Managing Risk BONUS CHAPTER C McGraw-Hill/Irwin Copyright © 2015 by the McGraw-Hill Companies, Inc. All rights reserved.

LEARNING OBJECTIVES Identify the environmental changes that have made risk management important. Explain the four ways of managing risk, and distinguish between insurable and uninsurable risk. Define insurance policies, and explain the law of large numbers and the rule of indemnity. 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! Companies: A mutual insurance company C-4

WHAT’S ENTERPRISE RISK MANAGEMENT? LO C-1 Goals of enterprise risk management (ERM): Defining which risks the program will manage. What risk management processes, technologies, and investments will be required. How risk management efforts will be coordinated across the firm. See Learning Objective 1: Identify the environmental changes that have made risk management more important. The risk management function of large corporations plays an important role in the organization’s success. 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. See Learning Objective 2: Explain the four ways of managing risk and distinguish between insurable and uninsurable risk. C-6

HOW to DEAL with PURE RISK LO C-2 Reduce the risk Avoid the risk Self-insure against the risk Buy insurance against the risk See Learning Objective 2: Explain the four ways of managing risk and distinguish between insurable and uninsurable risk. C-7

Northridge California Earthquake MOST COSTLY DISASTERS LO C-2 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 See Learning Objective 2: Explain the four ways of managing risk and distinguish between insurable and uninsurable risk. This slide presents the costliest disasters in billions of dollars. Ask students: How many of these disasters do you remember? (Most of them should identify the 9/11 terrorist attacks and Hurricane Katrina as the most talked about events.) From a risk standpoint, ask the students: How can a business prepare for such disasters? (Taking precautionary actions by ensuring appropriate types and coverage of insurance, employee preparedness, etc. should be absolutely essential. The companies need to protect their people, property, data & information, and finances.) 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 self- insure can “go bare” and pay claims from their operating budgets or set up special funds to pay for claims. See Learning Objective 2: Explain the four ways of managing risk and distinguish between insurable and uninsurable risk. Many large companies use self-insurance as a means of risk management. 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 See Learning Objective 2: Explain the four ways of managing risk and distinguish between insurable and uninsurable risk. C-10

WHAT RISKS are INSURABLE? LO C-2 Insurable Risk -- A risk that the typical insurance company will cover, using the following guidelines: The policyholder must have an insurable interest. The loss must be measurable. The chance of loss must be measureable. The loss must be accidental. The insurance company’s risk should be dispersed among different areas. The insurance company can set standards for accepting risks. See Learning Objective 2: Explain the four ways of managing risk and distinguish between insurable and uninsurable risk. C-11

PUBLIC INSURANCE LO C-2 See Learning Objective 2: Explain the four ways of managing risk and distinguish between insurable and uninsurable risk. 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? Hurricanes, terrorist threats, identity theft and an unstable economy have all contributed to additional risk and the need for greater risk management. Pure risk is the threat of loss with no chance for profit, such as the threat from a fire. If your house burns to the ground you lose money, but if it does not you gain nothing. Speculative risk can result in either profit or loss. An entrepreneur’s chance to make a profit is considered speculative risk. The four major options for handling risk are: (1) Reduce the risk, (2) avoid the risk, (3) self-insure against the risk, and (4) buy insurance against the risk. Examples of uninsurable risk include: Market risk, political risk, personal risk and some risk of operation. C-13

INSURANCE POLICIES LO C-3 Insurance Policy -- A written contract between the insured and 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. See Learning Objective 3: Define insurance policies and explain the law of large numbers and the rule of indemnity. 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. See Learning Objective 3: Define insurance policies and explain the law of large numbers and the rule of indemnity. 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. See Learning Objective 3: Define insurance policies and explain the law of large numbers and the rule of indemnity. C-16

STOCK and MUTUAL INSURANCE COMPANIES LO C-3 Stock Insurance Companies Hartford Life Metropolitan Life Prudential Life Mutual Insurance Companies Mass Mutual New York Life Northwestern Mutual See Learning Objective 3: Define insurance policies and explain the law of large numbers and the rule of indemnity. Stock and Mutual Insurance Companies This slide profiles some of stock insurance companies and mutual insurance companies. If time permits, have students examine some of the differences among the stock and mutual insurance companies listed on this slide. C-17

What is the law of large numbers? What is the rule of indemnity? TEST PREP What is the law of large numbers? What is the rule of indemnity? 1. The law of large numbers means that If a large number of people or organizations are exposed to the same risk, a predictable number of losses will occur during a period of time.   2. The rule of indemnity says an insured person or organization cannot collect more than the actual loss from an insurable act. 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. See Learning Objective 4: Discuss the various types of insurance businesses can buy to manage risk. 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. See Learning Objective 4: Discuss the various types of insurance businesses can buy to manage risk. Employers in all 50 states are required to provide worker’s compensation insurance. C-20

GETTING the MOST out of LIFE INSURANCE LO C-4 Quit smoking, lose weight and go to the gym! Figure out how much insurance you need. Pick a good insurance company. Find a good financial planner. See Learning Objective 4: Discuss the various types of insurance businesses can buy to manage risk. The cost of life insurance increases if you smoke or are overweight, so addressing these issues will reduce your premiums. Source: Entrepreneur, www.entrepreneur.com, accessed November 2014 . C-21

Photo Credit: Paul Wilson LIABILITY INSURANCE LO C-4 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. See Learning Objective 4: Discuss the various types of insurance businesses can buy to manage risk. 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. See Learning Objective 4: Discuss the various types of insurance businesses can buy to manage risk. C-23

HOME MATTERS What You Need to Know About Home Insurance LO C-4 Not all policies cover home-based businesses. Don’t buy too much coverage. Small claims can add up. The home’s history matters. See Learning Objective 4: Discuss the various types of insurance businesses can buy to manage risk. 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? Disability insurance is important, because a young person is more likely to become disabled than to die. The kinds of private insurance include: Life insurance (Whole and Term), medical, property insurance, renter’s insurance, professional liability insurance, disability and workers’ compensation. C-25