Managing Risk Bonus Chapter C McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

LEARNING GOALS Bonus Chapter C 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

JOACHIM OECHSLIN Munich Re Profile Oechslin is chief risk officer of Munich Re; the world’s largest reinsurer. Damage caused by a disaster is not limited to the immediate damage, but spreads throughout the supply chain. Oechslin and his team predict what those events will mean and how much insurance companies will have to pay. C-3

NAME that COMPANY Bonus Chapter C Every business faces risks that can affect the health of the company. When the government suspected some of our hens had been exposed to bird flu, we killed and buried some 15,000 hens in northwestern Arkansas. Name that company! Companies: Tyson Foods C-4

WHAT’S ENTERPRISE RISK MANAGEMENT? Understanding Business Risks LG1 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 Goal 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? Managing Risk LG2 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 Goal 2: Explain the four ways of managing risk and distinguish between insurable and uninsurable risk. C-6

HOW to DEAL with PURE RISK Managing Risk LG2 Reduce the risk Avoid the risk Self-insure against the risk Buy insurance against the risk See Learning Goal 2: Explain the four ways of managing risk and distinguish between insurable and uninsurable risk. C-7

MOST COSTLY DISASTERS Disaster Year Losses Managing Risk LG2 Disaster Year Losses Hurricane Katrina 2005 $122 Billion Kobe, Japan Earthquake 1995 $100 Billion Northridge California Earthquake 1994 $40 Billion Hurricane Ike 2008 $35 Billion Chilean Earthquake and Tsunami 2010 $30 Billion Hurricane Andrew 1991 $28 Billion 9-11 Terrorist Attacks 2001 $21.37 Billion See Learning Goal 2: Explain the four ways of managing risk and distinguish between insurable and uninsurable risk. Costliest Disasters This slide presents the costliest disasters in billions of dollars. We don’t yet know the economic impact of the 2011 earthquake and tsunami in Japan. 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: Fortune Magazine, April 11, 2011. C-8

WHAT’S SELF INSURANCE? Self Insurance LG2 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 Goal 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? Buying Insurance to Cover Risk WHAT RISKS are UNINSURABLE? LG2 Uninsurable Risk -- A risk that no insurance company will cover. Risks can include: Market risks Political risks Personal risks Operational risks See Learning Goal 2: Explain the four ways of managing risk and distinguish between insurable and uninsurable risk. C-10

WHAT RISKS are INSURABLE? Buying Insurance to Cover Risk LG2 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 Goal 2: Explain the four ways of managing risk and distinguish between insurable and uninsurable risk. C-11

PROGRESS ASSESSMENT Progress Assessment 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-12

Understanding Insurance Policies LG3 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 Goal 3: Define insurance policies and explain the law of large numbers and the rule of indemnity. C-13

BASICS of INSURANCE POLICIES Understanding Insurance Policies BASICS of INSURANCE POLICIES LG3 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 Goal 3: Define insurance policies and explain the law of large numbers and the rule of indemnity. One of five U.S. adults, about 45 million people, say it’s acceptable to defraud insurance companies under certain circumstances. Four of five adults think insurance fraud is unethical. (Four Faces of Insurance Fraud, Coalition Against Insurance Fraud, 2008) C-14

TYPES of INSURANCE COMPANIES LG3 Stock Insurance Company -- Owned by stockholders, just like any other investor-owned company. Mutual Insurance Company -- An organization owned by its policyholders. See Learning Goal 3: Define insurance policies and explain the law of large numbers and the rule of indemnity. C-15

STOCK and MUTUAL INSURANCE COMPANIES Types of Insurance Companies STOCK and MUTUAL INSURANCE COMPANIES LG3 Stock Insurance Companies Hartford Life Metropolitan Life Prudential Life Mutual Insurance Companies Mass Mutual New York Life Northwestern Mutual See Learning Goal 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-16

PROGRESS ASSESSMENT 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-17

HEALTH INSURANCE CHANGES LG4 The U.S. is going through major changes in health insurance. The debate of government involvement is ongoing. We are likely to see many variations of health coverage in the future. See Learning Goal 4: Discuss the various types of insurance businesses can buy to manage risk. C-18

EMPLOYER HEALTH INSURANCE OPTIONS LG4 Health Maintenance Organizations (HMOs) -- Offer a full range of healthcare benefits, with emphasis on helping members stay healthy through preventative care; restricted list of doctors. Preferred Provider Organizations (PPOs) -- Contract with hospitals and physicians, members usually pay some part of the bill; choose physician. Health Savings Accounts (HSAs) -- Tax-deferred savings accounts linked to low cost, high-deductible health insurance policies. See Learning Goal 4: Discuss the various types of insurance businesses can buy to manage risk. C-19

OTHER TYPES of INSURANCE Disability Insurance and Workers’ Compensation OTHER TYPES of INSURANCE LG4 Disability insurance replaces part of your income if you become disabled and can’t work. Worker’s compensation insurance guarantees payment of wages, medical care and rehabilitation for employees injured on the job. See Learning Goal 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 Disability Insurance and Workers’ Compensation GETTING the MOST out of LIFE INSURANCE LG4 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 Goal 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, March 2010. C-21

Photo Courtesy of: Paul Wilson LIABILITY INSURANCE Liability Insurance LG4 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 Goal 4: Discuss the various types of insurance businesses can buy to manage risk. Photo Courtesy of: Paul Wilson C-22

HOME-BASED BUSINESSES Insurance Coverage for Home-Based Businesses HOME-BASED BUSINESSES LG4 Homeowners’ policies usually don’t provide protection for home- based businesses. For more coverage, you may need to add a rider to your homeowner’s policy. See Learning Goal 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 Insurance Coverage for Home-Based Businesses HOME MATTERS What You Need to Know About Home Insurance LG4 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 Goal 4: Discuss the various types of insurance businesses can buy to manage risk. Source: Money, September 2010. C-24

PROGRESS ASSESSMENT 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 insurance (PPO and HMO), property insurance, renter’s insurance, professional liability insurance, disability and workers’ compensation. C-25