Chapter Outline 12.1Risk Identification and Evaluation Identifying Exposures Property Loss Exposures Liability Losses Losses to Human Capital Losses from External Economic Forces Evaluating the Frequency And Severity of Loss Frequency Severity Expected Loss and Standard Deviation

Chapter Outline 12.2Retention and Insurance Revisited Benefits of Increased Retention Savings on Premium Loadings Reducing Exposure to Insurance Market Volatility Reducing Moral Hazard Avoiding High Premiums Caused by Asymmetric Information Avoiding Implicit Taxes due to Insurance Price Regulation Maintaining Use of Funds

Costs of Increased Retention Closely-held vs. Publicly-Traded Firms with Widely Held Stock Firm Size and Correlation Among Losses Correlation of Losses with Other Cash Flows and with Investment Opportunities Financial Leverage A Basic Guideline for Optimal Retention

Chapter Outline 12.3Benefits and Costs of Loss Control Basic Cost-Benefit Tradeoff Examples of Identifying Benefits and Costs Installation of Automatic Sprinkler System Installation of Safety Guards Child-Resistant Packaging of Non-Prescription Drugs Qualitative vs. Quantitative Decision-Making

12.4Statistical Analysis in Risk Management Approximating Loss Distributions with the Normal Distribution Illustration Problems and Limitation Computer Simulation of Loss Distributions Illustration Comparison of Results Assuming the Normal Distribution Limitations of Computer Simulation

Chapter Outline 12.5Use of Discounted Cash Flow Analysis The Net Present Value Criterion Example: Forming a Captive Insurer The Appropriate Cost of Capital 12.6Summary

Identifying Exposures Types of Exposures - Methods of identification -

Identifying Exposures – Documents Current Policies Financials Brochures Contracts – Loss Analysis – External Sources Best’s Underwriting Guide Other Professionals: CPA, Attorney, Engineer

Assessing Loss Exposures (We will come back to this later) – Ideally, a risk manager would have information about the probability distribution of losses – Then assess how different risk management approaches would change the distribution – Summary measures of probability distributions: frequency severity expected loss standard deviation skewness

Risk Sources

Property Exposures Classifying Property Losses by Property Type – _____ (Structures and Attachments) – _______ Property in Use - machinery and furniture Property for sale - finished goods, merchandise Classifying Property Losses by Type of Loss – _________ - reduction in value of property itself e.g. fire, vandalism, theft of money

– _________ - reduction in value of property due to direct damage to other property Classifying Property Losses by Basis of Interest in the Property -

Valuation of Property Losses -

Net Income Loss Exposures – Revenue Declines -

– Expense Increases -