Professional Documents
Culture Documents
– Particularly among those with a strong aversion to – An unsafe act or the existence of a physical hazard
risk
– Accident
• However, avoidance is not always feasible
– Injury
– Or may not even be desirable if it is possible
• Each step can be thought of as a domino that falls, which in
• When risk is avoided, the potential benefits, as well as costs, turn causes the next domino to fall
are given up
– If any of the dominos prior to the final one are
Loss Control removed
• When particular risks cannot be avoided • The injury will not occur
– Actions may often be taken to reduce the losses – Often argued that the emphasis of loss control
associated with them should be on the third domino
• The air bags will not prevent accidents from – The general rule is that to justify the expenditure
occurring, but they will reduce the probable injuries
that employees will suffer if an accident does happen • The expected gains from an investment in
loss control should be at least equal to the expected
• Separation costs
– Involves the reduction of the maximum probable loss Potential Benefits of Loss Control
associated with some kinds of risks
• Many of the benefits are either readily quantifiable or can be
• Duplication reasonably estimated
– Spare parts or supplies are maintained to replace • These may include the reduction or elimination of expenses
immediately damaged equipment and/or inventories associated with the ff:
– Implemented before any losses occur – Extra costs to maintain operations following a loss
– Activities that take place concurrently with losses – Medical costs to treat injuries
– Always have a severity-reduction focus • Another potential quantifiable benefit of loss control
• One example is trying to salvage damaged – A reduction in the cost of other risk management
property rather than discard it techniques used in conjunction with the loss control
Potential Costs of Loss Control • If the maximum possible loss associated with
a recognized risk is significantly underestimated
• It is usually easier to estimate the potential costs
Funded Versus Unfunded Retention
• Two obvious cost components are installation and
maintenance expenses • Many risk retention strategies involve the intention to pay
for losses as they occur
– For example, a sprinkler system will have an initial
cost to install and also will have ongoing expenses – Without making any funding arrangements in
necessary to maintain it in proper working order advance of a loss
• The challenge of cost estimation is often identifying all of • Known as unfunded retention
the ongoing expenses
• Funded retention
– Also, some of the ongoing cost may merely be
increases in other expenses – Preloss arrangements are made to ensure that
money is readily available to pay for losses that occur
Risk Retention
Funded Retention
• Involves the assumption of risk
• Credit
• If a loss occurs, an individual or firm will pay for it out of
whatever funds are available at the time – May provide some limited opportunities to fund
losses that result from retained risks
• The establishment of a fund to pay for those • Problems may result if there is considerable
losses is a special form of planned, funded retention variability in the range of possible losses
– In part because of the large firm’s greater financial • Involves payment by one party (the transferor) to another
resources (the transferee, or risk bearer)
– Thus, losses due to many risks may merely be • Transferee agrees to assume a risk that the transferor
absorbed as losses occur, without much advance desires to escape
planning
Hold-Harmless Agreements
• Examples may include pilferage of office
supplies, breakage of windows, burglary of vending • Provisions inserted into many different kinds of contracts
machines
• Can transfer responsibility for some types of losses to a
• The following elements from a firm’s financial statements party different than the one that would otherwise bear it
should be considered when choosing possible retention
levels • Also known as indemnity agreements
– Total assets, total revenues, asset liquidity, cash • Intent of these contractual clauses
flows, working capital, ratio of revenues to net worth,
retained earnings, ratio of total debt to net worth – To specify the party that will be responsible for
paying for various losses
• Ability to predict losses
– Usually, no dollar limit is stated
• Forms of hold-harmless agreements • Diversification
• Clarifies that all parties are responsible for – Combining businesses or geographic locations in one
liabilities arising from their own actions firm can even result in a reduction in total risk
– Are not always legally enforceable – The most widely used form of risk transfer
– Particularly true of broad-form hold- – The project should increase the value of the firm
harmless agreements
• However, shareholders in a publicly traded corporation can
Incorporation eliminate firm-specific risk
• The most that an incorporated firm can ever lose is the total – By holding a diversified portfolio of different
amount of its assets company stocks
• Personal assets of the owners cannot be attached to help • Therefore, the shareholder would appear to
pay for business losses care little about the management of nonsystematic
or firm-specific risk
– As can be the case with sole proprietorships and
partnerships • This would appear to make many risk
management activities negative net present value
Diversification, Hedging, and Insurance projects
– However, many corporations engage in Integrated Risk Management
a number of activities directed at managing firm-
specific risk • The enterprise view of risk management
• Mayers and Smith suggest reasons for the transfer of risk by – Considers financial, commodity, credit, legal,
the corporation environmental, reputation, and other intangible
exposures that could adversely impact the value of the
– Insurance contracts and other forms of risk transfer corporation
can allocate risk to those of the firm’s claim holders who
have a comparative advantage in risk bearing • The formation by some firms of the new position of chief risk
officer (CRO)
– Risk transfer can provide benefits by lowering the
expected costs of bankruptcy – Reflects a realization of the importance of identifying
all risks that could negatively impact the firm
– Risk transfer increases the likelihood that the firm
will meet its obligations to its debtholders and assures – Suggested responsibilities of the CRO include
that funds will be available for future investment in
valuable projects • Implementation of a consistent risk
management framework across the organization’s
– The comparative advantage of insurers in providing business areas
services related to risks can be an advantage of risk
transfer through insurance • Implementation and management of an
integrated risk management program
– When the tax system is progressive
– With particular emphasis on
• The additional tax from increases and operational risk
earnings is greater than the reduction in taxes
associated with decreases in earnings • Communication of risk and the integrated risk
management program to stakeholders
• A broader view of risk underpins the movement toward
enterprise risk management • Mitigation and financing of risks