Chapter 5: The Case Study Approach 1

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Objectives » Demonstrate how surveys, flow charts and financial statements are used to analyze the loss exposures of an insured or a potential insured; » Analyze a case study and explain what factors must be considered to design a risk management program. 2

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Introduction » It is important to dig for the necessary information to do a through job. » To do this: use a systematic approach. » Suggested methods for identifying exposures: » Physical inspections, » Financial statement analysis, » Flow charting of operations, » The use of checklists, and » Other methods for the identification of exposures. 3

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Surveys 4 » Surveys or questionnaires have been developed by many insurers and other organizations to obtain information. » Minimally, each producer should make use of a survey and a physical inspection as part of a systematic information gathering process. » There is no best survey – producers may wish to develop their own. » FLAW: » Individualized risk identification procedures may be required.

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Flow Charts and Financial Statements 5 » Two procedures some producers use for risk identification are: » The flow chart method, and » Financial Statement analysis. » A combination of the two, with a survey or questionnaire as a final check, may be desirable.

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Flow Chart Method 6 » A chart is drawn showing the flow of labour, materials, and other production factors through the firm, from suppliers to customers, and the flow of money through the firm in the opposite direction. » The flow chart allows examination of the firm’s operations systematically, step by step, in search of loss exposures. » Most flow charts will be more complex. » It may be necessary to prepare several flow charts depicting each segment of a larger operation.

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Flow Chart Method 7

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Financial Statement Analysis 8 » Involves detailed questioning to find loss exposures that are not apparent on the surface. » See Exhibit 5-2: Balance Sheet – Versatile Adapter Corp. » Analyzing the financial statements can help identify and evaluate obvious and obscure loss exposures.

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Financial Statement Analysis 9

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 REVIEW: 10 » Case Studies: » Joyner Sales and Service Corporation » Cornucopia Enterprises » Back of the chapter – part of Test #1

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corporation - Overview » Over 80 years in operation and the best automotive service centre in a large Canadian city » Run by brothers Sam and Tony Joyner (sons of founder). » Large premises with parking spaces for monthly rentals. » 18 full-time mechanics including specialists. » Waiting list of several days as they do specialized work. » Drive customers cars and drive customers home. » Large gas operation, all products supplied by Imperial. 11

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corporation - Overview » $8M per year in parts sales but issues with building layout. » Long range plans to change office layout by financing through retained earnings. » Parts supplied by national jobbers. Over 35 manufacturers in product line and each automotive product has a choice of between 2 and 7 manufactures. » 60 total employees – some long time employees. No retirement or life/health program for these employees. Recent accident has shown the brothers this is a major issue. » Brothers plan to retire soon. » See Additional Information 12

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corp. 13 » Property Exposed to direct loss: » Real and personal property » » Showroom windows and sign » Personal property intended for permanent placement » » Personal Property subject to regular movement (but not necessarily intended for regular movement) » »

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corp. 14 » Property Exposed to direct loss: » Real and personal property » Personal Property intended for movement (frequent)

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corp. 15 » Measuring Direct Damage Losses » Replacement cost insurance: pays the cost of replacement without deduction for depreciation. » Actual Cash Value (ACV): Replacement cost minus depreciation. » Replacement Cost: the cost to rebuild at present prices with new materials of like kind and quality. » Two cautions about replacement cost calculations: » »

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corp. 16 » Measuring Direct Damage Losses » Depreciation: actual using up of the building, including the allowance for physical depreciation and obsolescence of the building. » Difficult to estimate – percentage of expected useful life is a common approximation. » Personal property – gain guidance from published sources, people in the business of selling that property, and claims representatives and adjusters of insurance companies. » NOTE: Actual Cash Value (ACV) will be calculated at the time of the loss.

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corp. 17 » Measuring Direct Damage Losses » No matter how much insurance is purchased, no more than the actual cash value at the time of the loss will be paid (Indemnity). » Insure to value ( ) as direct damage insurance will generally pay the smaller of either the face amount of the policy (amount of insurance) or actual cash value of the loss. » A customer’s balance sheet and other financial records provide very little help in determining values for long- lived assets. » Useful in identifying exposures but not in measuring the extent of those exposures or values of those assets (as historical cost or other GAAP measure).

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corp. 18 » Measuring Direct Damage Losses » Inventory – the method used to value inventory must be carefully checked. » LIFO ( ) – inventory may be significantly undervalued. » FIFO ( ) – uses current cost elements and valued on the most recent production costs. » During high inflation FIFO values may be understated. » Discuss peak season endorsement later to deal with fluctuations as a result of seasonal changes.

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corp. 19 » Indirect Loss Exposure Analysis » Indirect losses can be difficult to identify, may take some imagination. » Business Interruption Insurance » Gross Earning (US origin) » Profits (British origin – Net Profits) » Key difference – both forms pay, within their limitations, the loss of earnings including continuing expenses HOWEVER » Gross Earnings only pays

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corp. 20 » Indirect Loss Exposure Analysis » Business Interruption Insurance » It is possible that customers will return after a loss and Gross Earnings is adequate and less expensive BUT Always let the potential client make a choice like this – otherwise if you secure the business and there is a loss in which things do not turn out as expected, they may feel that you persuaded them to make the wrong decision. » If in doubt, insure on Profits form.

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corp. 21 » Indirect Loss Exposure Analysis » Business Interruption Insurance » Co-insurance » can be 80% or 50% of Gross Earnings form » Profits always 100% co-insurance » Boiler exposure – make sure to get a quotation for this from the boiler insurer if this is a factor.

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corp. 22 » Indirect Loss Exposure Analysis » Extra Expense Insurance » Pays the extra expense of keeping normal business activities going even if this in not economical (if possible). » For firms that must absolutely stay in business when the insured peril strikes. » Other Indirect Losses » Valuable Papers Exposure » Local Building Codes

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corp. 23 » Liability Exposure Analysis » Premise exposure – claims from bodily injury or property damager occurring on premises » Operations exposure – off or on premises activities that create claims. » Products and Completed Operations exposure – a part sold causes injury (products) or a repair is done incorrectly causing injury (completed operations). » Contractual Liability » Insured contracts in the CGL policy must be kept in mind.

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corp. 24 » Liability Exposure Analysis » Independent contractors – no apparent issue. » Watercraft and Aircraft – no indication of exposure here. » Automobile Liability Exposures – Many exposures » Employee could be driving a personal, company or customer car and have an accident. » Bailee’s exposure – “care, custody and control” of unowned property (automobiles) is a major part of Joyner’s business » Special insurance policy is needed.

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corp. 25 » Measuring Liability Exposures » Liability exposure is unlimited. » Maximum loss can be greater than entire assets of business. » Sole proprietor or partnership is at a greater risk than a corporate business as their personal and business assets are at risk along with future income. » Corporation – only the corporate assets are exposed (advantages of incorporation).

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Joyner Sales and Service Corp. 26 » Human Asset Exposures » Death and Disability insurance – loss of income due to death or disability is a risk for employees and their families. » Medical Care Cost – area of concern for employees – employees and their families should have access to major medical insurance. » Retirement Income » » Provisions for continuation of the business in case of death or disability of partners.

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Risk Management Process and Joyner Sales 27 » Exposure analysis involves a determination of the potential impact of a loss from exposures which have been identified. » Producer must evaluate frequency and severity » Measure the loss exposures » Large loss principle – devastating exposures to loss should be transferred either through noninsurance transfers or insurance. Such exposures should not be retained. » principle – Insurance premiums will be calculated so that, in the long run, the insurer will take in what it pays out in losses plus expenses. » Exposure treatment for small losses could be “loss retention”

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Risk Management Process and Joyner Sales 28 » Deductibles (retentions) – using deductibles on property, small frequent loss can be retained while transferring the potential of a large loss to the insurance company. » Liability exposures can be severe – retention, in most cases, is unwise. » Loss exposure treatment process includes: avoidance, retention, noninsurance transfer, loss control and insurance. » Loss control can only be employed in conjunction with retention, transfer, or insurance (not a sole remedy). » Avoidance is restrictive and frequently impractical » Loss Control is especially important for a business like Joyner.

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Risk Management Process and Joyner Sales 29 » SUMMARY » Total Risk Management Process Involves: 1.Identifying and measuring loss exposures; 2.Determining which loss exposure treatment to use on the basis of information gathered in (1); 3.Implementing the decision in (2); 4.Monitoring the program.

C72 – Intro to Risk Mgmt and Comm. Insurance – Chapter 5 Questions??? 30