BONUS CHAPTER C

Managing Risk

McGraw-Hill/Irwin Copyright © 2015 by the McGraw-Hill Companies, Inc. All rights reserved.
 LEARNING OBJECTIVES

1. Identify the environmental changes

that have made risk management
important.
2. Explain the four ways of managing risk,
and distinguish between insurable and
uninsurable risk.
3. Define insurance policies, and explain
the law of large numbers and the rule
of indemnity.
4. Discuss the various types of insuranceC-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 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!

C-4
 WHAT’S ENTERPRISE RISK LO C-1

MANAGEMENT?

• Goals of enterprise risk management

(ERM):
1) Defining which risks the program will
manage.

2) What risk management processes,

technologies, and investments will be
required.

3) How risk management efforts will be

coordinated across the firm.
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 C-6
HOW to DEAL with PURE RISK
LO C-2

1) Reduce the risk

2) Avoid the risk

3) Self-insure against
the risk

4) Buy insurance
against the risk

C-7
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
1994 $40 Billion
Earthquake

Hurricane Ike 2008 $35 Billion

Hurricane Andrew 1991 $28 Billion

9-11 Terrorist Attacks 2001 $21.37 Billion

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. C-9
 WHAT RISKS are LO C-2

UNINSURABLE?

• Uninsurable Risk -- A risk that no

insurance company will cover. Risks can
include:

- Market risks

- Political risks

- Personal risks

- Operational risks

C-10
 LO C-2
WHAT RISKS are INSURABLE?

• Insurable Risk -- A risk that the typical

insurance company will cover, using the
following guidelines:
1) The policyholder must have an insurable
interest.
2) The loss must be measurable.
3) The chance of loss must be measureable.
4) The loss must be accidental.
5) The insurance company’s risk should be
dispersed among different areas.
C-11
 LO C-2
PUBLIC INSURANCE

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? 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 toC-14
 BASICS of LO C-3

INSURANCE POLICIES

• 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.
C-15
 TYPES of LO C-3

INSURANCE COMPANIES

• Stock Insurance Company -- Owned by

stockholders, just like any other investor-
owned company.

• Mutual Insurance
Company -- An
organization owned
by its policyholders.

C-16
 STOCK and MUTUAL LO C-3

INSURANCE COMPANIES

Stock Insurance Mutual Insurance

Companies Companies

Hartford Life Mass Mutual

Metropolitan Life New York Life

Northwestern
Prudential Life
Mutual

C-17
 TEST PREP

• What is the law of large numbers?

• What is the rule of indemnity?

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.

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 C-20
 GETTING the MOST out of LO C-4

LIFE INSURANCE

1. Quit smoking, lose

weight and go to the
gym!

2. Figure out how much

insurance you need.

3. Pick a good insurance

company.

4. Find a good financial

planner.
Source: Entrepreneur, www.entrepreneur.com, accessed November 2014 .
C-21
 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
Photo Credit: Paul Wilson

sold. 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. C-23
 HOME MATTERS LO C-4

What You Need to Know About Home Insurance

1. Not all policies

cover home-based
businesses.

2. Don’t buy too much

coverage.

3. Small claims can

add up.

4. The home’s history

Source: Money, www.money.com. accessed November 2014.

matters. C-24
 TEST PREP

• Why should someone buy disability

insurance?

• How many different kinds of private

insurance can you name?

C-25