Risk Management Exam 1 Study Guide TOPIC 1 Pure vs Speculative Risks Pure Risks Speculative Risks The focus of TRM Only possibilities are LOSS or NO LOSS You can buy insurance for pure risks Ex flood fire earthquake death kidnapping etc The focus of ERM Three possibilities LOSS NO LOSS or GAIN You cannot buy insurance for speculative risks morale Ex gambling kids investments homeownership hazard business Statics vs Dynamic Risks Static Risks injuries Dynamic Risks Major Types of Pure Risk Personal Pure Risk Doesn t change over time Ex natural disasters inflation flipping a coin death Risk resulting from changing circumstances or Ex terrorism technology advances of medicine laws conditions Human capital ability to generate income Subject to life and health exposures ex injury illness Financial consequences loss of income medical bills Property Pure Risk Ownership of financial or physical assets Financial consequences loss of income loss of assets Liability Pure Risk Result of a tort legal breach of a duty negligence Ex legal fees settlements reputation loss defense death etc rent costs Factors Affecting Risk Frequency the probability of a loss Number of losses in a given time period discrete count Likelihood of a loss continuous measure Good for high frequency losses once a year Good for low frequency losses natural disasters Can be equal to 0 Severity the size of loss usually in terms given a loss Peril the immediate cause of loss the actual action event occurs Hazards conditions that increase frequency severity or both Random event Ex flood natural disaster fire theft car accident injury Ex smoking icy roads faulty wiring chemical exposure 3 Types of Hazards 1 Physical hazard property people operations 2 Moral hazard increases intentional loss or exaggeration Must have insurance and changes your 3 Morale hazard increased carelessness to loss Change in attitude NOT behavior behavior Goal of Risk Management to minimize the Cost of Risk Measuring Pure Risk Actual Losses Expected Losses or AL EL EL TOPIC 2 THE RM PROCESS 6 step RM process Look at historical information internal external 1 Identify the Risks most crucial step 2 Analyze the Risks measure evaluate the frequency severity 3 Identify RM options 2 categories Risk Control trying to reduce frequency or severity Risk Financing how to pay for the loss insurance Self cameras insure 4 Select from RM options what to consider 5 Implement the selected option 6 Monitor selected option is it working Cost of Risk includes financial losses cost of RM cost of residual uncertainty Operational Goals for RM 2 categories Pre loss goals Economy of operations Reduce uncertainty anxiety Meet legal obligations Social responsibility Post loss goals Survival Continuity of operations Profitability Earnings stability Social responsibility Loss Exposure Possibility of a financial loss That a particular entity faces As a result of a particular peril Affecting a thing of value exposure TOPIC 3 TYPES OF LOSS EXPOSURES TRM Loss Exposures Property Loss Exposure Must have legal interest in property 5 sources of legal interest 1 Ownership 2 Lease agreement 3 Secured creditors 4 Buyers Sellers 5 Bailment Liability Loss Exposure Net Income Loss Exposure A loss due to a legal liability or negligence Another loss must happen first for a NI loss to occur Several different events can cause NI losses Loss to property you own Loss to property owned by others Legal liability losses products liability A personal loss suffered by a firm s KEY employee For the employee Loss of income medical expenses For the firm decrease in revenue increase in expenses Personnel Loss Exposure ERM Loss Exposures focus on 1 source of risk 2 Who manages it 3 Is it Pure or Speculative and 4 Diversifiable or Non diversifiable Hazard Risks Operational Risks Financial Risks TRM type exposures property liability theft fire etc Pure Risks Diversifiable only applies to one or a few firms RM options buy insurance or self insure Risks arising from day to day operations Ex supply chain issues product recalls customer service employee turnover manufacturing products etc Pure Risks Diversifiable RM options could be a lot of different things Risks arising from changing financial markets or conditions Ex asset valuation legislative changes commodity prices debt rating interest rates foreign exchange rates etc Speculative Risks Could be Diversifiable or Non diversifiable RM options financial tools by CEO ex Stock options Risks regarding a firm s S W O T analysis Ex Bad business decisions improper management Speculative Risks Diversifiable decisions Strategic Business Risks Risk Map Compares the different risks across an organization Measures Frequency Severity High frequency High severity deserve the most attention first High frequency severity examples supply chain and competition TOPIC 4 Measurement of Loss Exposures Step 2 in RM Process Measures by AL EL or AL EL EL P Expected Loss or Weighted average of the loss amounts Ex Loss Amount Probability of X loss 0 85 0 1 000 5 000 10 000 0 10 0 03 0 02 1 00 or 100