not Cover Deny Exclude Bankrupt