Dr. James Kallman, ARM Advanced PowerPoint Presentation ©2009 The National Underwriter Company

Dr. James Kallman, ARM This Advanced PowerPoint Presentation accompanies the “Tools & Techniques of Risk Management & Insurance” textbook. Each of the 28 chapters in the textbook are presented here in the following sections:  Outline  Key concepts (Key words are italicized)  Major sections  Chapter summary ©2009 The National Underwriter Company

Dr. James Kallman, ARM Contents Techniques of Risk Management & Insurance Ch 1 Introduction to Traditional Risk Management……………1-5 Ch 2 Enterprise Risk Management…………………………….2-1 Ch 3 Risk Assessment: Identification…………………………..3-1 Ch 4 Risk Assessment: Quantification…………………………4-1 Ch 5 Overview of Risk Treatment Alternatives………………. 5-1 Ch 6 Non-insurance Transfer of Risk…………………………. 6-1 Ch 7 Insurance as a Risk Transfer Mechanism……………….7-1 Ch 8 Overview of Alternative Risk Transfer Techniques……..8-1 Ch 9 Global Risk Management………………………………….9-1 Ch 10 Loss Control Techniques……………………………… Ch 11 Emergency Response Planning……………………… Ch 12 Business Continuity Planning………………………… Ch 13 Claims Management…………………………………… Ch 14 Monitoring Claims for Financial Accuracy…………… Ch 15 Insurance Companies and Risk Management……… Ch 16 Working with an Agent or Broker……………………….16-1

©2009 The National Underwriter Company Dr. James Kallman, ARM Contents Tools of Risk Management & Insurance Ch 17 Commercial General Liability Insurance……………….17-1 Ch 18 The Workers’ Compensation System………………….18-1 Ch 19 Commercial Property Insurance……………………… Ch 20 Directors and Officers’ Liability Insurance…………… Ch 21 Employment-Related Practices Liability Insurance… Ch 22 Business Automobile Insurance……………………… Ch 23 Crime Insurance………………………………………….23-1 Ch 24 Capital Markets Risk Transfer Tools………………… Ch 25 Loss Control Tools……………………………………….25-1 Ch 26 The Certificate of Insurance…………………………….26-1 Ch 27 Surety Bonds…………………………………………… Ch 28 Claim Reviews……………………………………………28-1

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management Outline Understanding the Nature of Risk A Brief History of Risk Management The Risk Management Process Steps in the Process Importance of Risk Management to the Organization The Risk Management Policy Statement Traditional Risk Management vs. Enterprise Risk Management Chapter Summary Glossary: at the end of each chapter – key words to learn

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management Understanding the Nature of Risk Risk can be managed and controlled Event risks (fortuitous risks) are insurable risks Business risks (uninsurable) are just another cost of doing business Key point: risk is a type of volatility Risk is independent of who pays for losses. Supplement Objective risk is the variation from an expected outcome over time Objective risk enables the measurement of three key variables: expected outcome variation time

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management Understanding the Nature of Risk Risk can be illustrated as the dispersion from the expected outcome at some time. The red risk at time 1 is less risky (volatile) than the blue risk at time 3.

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management A Brief History of Risk Management Risk Management has been a viable discipline since the 1960s Earlier work was in insurance purchasing Insurance companies provided risk transfers capacity and loss control engineering activities Risk management pioneers include Robert Hedges & George Head The centerpiece of their research was to develop a risk management process Today’s emphasis is on Enterprise Risk Management

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management The Risk Management Process The risk management process focuses on the firm’s ability to recognize and correct dangerous occurrences that could lead to catastrophic losses Risk management is proactive – it is a pre-loss exercise, not only post-loss The scope of risk management activities are defined by the firm’s goals. The goals must be clearly understood before moving on.

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management The Risk Management Process Supplement 1.Develop a Risk Management Program 2.Risk Analysis 3.Solution Analysis 4.Decision Process 5.System Administration

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management The Risk Management Process Supplement 1. Develop a Risk Management Program a.Plan – create and synchronize strategic, operational, and tactical goals b.Organize – coordinate risk associates with the risk management department. Place the risk function within the organizational chart. c.Write – articulate the organization’s risk philosophy (tolerance and appetite), and prepare a risk management standard operating procedures manual, update, and adjust.

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management The Risk Management Process Supplement 2. Risk Analysis a.Identify – all possible risks—speculative and pure b.Measure – using quantitative and qualitative analysis tools c.Evaluate – create a portfolio of risks and consider interaction effects (correlations).

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management The Risk Management Process Supplement 3. Solution Analysis a.Identify – all possible opportunities to modify the risks, including first risk control and then risk financing b.Measure – using quantitative and qualitative analysis tools c.Evaluate – the holistic impact of the portfolio of solutions

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management The Risk Management Process Supplement 4. Decision Process a.Decision models – consider all possible models, including benchmarking, financial analysis, experience, ethics, and multi-attribute models b.Support – leadership in gaining stakeholder buy-in and participation c.Implement – allocate resources of people, time, and money; prepare budgets and time allocation charts; including managing and training employees

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management The Risk Management Process Supplement 5. System Administration a.Monitor – use a modern Enterprise Risk Management Information System b.Judge – evaluate the success of the solution portfolio using statistical quality control tools (such as six-sigma) c.Communicate – prepare documents and reports to comply with stakeholder and regulatory demands

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management Steps in the Process Step 1. Identify risks Step 2. Quantify and analyze risks Step 3. Evaluate potential treatments Step 4. Implement selected treatments Step 5. Monitor the effectiveness and make adjustments

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management Steps in the Process Step 1 - Risk Identification That which cannot be identified cannot be managed The two major sources of risk are: Assets and Operations Most asset risks are first party risks Most operations risks are third party risks Third party risks are generally represent the greatest threat Risks that must be financed or transferred are baseline risks

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management Steps in the Process Step 2 – Quantitative Analysis Determine the maximum and expected loss for each risk The maximum should be the probable maximum loss (MPL) For third party risks, ask 2 questions: 1)How much of a loss can we withstand? 2) How much of a loss can we withstand and be financially viable?

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management Steps in the Process Step 3 – Evaluating Risk Treatment Options Most risk management plans include a financing & control option Financing options are either on-balance sheet or off-balance sheet On-balance sheet financing options are called retention Off-balance sheet financing options are transfers, such as insurance Active loss retention is also called self-funding Passive loss retention is being uninsured

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management Steps in the Process Step 3 – Evaluating Risk Treatment Options Controlling risk means controlling the variation, expected outcome, or timing of losses Financial transfers is not risk control – it only shifts the payment Risk control is the most important risk management activity Risk control can be either prevention and/or reduction Loss prevention decreases the probability of losses Loss reduction decreases the severity of losses

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management Steps in the Process Step 4 – Implement To implement – first decide on the portfolio of treatment options Next, get support from all stakeholders Then, get sufficient resources allocated

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management Steps in the Process Step 5 – Risk Administration Monitoring and Adjusting Nothing is static – plan on continuous adjustments Continuous monitoring requires a structured approach Monitoring is done with a Risk Management Information System

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management Importance of Risk Management to the Organization Risk management is an essential part of overall management Simply transferring all risks is not a viable option (why not?) Excessive use of insurance is expensive and inefficient The primary duty of a risk manager is to design and execute a plan Risk management should be a part of an organization’s culture Risk management should be considered in every major decision Risk management balances sales with growth and stability Risk management must contribute a positive NPV – it is an investment Senior managers should view risk management as a long-term investment

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management The Risk Management Policy Statement Goals and objectives must be clearly defined And communicated A risk management policy statement reflects the organization’s stated values relative to risk The risk management policy statement is a strategic issue Supplement It should articulate its broad risk philosophy risk appetite risk tolerance

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management Traditional Risk Management versus Enterprise Risk Management Traditional risk management evolved from the insurance industry Supplement ERM employs three distinct forms of risk management: 1)Strategic risks – the variation to long-term projects, or events that have long-term impacts 2)Operational risks – the variation to short-term projects ; also called business or hazard risk 3)Economic risks – the variation to financial conditions and to other macro-economic conditions e.g., political or regulatory environments

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management Traditional Risk Management versus Enterprise Risk Management ERM has created the convergence of Securitization & Insuritization Securitization – A type of structured financing in which the firm separates its credit (sales) and debit (funding) activities e.g., Cash securitization – a bank pools its loans and sells portions (tranches) of the pooled asset Insuritization – A type of hedge in which the firm offers catastrophe bonds or Insurance derivatives to stabilize outcomes e.g., An insurance call option gives the insurer the right to buy reinsurance at a specified price

©2009 The National Underwriter Company Dr. James Kallman, ARM Chapter 1 Introduction to Traditional Risk Management Chapter Summary Understanding the Nature of Risk Variation from the expected outcome over time A Brief History of Risk Management Insurance  Loss control  RM process  ERM The Risk Management Process Proactive focus on goals and catastrophic events Steps in the Risk Management Process Identify risks  Analyze  Treatments  Implement  Monitor Importance of Risk Management to the Organization Risk management contributes to shareholder value The Risk Management Policy Statement Defined, communicated, strategic risk management goals Traditional Risk Management vs. Enterprise Risk Management Hazard risks vs. Strategic+ Operational+Financial risks, managed with securitization and insuritization