BONUS CHAPTER C Managing Risk Mc Graw-Hill Irwin Copyright

LEARNING OBJECTIVES 1. Identify the environmental changes that have made risk management important. 2. Explain the four ways of managing risk, and distinguish between insurable and uninsurable risk. 3. Define insurance policies, and explain the law of large numbers and the rule of indemnity. 4. Discuss the various types of insurance businesses can buy to manage risk. C-2

DAN AMOS Aflac • Amos has been CEO of Aflac for over 25 years. • The company has decided to only operate in the U. S. and Japan covering expenses that normal health insurance does not. • Aflac is one of the 100 best U. S. companies to work for and Amos claims much of the credit goes to the duck! C-3

NAME that COMPANY This type of insurance company is a nonprofit organization owned by its policyholders. Any excess funds (over losses, expenses, and growth costs) go to the policy-holders in the form of dividends or premium reductions. Name that company! C-4

WHAT’S ENTERPRISE RISK MANAGEMENT? LO C-1 • Goals of enterprise risk management (ERM): 1) Defining which risks the program will manage. 2) What risk management processes, technologies, and investments will be required. 3) How risk management efforts will be coordinated across the firm. C-5

WHAT’S RISK? LO C-1 • Risk -- The chance of loss, the degree of probability of loss, and the amount of possible loss. • Speculative Risk -- A chance of either profit or loss. • Pure Risk -- The threat of loss with no chance for profit. C-6

HOW to DEAL with PURE RISK LO C-2 1) Reduce the risk 2) Avoid the risk 3) Self-insure against the risk 4) Buy insurance against the risk C-7

LO C-2 MOST COSTLY DISASTERS Disaster Year Losses Hurricane Katrina 2005 $122 Billion Central U. S. Drought 1988 $76. 4 Billion Superstorm Sandy 2012 $65. 7 Billion Northridge California Earthquake 1994 $40 Billion Hurricane Ike 2008 $35 Billion Hurricane Andrew 1991 $28 Billion 9 -11 Terrorist Attacks 2001 $21. 37 Billion Source: NOAA, www. noaa. gov, accessed November 2014. C-8

WHAT’S SELF INSURANCE? LO C-2 • Self-Insurance -- The practice of setting aside money to cover routine claims and buying only “catastrophe” insurance policies to cover big losses. • Companies that selfinsure can “go bare” and pay claims from their operating budgets or set up special funds to pay for claims. C-9

WHAT RISKS are UNINSURABLE? LO C-2 • Uninsurable Risk -- A risk that no insurance company will cover. Risks can include: - Market risks - Political risks - Personal risks - Operational risks C-10

WHAT RISKS are INSURABLE? LO C-2 • Insurable Risk -- A risk that the typical insurance company will cover, using the following guidelines: 1) The policyholder must have an insurable interest. 2) The loss must be measurable. 3) The chance of loss must be measureable. 4) The loss must be accidental. 5) The insurance company’s risk should be dispersed among different areas. 6) The insurance company can set standards for accepting risks. C-11

PUBLIC INSURANCE LO C-2 C-12

TEST PREP • Why are companies more aware now of the need to manage risk? • What is the difference between pure risk and speculative risk? • What are the four major options for handling risk? • What are some examples of uninsurable risk? C-13

INSURANCE POLICIES LO C-3 • Insurance Policy -- A written contract between the insured an insurance company that promises to pay for all or part of the loss by the insured. • Premium -- The fee the insurance company charges, the cost of the policy to the insured. • Claim -- A statement of loss that the insured sends to the insurance company to request payment. C-14

BASICS of INSURANCE POLICIES LO C-3 • Law of Large Numbers -- If a large number of people or organizations are exposed to the same risk, a predictable number of losses will occur during a given period of time. • Rule of Indemnity -An insured person or organization can’t collect more than the actual loss from an insurable risk. C-15

TYPES of INSURANCE COMPANIES LO C-3 • Stock Insurance Company -- Owned by stockholders, just like any other investor-owned company. • Mutual Insurance Company -- An organization owned by its policyholders. C-16

STOCK and MUTUAL INSURANCE COMPANIES Stock Insurance Companies Mutual Insurance Companies Hartford Life Mass Mutual Metropolitan Life New York Life Prudential Life LO C-3 Northwestern Mutual C-17

TEST PREP • What is the law of large numbers? • What is the rule of indemnity? C-18

HEALTH INSURANCE CHANGES LO C-4 • The Affordable Care Act has the government much more involved in the health insurance process. • We are likely to see many variations of health coverage in the future. C-19

OTHER TYPES of INSURANCE LO C-4 • Disability insurance replaces part of your income if you become disabled and cannot work. • Worker’s compensation insurance guarantees payment of wages, medical care and rehabilitation for employees injured on the job. C-20

GETTING the MOST out of LIFE INSURANCE LO C-4 1. Quit smoking, lose weight and go to the gym! 2. Figure out how much insurance you need. 3. Pick a good insurance company. 4. Find a good financial planner. Source: Entrepreneur, www. entrepreneur. com, accessed November 2014. C-21

LO C-4 LIABILITY INSURANCE • Professional liability insurance covers people found liable for professional negligence; also known as malpractice insurance. • Product liability insurance covers liability arising out of products sold. Photo Credit: Paul Wilson C-22

HOME-BASED BUSINESSES LO C-4 • Homeowners’ policies usually do not provide protection for home-based businesses. • For more coverage, you may need to add a rider to your homeowner’s policy. • Cyber risk insurance can help a business in case of hacking. C-23

HOME MATTERS LO C-4 What You Need to Know About Home Insurance 1. Not all policies cover home-based businesses. 2. Don’t buy too much coverage. 3. Small claims can add up. 4. The home’s history matters. Source: Money, www. money. com. accessed November 2014. C-24

TEST PREP • Why should someone buy disability insurance? • How many different kinds of private insurance can you name? C-25