CH 3- Liability LOSS Exposures + ERM/TRM PDF

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Professor McCloskey lecture notes SPRING 2019...

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CH 3: LIABILITY LOSS EXPOSURES + ERM/TRM Lawsuits (arise from) ● Bad behavior ● Breaking a contract can lead to a lawsuit ● Behavior is commonly classified as either: ○ Intentional (assault, libel, slander) ■ Libel and slander have increased recently because of social media ○ Unitionional (negligence or carelessness) - most common type Negligence and Legal Liability ● Legal liability is established when: ○ There was negligence (jaywalking, speeding) ○ There was actual damage or loss What constitutes Negligence? ● A failure of a person to exercise the proper degree of care ● A jury decides what negligence is ○ The absolute burden is on the injured party ● absolute/strict liability: doesn’t try to figure out who’s as fault, always employer ○ LL is established because accidents happen ○ Imposed whether anyone was at fault ○ Happens if children are involved - may not be able to read, also happens with workers compensation Measurement Issue ● Usually easy to establish injury or damage occurred ● Establishing the amount of damage is difficult ○ How much is someone’s life worth Measurement of Losses ● Property loss (PL) ○ Relatively simple to calculate ○ Get in a card accident and insurance co determines how much the car was worth/damages ● Bodily Injury (BI) ○ Special damages ■ Compensate for measurable losses ● Medical expenses ● Loss of income (look at W2 to verify) ● Easy to calculate - human behavior element makes it slightly subjective (some over exaggerate) ● General damages ○ Compensate for intangible losses ○ Pain and suffering ○ Mental anguish ○ Difficult to estimate and measure ■ Similar to an inconvenience fee ($ for having to deal with something) ■ Ex: tennis player gets hit by driver that is texting, can’t play tennis

anymore - tennis player is compensated for not being able to play tennis anymore (very subjective) ■ Ex: elevator malfunction ○ $ is determined by who and how they react ■ Surgeon killed gets more $ than a janitor killed ● Punitive damages ○ Amount assessed as a form of punishment ○ Gross negligence is involved: company knew about error ○ Difficult to estimate and measure ○ Typically seen in product type data: because there are facts and research behind them Defense to Liability ● Assumption of risk defense (by injured party) ○ One recognizes dangers involved in an activity ○ Voluntarily chooses to encounter it ■ Attending a hockey game ■ Going skydiving - you know you’re getting into something risky ○ Loss must be inherent to actual activity ● comparative/contributory negligence ○ “You’re not an innocent party” ○ Plaintiff was partially to blame for what happens ○ Ex: two people fighting, 1st person throws a punch and misses and the 2nd person fights back. 1st person sustains losses but is not innocent because he instigated it Res Ipsa Loquitur (not strict liability) ● “The thing speaks for itself” ● Modification to law of negligence ● Presumption of negligence on part of defendant ● The fact of an injury sometimes enough ○ Often seen in medical area because there is limited expertise ● Requirements: ○ Normally would not occur unless negligence ○ Defendant exclusively controls tool/equipment ○ Injured party does not contribute to loss ■ Dentists removes wrong tooth, surgeon operates on wrong ACL Vicarious Liability ● One person becomes LL for the negligent behavior of another ● Employers are held responsible for actions of their employees acting within the capacity of employment ○ Employee must act on behalf of employer Joint and Several Liability ● Negligence of two or more parties contribute to the injury or damage ○ Walking on campus construction site, machine hits you and you suffer damages sue construction company and temple ( temple hired contractors)

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Injured party may recover the entire amount of compensation from any negligent party who is able to pay - regardless of degree of that party’s negligence ● “The search for the deep pockets” - sue the person with the most $ ○ Construction 90% responsible, TU only 10% - construction co says they will go out of business so TU takes the blame Product Liability ● Manufacturers of a faulty product that injures someone or damages property may be held LL ● negligence ○ Product is negligently made or improperly designed ■ Faulty coffee cup lid ○ Proper warning is not given to the consumer ■ Warning label of peanuts in product is not properly specified Product Liability Loss ● Cost of defending and paying claims for injury ● Cost of recalling and batched of products suspected of being defective ● Damage to your names - bad publicity ● Evolution of coffee cup is risk management Premises Liability (harm to people) ● Owner or tenant may be held liable for damages if someone’s injured ● If the property of others is damaged as a result of a condition in or arising out of the premises ● Trespasser - never kids ○ Someone comes without right and consensent - only obligated to abstain from doing intentional harm ● Licensee (door hangers, law enforcement) ○ Comes onto property without knowledge of owner ○ No purpose of benefit to owner ○ Must warn of any hidden dangers ● Social guest/invitee ○ Been invited for some purpose ○ From business perspective: customer in store ○ Must keep premises safe so no harm comes ○ Ex: party, kid gets hurt - kid sues everyone on the lease and co signers Animal Liability ● Exotic animals - tiger, giant snake ○ Strict liability: owner is liable ● Dogs ○ Some states have strict liability ○ Some states “one bite rule” - if dog has never bit before, could easily escape liability ○ Most insurance co won’t cover you if you own a “dangerous breed” if dog does something ■ 5 year old bit by neighbor's pit bull, sued and got lots of $

Traditional Risk Management ● TRM ● 4 loss exposures (property, net income, personnel, liability) ● Silo approach: individualized, departments ○ property/liability pure risk (hazard risks) - risk manager ○ Personnel risk - human resources ○ Operation risk - COO/business units ○ Financial risk - CFO ○ Strategic risk - CEO/Board of directors ● Pure insurable risks Enterprise Risk Management ● Manage risk and seize opportunity - proactive ● Risk based approach to managing an enterprise ● Very strategic, scientific approach ● Breaks it down into quadrants ● ERM does not ignore TRM ● Quadrant #1: Hazard risks (TRM) ○ Fire, flood, lawsuits/liability ○ Generally pure ● Quadrant #2: financial risks ○ Inflation, foreign exchange rates/currency, stock market, interest rates, volatility, liquidity, credit, debt rating, mostly speculative ■ How do these things impact how I finance things? ■ If I cant finance things how does that impact the future of my business? ● Quadrant #3: operational risks (risks that arise out of business operations) - mostly pure ○ Manufacturing products ■ Supply chain issue ■ service provider failures ■ system failures ■ product recall ○ Regulatory issues: (Commerce Bank example) ○ Employment practices/company policies and procedures ■ Discrimination - TRM would only worry about this ■ Turnover ■ Workplace violence/sexual assault - ERM worries about this ● Quadrant #4: strategic of business risk (SWOT): speculative in nature ○ Customer service issues (growing to be important because of social media) ○ Public relations (how you deal with certain things, topics, or issues) ○ Reputation ○ Competition ○ Bad business decisions (Blockbuster had the opportunity to buy Netflix and said no, they weren’t worry about streaming, they were only worried about Walmart BAD BUSINESS DECISION) ■ Amazon adapted and expanded horizons: very successful

○ Intellectual property ○ Ethics ○ Union issues ERM vs TRM ● TRM is a silo approach: departmentalized approach ○ Focuses mainly on hazard risks (flood, fire) - handles by risk management area ○ Financial type risks are handled by CFO, finance or accounting ■ People tend to focus on what they manage, don’t think about other departments or business in total (close minded approach) ○ Other risks are handled by their specific areas (departments) ○ Not much effort to make comparisons among various risks to understand cumulative impact on the firm ● ERM is an integrated approach: occurs at enterprise level instead of individual departments ○ Risk management activities heavily impact business decisions ○ Designed to facilitate comparison and evaluation ○ Identify risks and determine if risks are correlated or independent ■ Certain departments (in TRM) may not know if they correlate ○ Risk maps ○ CRO ■ Change business strategy ■ Seize opportunity ■ CRO is critical...