CAIB 3 Chapter 6: Risk Management

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Two Dimensions of Risk Management Process:	1. Decision Process 2. Management or administrative process
Five Steps in Decision Making Process:	1. Identify & analyze loss exposures 2. Examine alternative risk management techniques 3. Select risk management techniques 4. Implement techniques 5. Monitor results
Four Administrative Areas in the Risk Management Process:	1. Plan 2. Oraganize 3. Lead 4. Control
Five Advantages of a Risk Management Approach:	1. More informed clientele 2. Increased retention 3. Increased customer referrals 4. Increased claims satisfaction 5. Reduction in errors and omissions potential
STEP ONE- IDENTIFY & ANALYZE LOSS EXPOSURES: Purpose of Identification:	Recognizes losses which might possibly occur.
Purpose of Analysis:	Estimates the likely significance of those possible losses.
Three Classifications of Loss Exposure:	1. Type of value exposed to the loss 2. Peril causing the loss 3. Financial consequences of the loss
Four Broad Categories of the Type of Value Exposed to Loss:	1. Property values 2. Net income values 3. Liability loss 4. Personnel Loss
Two Types of Property Values:	1) Tangible: Real, can be touched, has form and substance. Subject to loss which must be considered in assessing property loss exposure. 2) Intangible: No Physical substance: consists of legal rights rather than things
Types of Tangible Property:	-Real property -Personal property -Debris removal -Demolition expense -Undamaged property -Increased cost of construction -Pair or set value -Going concern value
Types of Intangible Property:	-Securities; stocks and bonds -Trademarks and trade names -Right to collect accounts - Copyrights and patents -Licenses -Leasehold interests
Two Factors Affecting the Net Income Value of an Organization:	1. Decrease in revenue 2. Increase in expenses
1. Decrease in Revenue:	1. Business Interruption 2. Contingent Business Interruption 3. Loss of Profits on Finished Goods 4. Reduced Rental Income 5. Decreased Collactions of Accounts Recievables
1. Business Interruption:	Damage to its premises. When an organization is unable to opertae after loss or only able to do so on a limited basis, income is interuppted. The amount of reduction of net income serves as the measure of loss.
2. Contingent Business Interruption:	Occurs away from the premises of the organization. Potential for loss originating on the premises of a major supplier constitutes a contributing exposure. A loss at the location of the organizations main customer creates a recipient exposure.
3. Loss of Profits on Finished Goods:	Loss exposure considers the profit that might have not been realized had the accident not occurred.
4. Reduced Rental Income:	Most lease and rental agreements will excuse the tenant from any further payments if physical damage to the premises makes them unsuitable for continued occupancy. Not all losses result in a net income loss.
5. Decreased Collections of Accounts Recievables:	When accounts recievables records are lost or damaged the owner has no way to accurately bill customers. Difference in amounts collected compared to actualy owed constitutes a net income loss.
2. Increase in Expenses:	1. Increased Operating Expenses 2. Increased Rental Expenses 3. Expediting Costs
1. Increased Operating Expenses:	Most organizations are able to continue operating after a loss, sometimes continuing on the same premises, but at an additional cost. Ex a rented mobile home may be moved onto an adjacent parking lot in the interim while repairs are being done.
2. Increased Rental Expenses:	If property damage is severe, alternative premises must be rented if operations are to continue. Increase in rental expense loss exposure exists if rent charged at alternative location exceeds that currently paid.
3. Expediting Costs:	- Advertising costs to advise customer of location change -overtime salaries -Telephone and mailing costs -costs of speeding up repairs -Extra transportation expense for securing equipment or reimbursing employees for extra commute -Contracting out work to similar firm to maintian contact with the business -Renting facilities from a similar firm during off times in order to maintain customer contact
Two Categories of Liability Loss Exposure:	1) Entity to Whom Duty Is Owed: - Society -Particular individuals or organizations 2) Source of Legal Duty: -Costs to investigate and defend -Payment of an award for damages, or costs of corrective action -The amount of any out of court settlement the business may decide to pay rather than go to trial -The amount of any voluntary payments made by the business to gain the claimants goodwill or reduce the final amount of the settlement or verdict
Two Factors Affecting Measurement of Personnel Loss:	1. The value of an employees service 2. The costs of providing employee benefits
Three Origins of Perils Causing Loss:	1) Natural Perils-Largely beyond human control. Ex. earthquake, flood, hail, ice, cave-in, mould, rust, tides, vermin, weeds, wind 2) Human Perils- Those that find their origin in the individual or group and which can cause a loss to occur. Ex. arson, contamination, dust, electrical overload, explosion, fire, pollution, riot, terrorism, theft, vandalism, vibration 3) Economic Perils-Stem from the actions of large numbers of persons or of governments. Ex. currency fluctuations, depression, exploration, recession, strikes, technological advantages, war
Four Factors to Quantify the Financial Consequence of a Loss:	1. Likelihood of loss occurring (loss frequency) 2. Seriousness of losses that could occur (loss severity) 3. Potential dollar losses in any given period of time (frequency times severity) 4. Reliability of the predictions of frequency and severity
Loss Frequency:	1. Almost NIL- Extremely unlikely to happen, virtually no possibility. 2. Slight- Could happen, but has not.- -potential exists, but there has never been a loss to property from this exposure. 3. Moderate- Happens once in awhile -Infrequent occurrences that can happen again (floods, tornadoes, etc) 4. Definite- Happens regularly
Loss Severity:	1. Slight- Business can readily retain each loss. Organization may decide to absorb costs as it does other business expense. 2. Significant- Organization cannot retain each loss, some part of which must be transferred. Amount cannot be absorbed by the business to achieve objectives, may decide to transfer the financial responsibility to others with greater ability to pay. 3. Severe- Business must transfer virtually all of the loss, or endanger its survival.
Inverse Relationship Between Loss Severity and Loss Frequency:	The more frequent a loss from a given exposure , the less severe it tends to be; the more severe a loss tends to be, the less frequent its occurrence.
Six Methods to Provide a Proper Basis of Exposure Identification and Analysis:	1. Standardized Survey/ Questionnaires 2. Financial Statements & Underlying Records 3. Other Records and Documents 4. Flowcharts 5. Personal Inspections 6. Consultation with Experts Within and Outside the Business
1. Standardized Surveys/ Questionnaires:	Surverys are standardized so that questions are relevant to all types of organizations. Can range in complexity from 1 page to 100 pages. Many of the surverys/ questionnaires serve insurance purposes most of the questions relate to loss exposures for which insurance coverage is available.
2. Financial Statements and Underlying Records:	Consequence of losses will normally impact an organizations finances. 1) Balance Sheet- listing of the bussiness's assets and liabilities for the end of each accounting period. 2) Operating (Profit and Loss) Statement: Provides information about the sources of an organizations income and expenses for a specific period. 3) Statement of Changes in Financial Position: Reflects the cources and uses of bussiness funds. 4) Opinion Letter: 5) Notes: provide - explanation of various entries -summary of significant accounting policies explanation of how assets have been valued and amrtized - explanation of unusual details underlying these statements
Other Records and Documents:	-Every record or document possessed by the organization may contain valuable information regarding its loss exposures. Only redcords and documents which are most likely to reveal changes in loss exposures should be examined. Including: -minutes of meetings of management groups -memoranda exchanged between official -sales or purchase contracts over a predetermined amount -plans or drawings for architectual or engineering changes in the organization
4. Flowcharts	Graphic designs of the organzations activities in its basic form. Often used to reveal key areas. Processes shown in a flowchart may encompass: -particular activity within the business -the business's internal activities -complete chain of economic activities of which the business is part
Personal Inspections:	No subsitute for personal inspections. First hand look at the exposure will normally lead to better loss forecasts.
6. Consultation with Experts Within and Outside the Business:	Sources of information available to assist in categorizing and analyzing loss exposures: 1) Internal Sources: the bussiness's personnel and documents it generates. Close contact with the organizations production, purchasing, marketing and other executives. A continuing relationship with employess indicates support shown for the risk management. 2) External Sources: The risk manager depends on other professionals in other areas including law, accounting, and statistics. Trade and professional agencies also provide valuable information. The role of the broker/ risk manager is to know where the information can be obtained and once obtained extract what is relative to the exposure.
STEP TWO- EXAMINE ALTERNATIVE RISK MANAGEMENT TECHNIQUES: Five Risk Control Techniques:	1. Exposure Avoidance 2. Loss Prevention 3. Loss Reduction 4. Segregation of Exposure Units 5. Contractual Transfer
1. Exposure Avoidance:	Eliminates any possibility of loss. It is the most complete form of risk control and achieved by: 1) Completely avoiding the exposure; or 2) Eliminating the exposure An exposure that has been avoided or eliminated cannot produce a loss.
2. Loss Prevention:	When exposure avoidance is not practical, the business is not exposed to loss. Measures taken to reduce the frequency falls within loss prevention. Most loss prevention focuses on how losses are caused, once identified, measures are taken to stop the loss from happening or make it less likely. Loss prevention measures are desireable in reducing the frequency but they are not completely effective in eliminating them.
3. Loss Reduction:	Loss reduction measures reduce the severity of the losses that occur. Proper analysis of loss reduction measures that can be undertaken by an organization will depdnd upon: 1) Assuming that a loss has occurred 2) Determining what could have been done either before or after lossto reduce the severity.
Segregation of Exposure Units:	Involves arranging an organization activities and resources so that no single event can cause simultaneous losses to all of them. Resulting in individual losses becoming smaller and more predicatble, hence less disruptive. Two ways to achieve by: 1. Speration 2. Duplication
5. Contractual Transfer:	Organization may shift its legal and financial responsibility for a loss from an asset or particular activity to others. -Property Values -Net Income Values -Liability Loss
Pre-Loss Measures:	Intended to reduce the amount of property, number of persons, or other things of value that may suffer loss from a single event. Ex erecting firewalls, limiting number of persons permitted on premises at once, reducing value of single shipment.
Post-Loss Measure:	Focuses on emergency procedures, salvage operations, rehabilitiation activities, or legal defences to halt the spread of loss or counter its effects. Ex installing efffective fire detection, developing procedural plan to be followed, expediting repairs quickly as to continue business after a loss, returning key personnel to work as soon as possible or making other arrangement.
1. Separation:	Consists of dividing an organizations single asset/operation into two or more seperate units. Reduces concentration of value subject to a single accident. Ex dividing exisiting inventory between warehouses, storing customers property in seperate buildings, dividing one persons duties among others.
2. Duplication:	Complete reproduction of the organizations own "standby"asset or facility to be kept in reserve. Not used unless the primary asset or activity is damaged or destroyed. Ex keeping spare parts to the originals, cross training staff, maintaining duplicate accounts recieveable records.
Forced Retention:	Occurs when there are no transfer options. Includes: -Amount of any losses exceeding limits of coverage provided by the business' insurance policy. -Losses resulting from certain uninsurable perils.
Optional Retention:	Assumes that some form of retention is more cost effective than any type of transfer. Includes: -Loss exposures which are unlikely to cause a large number of losses within a short period. -Losses which are sufficiently frequent so as to be routinely budgeted.
Contractual Transfer Can be Achieved By:	1) Non Insurance Transfer: Financial burden for payment of losses sustained by the business may be transferred to others by way of Indemnity Contract or Hold Harmless Agreement. 2) Commercial Insurance: Most widely used of all risk financing techniques. Effective risk management program uses insurance for risk financing as a last resort when no other techniques are sufficient.
STEP THREE- SELECT RISK MANAGEMENT TECHNIQUE: Two Steps Before Reaching a Decision of Risk Control and Financing Techniques:	1.Forecasting 2. Selection Criteria
1.Forecasting:	Procedure involves forecasting the effects the available risk management options are likely to have on the organizations ability to fulfil objectives. Three forecasts necessary to establish meaningful priorities: 1) Forecast of frequency and severity of losses that can be expected. 2) Forecast of the effects that various risk control and risk financing techniques are likely to have on the frequency, severity and predictability of those projected losses. 3) Forecast of the costs of these techniques.
2. Selection Criteria:	Once losses have been forecast, each alternative risk management technique is assessed by: 1) Effectiveness: relates to how well the chosen techniques will assist the organization in achieving desired goals. 2) Economy: refers to the selection of the least expensive of the possible effective ways to ensure the fulfillment of the business' goals. Criteria used for assessment will consider their effect on the rate of return, survival, continuity of operations, profitability, stability or earnings and growth.
STEP FOUR- IMPLEMENT TECHNIQUE: Proper Implementation Involves Making the Following Decisions:	1) Technical Decisions: Relate to those matters which deal with the purely technical aspects of the risk management program. Can vary in range from ways to handle new exposures to selecting an underwriter for the organizations needs. 2) Managerial Decisions: To ensure successful implementation, it is essential that the cooperation and support be obtained. When no risk. When there is no risk manager, all persons working in the business must actively support the program in order to work.
STEP FIVE- MONITOR RESULTS: Once Implement the Risk Management Program Needs To Be:	1) Monitored: Ensures that the risk management program is achieving the results expected of it. 2) Adjusted: New exposures develop and old exposures change/eliminate. Risk management must be flexible enough to deal with changing loss exposures on an ongoing basis. This helps to ensure that the program will always incorporate techniques that represent the best available risk management options.
Setting Standards to Measure Performance:	If effective monitoring and adjustment are to occur, there must be some standard against which actual performance can be evaluated. When results fall below those standards, the risk management program should identify means for improving performance.

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