CHAPTER 5 NOTES

BY COURTNEY GILLIAM

POTENTIAL SOURCE OF LOSS TO A

PERSON OR A FRIM?
Loss Exposure

WHAT ARE THE 5 DIFFERENT TYPES OF

RISK IDENTIFICATION?
Property Risk
Liability Risk
Life Risk
Health Risk
Loss of income risk

LISTS POTENTIAL SOURCE OF LOSS FROM

DESTRUCTION OF ASSETS AND LEGAL
LIABILITY?
Risk Identification Tools
Some are designed for specific industries, such as retailers
and manufacturers

Others focus on specific category of exposures (product, real

property)

SOME EXAMPLES OF RISK IDENTIFICATION

TOOLS?
Property Risk
Liability Risk
Human resources
Crime
Employee Benefits
Foreign

ALL ITEMS ON A FIRM'S BALANCE SHEET AND

INCOME STATEMENT ARE ANALYZED IN
REGARD TO RISKS THAT MAY BE PRESENT?
Financial statement analysis

IDENTIFYING SOURCES OF RISK IN A PRODUCTION

PROCESS AND IT ALLOWS RISK MANAGERS TO
PINPOINT AREAS OF POTENTIAL LOSSES?

Flowchart

CONTRACTS TO STATE THAT SOME LOSSES

ARE TO BE BORNE BY SPECIFIC PARTIES
(LEASE AGREEMENTS)
Contract analysis

TALK WITH MANAGERS TO SEE THEIR

REGARD OF THEIR ACTIVITIES?
On-site inspections

MOST INSURERS USE __________ TO CALCULATE

THE EXPECTED LOSSES WITH EACH RISK &
ALSO WHAT IS THIS USED FOR?
A) statistical approach
B) Risk Evaluation

WHAT DOES RISK EVALUATION

MEASURES?
Measures of central tendency
Measures of variation
Coefficient of variation
Probabiltiy distribution
Law of large numbers

WHAT DO WE NEED TO HAVE A GOOD

RISK MANAGER?
Large number of units and good data over a long period of
time

IS HIGH STANDARD DEVIATION BAD?

Yes, having high standard deviation is bad

If the Degree of Risk is too high, then the risk numbers are
too high.

PREDICTED VALUE OBTAINED FROM USING A LARGE

SAMPLE WILL BE TO CLOSER TO THE TRUE VALUE THAN
RESULTS OBTAINED FROM USING A SMALLER DATA?

Law of Large Numbers

For insurance purposes, the more exposure units insured, the

more accurately the insurers can predict the actual number
of damages

STANDARD DEVIATION/ EXPECTED VALUE

Coefficient of Variation

COV decreases, as number of exposures increases

CHAPTER 6 NOTES
BY COURTNEY GILLIAM

WHY ARE RISK MANAGEMENT

TECHNIQUES IMPORTANT?
Understanding the various risk management techniques
Deciding which techniques to use for which type of risks

MAKE SURE TO KNOW THIS TABLE/GRAPH

NOT TO EXPOSE ONE'S SELF OR FIRM TO A

PARTICULAR RISK &
DECREASES ONE'S CHANCE OF LOSS .... THIS IS
KNOWN AS?

Avoidance
Comes with unintended consequences
When a risk is avoided, the potential benefits are growing

WHEN A PARTICULAR RISK CANNOT BE

AVOIDED, ACTIONS MAY BE TAKEN TO
REDUCE THE RISK?
Loss Control

REDUCES LOSS FREQUENCY (BEFORE

LOSS)
Loss Prevention

REDUCES LOSS SEVERITY ( AFTER LOSS)

Loss reduction

LOSS PREVENTION
Measures put in place before loss occurs to reduce the
frequency of losses

A main job of risk managers is to reduce frequency of

employee accidents

ARE EMPLOYEE ACCIDENTS BAD FOR

COMPANIES?
Yes, employee accidents are bad for companies in many ways
because they can cause downtime, people are hurt or
injured, could bring lawsuits or higher costs to doing business
and bad for moral of the workplace

WHAT ARE THE TWO WAYS TO REDUCE

THE FREQUENCY OF EMPLOYEE
ACCIDENTS?
Domino Theory ("idiot proofing")
Safety Training

HEREDITY AND SOCIAL ENVIRONMENT,

PERSONAL FAULT, AN UNSAFE ACT OF THE
EXISTENCE OF A PHYSICAL HAXARD?
Domino theory ("idiot proofing")
First domino falls, then the next domino falls
Main emphasis should be on controlling the losses or hazard
as a way of lessening or not having an accident or injury

HOW SMART PEOPLE CAN CONSTANTLY

FIND WAYS TO INJURE THEMSELVES
Safety Training
Can make a huge difference in the number of injuries per
year

WHAT ELSE COULD HAVE BEEN DONE

THAT COULD REDUCE THE RISK?
Gotten a different chair with no rollers at the bottom

HOW TO REDUCE INJURIES?

Come up with the STEPS program

WHAT WAS THE RESULT OF THE STEPS

PROGRAM?
STEPS dropped the injury frequency rate percentage

MEASURES PUT IN PLACE OR CARRIED

OUT TO REDUCE THE SEVERITY OF LOSS
IF IT OCCURS?
Loss Reduction

WHAT ARE THE CATEGORIES OF LOSS

REDUCTION?
General
Separation
Duplication
Disaster Recovery

MINIMIZE LOSS AFTER OCCURRENCE,

ALSO BEFORE THE OCCURRENCE, AND
AFTER THE OCCURRENCE?
Severity reduction

INVOLVES THE REDUCTION OF THE MAXIMUM PROBABLE LOSS ASSOCIATED

WITH SOME KINDS
LOSS REDUCTION TECHNIQUE THAT DISPERSES A PARTICULAR ASSET OR
ACTIVITY OVER SEVERAL LOCATION?

Separation

WHAT IS THE PURPOSE OF SEPARATION?

To reduce severity of a loss at an individual location

LOSS REDUCTION TECHNIQUE THAT MAINTAINS

REDUNDANT ASSETS THAT ARE USED IF THEY
ARE DAMAGED OR DESTROYED
Duplication

WHAT IS THE MAIN DIFFERENCE BETWEEN

SEPARATION AND DUPLICATION?
Separation separating assets that you are actually using
Duplication- having backup assets in case the primary asset
cannot be used

FOCUSES ON RECOVERING FROM

CATASTROPHES BOTH NATURAL AND MAN
MADE?
Disaster Recovery Planning ("contingency planning")
Involves emergency response and post-disaster recovery to
ensure continuity of operations

TOOLS AND TECHNIQUES USED TO FINANCE THE COST

OF RISK AND THE COST OF LOSSES INTERNALLY; PAYING
YOU LOSSES FROM YOUR OWN FIRM?

Risk retention
Involves the consumption of risk
If losses occurs, individuals can pay for it out of whatever
funds are available at the time

PERSON OR FIRM IS NOT EXPECTING A LOSS

AND WHEN THE LOSS IS SO SEVERE OR
Unplanned Retention

KNOWLEDGE OF WHAT YOU WILL HAVE TO PAY

BUT STILL YOU MIGHT HAVE MONEY, FUNDED,
OR NOT HAVE ENOUGH MONEY, UNFUNDED?
Planned retention

WHAT IS SELF-INSURANCE?
Self insurance is funded

retention

Involves an assumtpion of recognized risk

FUND SPECIFICALLY DESIGNATED TO

COVER LOSSES?
Funded retention

FIRM IS AWARE OF RISK BUT DOES NOT PUT ASIDE

MONEY, PAYS OUT OF OPERATING INCOME, UNFUNDED
RETENTION SHOULD ONLY BE FOR WHAT? ( 2 ANSWERS)
1) Unfunded retention
2) small risks

WHICH IS BETTER TO BE SELF-INSURED,

PAY ALL OF YOUR CLAIMS, OR BUY YOUR
INSURANCE?
Buying your insurance is better

INVOLVES TRANSFER OF RISK FROM ONE

PARTY TO ANOTHER?
Risk Transfer

WHAT ARE THE 4 WAYS TO TRANSFER

RISK?
Hold- Harmless agreements
Incorporation
Hedging
Insurance

PROVISIONS INSERTED INTO MANY DIFFERENT KINDS OF

CONTRACTS, CAN TRANSFER RESPONSIBILITY FOR SOME
TYPES OF LOSSES TO A PARTY DIFFERENT THAN THE ONE THAT
WOULD OTHERWISE BEAR IT?

Hold Harmless agreements

EX:) A city hires a contractor to build a road, but th city ask

that they are held harmless

Are not

legally enforcable

TRANSFER RISK FROM SHAREHOLDERS

TO CREDITORS?
Incorporation
Shareholders or owners of the stock have nothing to lose but the
value of their money, so they can't be sued for actions of the
company, but a creditor or someone loaning money to the
company with no ownership or no chance of gain of the stock can
lose if a company goes bankrupt and they will not get their
money or goods back

BUSINESS TRANSACTION IN WHICH THE RISK OF PRICE

FLUCTUATIOS IS TRANSFERRED TO ANOTHER PARTY ;
BUYING ONE ASSET TO PROTECT THE OTHER?

Hedging

EX:) A newspaper may buy a ton of ink at a lower cost to hold

and use in the future in case of the cost of ink risk

MOST WIDELY FORM OF RISK TRANSFER?

Insurance

AVOID RISK IF POSSIBLE AND IT MAKES ECONOMIC

SENSE ; IMPLEMENT LOSS CONTROL MEASURES TO
REDUCE RISK AS LONG AS IT MAKES ECONOMIC SENSE?

Risk Control

FOR RISK REMAINING, SELECT THE

OPTIMAL MIX OF RISK RETENTION VS RISK
TRANSFER?
Risk Financing

AVOID RISKS THAT CAN BE ELIMINATED

WITH EFFECTING THE GOALS OF AN
INDIVIDUAL?
Avoidance

HOW DO YOU DECIDE WHETHER TO USE

LOSS CONTROL OR NOT?
Calculate the present value of the benefits and costs of loss
control

DO NOT IMPLEMENT LOSS CONTROL UNLESS BENEFIT

IS GREATER THAN THE COST!!!!

DESCRIBE THE FORD PINTO CASE.

Ford at one time had a problem with their car Pinto exploding
when hit with a truck. The cost to change the design and
engineering was very expensive and it was a long time
before Ford made any changes instead willing to take the risk
of the explosion and pay for the potential damage instead of
reengineering and the loss control needed

DESCRIBE PARETO PRINCIPLE.

80% of your losses comes from 20% of your exposures

COST/BENEFIT ANALYSIS SHOULD

CONSIDER HOW LOSS CONTROL WILL
AFFECT THE TRANSFER
Loss Control
EX:)

KFC found 20% of bad loss stores were in high crime

areas, so they took steps to loss control that was causing so
much of their losses

SELECTING A PARTICULAR DEDUCTIBLE LEVEL

IS ONE WAY OF MIXING RISK RETENTION AND
RISK TRANSFER?
Deductible Decision

Greater financial resources

Ability to more accurately predict losses

WHO IMPLEMENTS AND REVIEWS

DECISIONS?
Risk managers, insurance brokers, insurance carriers are
involved in this step.

AT THE END OF THE DAY, RISK

MANAGEMENT NEEDS:?
Risk management needs to be continuously reviewed
(insurance and the marketplace for them is constantly
changing).

CHAPTER 7 NOTES
COURTNEY GILLIAM

IS A TRANSFER OF RISK TO USUALLY A LARGER COMPANY

THAT TAKES YOUR RISK AND POOLS THEM WITH OTHER
SIMILAR UNITS OR RISK TO LESSEN THE PROBABILITY OF
LOSSES?

Insurance

WHAT HAPPENS TO RISKS THAT ARE NOT

DEVASTATING TO THE COMPANY AND HAVE
NO CHANCE FOR GAIN?
Can be insured

HOLISTIC APPROACH TO THE ORGANIZATION OR BUSINESSES

LOSS AND RISK EXPOSURE FROM FINANCIAL TO PURE,
STRATEGIC AND OTHERS THAT THE BUSINESS MAY BE
INVOLVED OR PLANNING FOR?

Enterprise risk management

ARE LOSSES THAT ARE SUDDEN AND

ACCIDENTAL?
Fortuitous

INSURANCE INVOLVES POOLING AND RISK

REDUCTION?
Nature of Insurance

SHARING OF TOTAL LOSSES AMONG A

GROUP?
Pooling

DECREASE IN THE TOTAL AMOUNT OF

UNCERTAINTY PRESENT IN A PARTICULAR
SITUATION?
Risk reduction

THEY TRANSFER RISKS TO THE INSURER AND

EXCHANGES A POTENTIALLY LARGE UNCERTAIN LOSS
FOR A RELATIVELY SMALLER CERTAIN PAYMENT?

Policyholder

NOT ALL RISKS ARE INSURABLE BY

PRIVATE INSURERS?
Requisites of Insurable Risks

EXAMPLES OF GOVERNMENT PROGRAMS?

Unemployment
Crop Insurance
Flood Insurance
Social Security

CHARACTERISTICS OF INSURABLE RISKS

(INSURERS)
Large number of similar objects
Accidental/ Unintentional losses only
Losses are determinable/measurable
Potential losses are not catastrophic

IT HELPS INSURERS PREDICT THE POSSIBLE

LOSSES BETTER AND THEY HAVE EXPERIENCE
IN UNDERWRITING AND PRICING?
Large number of similar objects

INSURERS NORMALLY EXCLUDE ANY LOSS

CAUSED INTENTIONALLY BY THE INSURED
Accidental/unintentional losses

BUSINESS MAY HAVE TOO MANY UNHEALTHY PEOPLE THE

INSURANCE COMPANY MAY BE ON THE RISK (GREATER THAN
AVERAGE CHANCE OF LOSS TO SEEK TO PURCHASE MORE
THAN AVERAGE AMOUNT OF INSURANCE)?

Adverse selection

WHEN ONE PARTY KNOWS INFORMATION THE OTHER PARTY DO NOT KNOW,
CREATES MORE EXPOSURE AND RISK FOR THE INSURANCE COMPANY BUT
THE PERSON DOESN'T DISCLOSE THAT INFORMATION (WHEN A
POLICYHOLDER POSSESSES KNOWLEDGE ABOUT LIKELY LOSSES THAT IS
UNAVAILABLE TO INSURERS)

Asymmetric information

PROCESS OF SELECTING/CLASSIFYING
POLICYHOLDERS FROM AMONG MANY
APPLICANTS?
Underwriting
Categorizing people by various characteristics that reflect
risk and charging higher

Try to add a lot of customers to avoid a small group of only

unprofitable risks

PLUG IT IN INSURERS ARE TESTING A SENSOR

TO MONITOR DRIVERS; MONITOR WHEN,
WHERE, HOW FAR, HOW FAST YOU DRIVE?
Reduce Adverse Selection
Great for parents and their children and people who want to
monitor their driving habits

WHAT ARE SOME EXAMPLES OF

POTENTIAL LOSSES ARE NOT
CATASTROPHIC??
Losses should be independent
The loss should not be bigger for the insurance company
because it puts their assets and ability to pay at risk

WHAT CAN INSURERS DO TO REDUCE

THEIR RISK FROM SUCH PERILS?
Can't write something
Raise the deductibles
Exclude certain types of perils/losses
Limit their coverage amount

WHAT RISKS ARE INSURABLE?

(POLICYHOLDER'S PERSPECTIVE)?
Large loss principle
Probability of loss must be too high

WHAT IS THE LARGE LOSS PRINCIPLE??

Loss must be relatively large

Businesses and individuals should insure
serious losses

WHAT IS THE PROBABILITY OF LOSS MUST

BE HIGH?
Probability of loss must not be too high, or the cost of risk
transfer will be excessive

Policyholder are willing to pay something to avoid a loss than

the true expected value of that loss

WHAT IS OFFERED THROUGH THE

GOVERNMENT?
Social Insurance

WHO DOES THE SOCIAL INSURANCE

BENEFIT??
People whose incomes are interruped by an economic or
social conditions

Solution is beyond the control of the indivdual

EXAMPLE OF SOCIAL INSURANCE?

Unemployment, Mental Disease, Ill Health, Drug Addiction,
Dependency of Children

IS NOT APPROPRIATE METHOD OF SOLUTION

FOR MANY OF THESE PROBLEMS BECAUSE THE
PERIL IS NOT ACCIDENTAL OR PREDICTABLE?
Private insurance

ENTERPRISE RISK MANAGEMENT

EQUATION?
Strategic, Operational, Finance, and Pure risk

MANAGE RISKS IN A COORDINATED AND

HOLISTIC MANNER?
Enterprise Risk Management

WHO ARE CONCERNED WITH ALL ASPECTS OF A

BUSINESS AND HOW LOSSES IN THE OPERATIONAL
SIDE AFFECT THE BUSINESS AS A WHOLE?

Risk Managers

ACHIEVE OPTIMAL SHAPE FOR PROBABILITY

DISTRIBUTION CURVE OF FUTURE OPERATING
CASH FLOWS?
Oal of Enterprise Risk Management

WHO STARTED TO RATE ON A FIRMS ERM

DEPARTMENT AND HOW IT HELPED OR DIDN'T
HELP THE ECONOMY?
Standard and Poor's

5 ELEMENTS THAT STANDARD AND POOR

RATING LOOKS FOR?
1) Risk management culture ( structure of RM team)
2) Risk control processes (Monitoring of risks)
3) Emerging risks management (Predicting/dealing with
events)

4) Risk and Economic capital models (Timely insight of

economic risks)

5)Strategic risk management (Management's group of risk)

THINGS THAT MAKE UP THE ENTERPRISE

RISK MANAGEMENT??
Risk Identification
Risk analysis
Risk evaluation

DOES NOT CHANGE ACCIDENT FREQUENCY OR

SEVERITY BUT DOES CHANGE PROBABILITY
DISTRIBUTION OF LOSSES?
Pooling

AVERAGE OF DIFFERENCES BETWEEN

POSSIBLE OUTCOMES AND EXPECTED VALUES
OF EACH OUTCOME?
Standard deviation