Download Mgmt.101 ~ Introduction to Business

Mgmt.101 ~ Introduction to Business
Risk Management & Insurance
Risk
• Uncertainty about future events.
• The chance of financial loss due to a peril.
• The probability of an event occurring times the consequence or out
come from that event.
Insurance
• A system that makes financial loss more affordable by transferring it
from individuals to large groups.
• The transfer of risk to another individual or company who will, for a
fee (premium), pay a specified amount in the event of certain
losses.
Risk
Businesses constantly face two basic types of risk:
Pure Risk ~ The possibility only of loss or no loss (i.e. no possibility of
gain). For example, an accidental fire that destroys business premises
and their contents.
Speculative Risk ~ The chance of either a loss or a gain. For example,
designing and distributing a new product, buying stock in the hope of
making a profit.
Risk Management
• The process of conserving the firm’s earning power and
assets by reducing the threat of losses due to
uncontrollable events.
• This involves analyzing the firm’s operations, evaluating
potential risks, measuring the frequency and severity of
losses, and figuring out how to minimize losses in a costeffective manner.
Steps for Risk Management
1) Identify possible risks; recognize what can go wrong
2) Analyze each risk to estimate the probability that it will
occur and the impact (i.e., damage) that it will do if it
does occur
3) Rank the risks by probability and impact
- Impact may be negligible, marginal, critical, and
catastrophic
4) Develop a contingency plan to manage those risks having
high probability and high impact
Managing Risk
Risk Avoidance: Stay away from situations that can lead to loss.
Risk Control: When risk avoidance is not practical or desirable, the
probability of risk can be lessened or minimized by requiring certain
work practices, e.g. by requiring people to wear safety equipment
and informing, educating, and training employees in safe working
practices.
Managing Risk
Risk Transfer: When the potential for risks cannot be avoided or
controlled, the risk can be transferred to another firm – namely, an
insurance company.
For a fee (called a premium), the insurance company issues a formal
agreement (a policy) to pay the firm (the policy holder) a specified
amount in the event of certain losses.
Where premiums are affordable, the risk can be transferred to an
insurance company.
Managing Risk
Risk Assumption or Retention (aka Self Insurance)
Where premiums become too expensive, or where the risk is
uninsurable, a firm can carry the risk itself. That is, cover any losses
with its own funds.
Insurable & Uninsurable Risk
Insurance companies divide risk into
Insurable Risk: property, legal liability, personal risk.
Uninsurable Risk: speculative, business, political.
They will offer coverage only on the former.
Criteria for Insurable Risk
The things being insured must be sufficiently numerous and similar to allow a
calculation of the probability of loss to be made.
The insured items could not all be insured by one broker.
Loss must be accidental and unintentional.
Loss must be determinable and measurable.
The loss must not be catastrophic. That is, a terrible event that results in a lot of
destruction and causes the insurance company to suffer very large losses.
The premium must be economically feasible.
Insurance Companies
• Non-depository financial institutions which sell financial
coverage of risk for premiums.
• The monies collected from premiums are invested in stocks,
bonds, real estate and other interest-earning operations.
• Earnings pay for insured losses such as death benefits,
vehicle accidents, business liability, etc.
Mutual Insurance Companies
An insurance company owned entirely by its policyholders.
Any profits earned by a mutual insurance company are rebated to
policyholders in the form of dividend distributions or reduced future
premiums.
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Examples in the U.S.
Liberty Mutual
Mutual of Omaha
Nationwide Mutual Insurance Company
New York Life
State Farm Insurance
Public and Private Insurance Companies
Public
• Unemployment Insurance
• Workers’ Compensation
Insurance
• Social Security
Private
• Stock Companies & mutual
Companies
• Property & Liability Insurance
• Health Insurance
• Life Insurance
The "Law Of Large Numbers"
The theory upon which all insurance exists.
The concept that seemingly random events
will follow predictable patterns if enough
events are observed.
See “actuarial tables”.
Actuaries
A professional who analyzes the financial consequences
of risk.
Uses mathematics, statistics and financial theory to
study uncertain future events, especially those of
concern to insurance companies.
What Insurance Do Companies Need?
Liability Insurance
Covers losses resulting from damage to people or when the insured is
judged responsible.
Property Insurance
Covers losses resulting from physical damage to or loss of the
insured’s real estate or personal property.
What Insurance Do Companies Need?
Business Interruption Insurance
Covers income lost during times when a company is unable to
conduct business.
Employee Health Care Insurance
Part of the benefits package for employees in larger firms. Losses
resulting from medical expenses as well as income lost from injury or
disease. It is expensive.
What Insurance Do Companies Need?
Workers Compensation Insurance
Coverage provided by a firm to employees for medical expenses, loss
of wages, and rehabilitation costs resulting from job-related injuries
or disease.
What Insurance Do Companies Need?
Directors and Officers
Malpractice
Fidelity Bond
Surety Bond
Motor Vehicle
Life
Power Plant
Credit
Hazardous Waste
Surplus Lines