RMIN 4000 Summer 2021 Chapter 1 PDF

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Just a brief class lecture powerpoint slide about chapter 1 for rmin4000. risk management and insurance...

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Risk and Its Treatment RMIN 4000 – Chapter 1 Daniel Brown

Risk of Driving a Car Things of Value (Assets) That Could be Lost “Exposures”

Things That Could Happen to these Assets “Perils”

What do you do to protect these assets and/or prevent/reduce losses? “Risk Management”

Car

Car Accident

Drive Safely

Health/Life (Driver & Passengers)

License Revoked

Insurance

Your Money

Acts of God

Car Alarm

Future Income

Breakdown

Lock Vehicle

Contents (stuff)

Vandalism

Driver’s Education

Freedom

Maintenance

Obey Laws

License

Theft

Wear Seat Belts

Lawsuit

Park in Safe Areas 2

What is Risk? • Textbook Definition – Uncertainty concerning the occurrence of a loss. • Better Definition – A calculated possibility of a negative outcome.

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Calculated Possibility • A probabilistic outcome (chance of loss, likelihood of loss) that is known or estimated. • Ranges from 0 to 1 (0% to 100%) 0 0% Impossible Event (No Risk)

.5 Highest Risk (Most Uncertainty)

1 100% Certain Event (No Risk)

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Negative Outcome • Loss • Must be Quantifiable ($)

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Frequency & Severity Frequency • How often does a loss occur? • The number of losses (such as fire, theft, collision) that occur within a specified time period. • Probability of a loss. • Ex: Probability of a fire is 0.0071 per loss exposure per year.

Severity • How much does it cost when a loss does occur? • The dollar amount of loss for a specific peril (fire, theft, collision). • Ex. Average fire loss is $32,547

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Frequency & Severity Equations

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Frequency & Severity Example Lannister Insurance Company insures 100,000 homes. In 2019, they paid a total of $30,000,000 in wind damage losses to the owners of 5,000 of those homes. What was Lannister’s wind loss frequency in 2019? What was Lannister’s average wind loss severity in 2019?

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Peril vs. Hazard Peril • Cause of Loss • Ex: Fire, tornado, collision, burglary, etc.

Hazard • Condition that creates or increases the frequency and/or severity of a loss. • Does not cause a loss. • Four types – physical, moral, morale (attitudinal), legal

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Physical Hazard A physical condition that increases the frequency and/or severity of a loss.

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Moral Hazard Book definition Dishonesty or character defects in an individual that increase the frequency and/or severity of a loss.

Better definition The presence of insurance changes the behavior of the insured.

Examples • Using a hammer to create “hail” damage to a roof. • Exaggerating the value of insured property.

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Morale (Attitudinal) Hazard Carelessness or indifference to a loss, which increases the frequency and/or severity of a loss.

Examples • Leaving car keys in an unlocked car. • Neglecting a tree limb growing over your roof.

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Legal Hazard Characteristics of legal system or regulatory environment that increase the frequency and/or severity of a loss. Examples • Juries in some areas are more sympathetic than other areas (meaning larger damage awards in liability lawsuits). • Georgia now requires Diminution in Value to be paid on property losses (meaning increased severity in Georgia).

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Risk Classifications • Pure vs. Speculative Risk • Diversifiable Risk • Nondiversifiable Risk • Enterprise Risk • Systemic Risk

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Pure vs. Speculative Risk Pure Risk (2 Future States)

Speculative Risk (3 Future States)

1) Loss

1) Loss

2) No Loss

2) No Loss/No Gain 3) Gain

Ex: Fire, Cancer, Dog Bites a Visitor

Ex: Investment, Gambling, Drinking

• Can you buy insurance for pure risks? • Can you buy insurance for speculative risks?

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Diversifiable Risk • Affects only individuals or small groups, not entire economy. • Can be reduced/eliminated through diversification. • Risks aren’t correlated (fire, theft, collision).

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Nondiversifiable Risk • Affects the entire economy or large numbers of groups/persons within the economy. • Cannot be reduced/eliminated through diversification. • Government assistance may be needed to insure. • Risks are correlated (inflation, unemployment).

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Enterprise Risk Encompasses all major risks faced by a business firm: • Pure Risk • Speculative Risk • Strategic Risk* • Operational Risk* • Financial Risk* *We’ll discuss these and Enterprise Risk in detail in Chapter 4.

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Systemic Risk • Risk of collapse of an entire system or entire market due to the failure of a single entity or group of entities that can result in the breakdown of the entire financial system. • Instability in the financial system due to the interdependency between the players in the market.

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Major Types of Pure Risks • • • • •

Personal Risk Property Risk Liability Risk Loss of Business Income Cyber-security

Which of the above are relevant to individuals & families? Which are relevant to businesses?

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Personal Risk Directly affects an individual or family; involves the possibility of loss of income, extra expenses, depletion of financial assets. What perils might be involved? • Death • Unemployment • Disability/Injury/Poor Health • Inadequate Retirement Income

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Personal Risk (continued) Disability – Council of Disability Awareness Personal Disability Quotient (PDQ) Calculator Inadequate Retirement – 2017 Employment Benefit Research Institute Survey • 47% of retirees had saved less than $25,000. • 24% had saved less than $1,000! • Only 38% of retirees had saved $250,000 or more.

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Property Risk The possibility of losses associated with the destruction or theft of property. Direct Loss Cost to repair or replace property damaged by a peril. Indirect Loss • Financial loss resulting as a consequence of a direct loss. • Ex: Fire damages your home, you have to pay to live elsewhere while it’s repaired. • For businesses, this includes Business Interruption, Loss of Income, etc.

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Liability Risk • Legal liability (financial consequences) resulting from injuries or damages you caused to someone else. • No upper limit • Liens can be placed on income, assets seized. • Defense costs – lawyers are expensive.

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Loss of Business Income • If a business has to shut down for a period of time due to a physical damage loss, it is unable to generate an income. • Is this a direct or indirect loss? • Example – Grease fire in the kitchen causes a restaurant to close down for 4 weeks while repairs are made. The restaurant has no income while closed.

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Techniques for Managing Risks Risk Control Techniques to reduce the frequency or severity of losses.

Risk Financing Techniques for funding losses.

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Risk Control Loss Prevention • Reduces frequency • Airport security, safety training programs • Does this eliminate the risk? Loss Reduction • Reduces severity (fire sprinklers) • Can occur pre-loss or post-loss Duplication, Separation, & Diversification

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Risk Control (continued) Avoidance - Technique in which: • A certain loss exposure is never acquired (proactive). • An existing loss exposure is abandoned (reactive). Why might avoidance be a bad technique?

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Risk Financing Retention – retaining part or all of losses that can occur from a given risk. • Active – Deliberately retaining risk (choosing a high deductible) • Passive – Unknowingly retaining risk (not purchasing disability insurance) When might retention be a good strategy? a bad strategy?

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Risk Financing (continued) Noninsurance transfer • By contract • Hedging – derivatives such as options, futures, etc. • Incorporation Insurance

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