RMI 3011 Test 1 Review o Uncertainty concerning the occurrence of a loss 1 Risk definition 2 Objective v subjective risk o Objective risk o Subjective risk 3 Peril 4 4 types of Hazards o Physical hazard Relative variation of actual loss from expected loss Uncertainty based on a person s mental condition or state of mind o Cause of the loss ex Collision is the peril in an auto accident Physical condition that increases the frequency or severity of loss Ex Icy road when driving Dishonesty or character defects in an individual that increase the frequency or o Moral hazard severity of loss Ex Dishonesty o Attitudinal Hazard Morale Hazard loss Ex Negligence o Legal Hazard Carelessness or indifference to a loss which increases the frequency or severity of a Characteristics of the legal system or regulatory environment that increase the frequency or severity of loss Ex Anything connected with the law system 5 Pure v speculative risk o Pure risk o Speculative risk 6 Burdens of risk on society losses Situation in which there are only the possibilities of loss or no loss earthquake Situation in which either profit or loss is possible gambling o Firms individuals would have to maintain large emergency funds to pay for unexpected o May discourage innovation depriving society of certain goods and services o Causes worry and fear 7 Techniques for managing risk retention v avoidance v non I xfer v Insurance o Avoidance o Retention Not applicable Determine retention level How to pay for losses Income Tax Treatment Deductible expense or not Single captive insurer or group insurer Consider if self insurance is a good way Pros Vs Cons Risk retention groups Pros vs Cons of a retention retention vs other 3 types what retention technique o 3 Non insurance transfer Ex Lease hold harmless agreement Transfers a risk to another party A transfer of risk by contract such as through a service contract or a hold harmless in a contract o 4 Insurance Pay premiums High Frequency Low Frequency Loss prevention retention Retention Low Severity Avoidance Non transfer High Severity 8 Risk financing o Refers to techniques that provide for payment of losses after they occur o Retention means that an individual or business firm retains part or all of the losses that can result from a given risk Active retention Passive retention Individual is aware of the risk and deliberately plans to retain all or part of it Risks may be unknowingly retained because of ignorance indifference or laziness Self Insurance Special form of planned retention by which part or all of a given loss exposure is retained by the firm o The insured is restored to his or her approximate financial position prior to the occurrence of 9 Indemnification the loss 10 Law of large Numbers and insurance o More exposure units means expected and actual loss come closer 11 6 characteristics of ideally insurable risks o Large number of units o Accidental unintentional loss o Measurable loss severity of loss o No catastrophic loss o Calculable chance of loss o Economically feasible premium o Affordable to consumers o Insurance companies need to be able to profit 12 Adverse selection o The tendency of persons with a higher than average chance of loss to seek insurance at standard rates o Results in higher than expected loss levels o Can be controlled by underwriting policy provisions 13 5 Social benefits of insurance o Indemnification for Loss o Reduction of Worry and Fear o Source of investment Funds o Loss Prevention o Enhancement of credit 14 Expense loading o Amount needed to pay all expenses including commissions general administrative expenses state premium taxes acquisition expenses and an allowance for contingencies and profit 15 4 steps of risk management process o 1 Identify potential losses o 2 Measure and analyze the loss exposures o 3 Select the appropriate combination of techniques for treating the loss exposures o 4 Implement and monitor the risk management program 16 Risk Financing methods pro s and con s of each retention payment options o Retention Pros o Save on loss costs o Save on expenses o Encourage loss prevention o Increase cash flow Cons o Higher losses o Higher expenses o Higher taxes no reduction for insurance premium o Non insurance Transfer Pros o Can transfer some losses that are not insurable o Generally less expensive o Can transfer loss to someone who is in a better position to control losses o Insurance Cons o Contract language may be ambiguous so transfer may fail in court o Lack of court precedence o If the other party fails to pay firm is still responsible for the loss o Insurers may not give credit Pros o Firm is indemnified for losses o Uncertainty is reduced o Insurers can provide valuable risk management services Cons o Premiums may be costly o Negotiation of contracts takes time and effort o The risk manager may o Premiums tax deductible become lax in exercising loss control o Retention Payment Methods o Current net income Losses are treated as current expenses o Unfunded reserve o Funded reserve o Credit line Losses are deducted from a bookkeeping account Losses are deducted from a liquid fund Funds are borrowed to pay losses as they occur o Insurer owned by a parent firm for the purpose of insuring the parent firm s loss exposures 17 Captive insurer 18 Know Ex 3 2 Disadvantages o Premiums may be costly o Negotiation of contracts takes time and effort o The risk manager may become lax in exercising loss control Advantages o Firm is indemnified for losses o Uncertainty is reduced o Insurers can provide valuable risk management services o Premiums are income tax deductible o 19 Cavuto video and McHugh tips 1 question 20 McHugh legal system lecture 2 questions 21 Insurable interest definition types and when it must exist o The insured must be in a position to lose financially if a covered loss occurs o Property insurance at the time of the loss o Life insurance only at inception of the policy 22 Subrogation o Substitution of the insurer person doing insuring in place of the insured person who has insurance for the purpose of claiming indemnity from a 3rd party for a loss covered by insurance o Only applies to contracts of indemnity 23 Utmost good faith void v voidable contracts o A higher degree of honesty is imposed on both parties to an insurance contract than is imposed on parties to other contracts o Void Cancelled end of story o Voidable The potential to be no good not automatically cancelled o Cancellable at the
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