2. Introduction to
Risk Management
Bus 200
Introduction to Risk Management and Insurance
Fall 2008
Prof. Jin Park
Overview
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Definition & Objectives
Process
Risk Management Technique
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Control vs. Finance
More on Risk Finance
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Retention, Captive, Insurance, Transfer
Definition and Objectives
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Risk Management
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A systematic process for managing (pure) risks faced by
an individual or organization.
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Loss Exposure
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Pre-loss vs. Post-loss risk management
Ay situation or circumstance in which a loss is possible
regardless of whether a loss occurs.
Objectives
Why?
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Management’s job
Reduce earnings volatility
Maximize shareholder’s value
Promote job and financial security
Risk and Relative Return
Zone 1
Insufficient
Risk Taking
Zone 2
Optimal
Risk Taking
RiskAdjusted
Return
Risk
Zone 3
Excessive
Risk Taking
Risk Management Process
Risk Management Process
Risk Management Process
The Process
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Step 1 - Identification
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Step 2 – Evaluation
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Frequency
Severity
Step 3 – Risk Management Selection
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Loss exposures
Methods
Control vs. Finance
Prevention vs. Reduction
Step 4 – Implementation and Monitor
Evaluation Tools
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Risk mapping
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A graphical presentation of potential
frequencies and severities of identified
loss exposures faced by
individual/organization
Critical issue tolerance boundary or risktolerance boundary
Prioritize risks
Risk management matrix
Risk Mapping
EE’s petty theft
Auto liability
Vandalism
Job related injuries
System
failure
Frequency
Robbery
Owner’s
disability
Fire on warehouse
Default on payment
Severity
Tornado
Flood on warehouse
Risk Management Matrix
High
Prevention
Retention
Avoidance
Low
Retention
Reduction
Insurance
Low
High
Frequency
Severity
Risk Management Techniques
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Risk Control
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Goals
Risk control options
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Avoidance
Loss control
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Prevention
Reduction
Pre-loss risk control
Post-loss risk
control
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Risk Financing
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Goals
Risk financing options
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Retention
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How?
Transfer
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Insurance
Non-insurance
Risk Financing - Retention
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A method of funding losses using internal
money
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No purchase of insurance
Retention with insurance
What determines the retention decision?
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Frequency & severity of expected losses
No other effective method available
Costs and availability of insurance
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MMP, Health care insurance
Highly predictable losses
Self-confidence or degree of risk aversion
Failure to identify
Risk Financing - Retention
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What determines the retention level?
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Degree of risk aversion
Financial condition
Ability to diversify the retained risk
Potential cost/benefit
Costs and availability of insurance
Ability to administer a retention program in a cost
effective manner
Risk Financing - Retention
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Self-Insurance, Captive, RRG
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Self-Insurance
Captive
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A form of self-insurance through a wholly
owned subsidiary (insurance company)
created to provide insurance to the parent
companies
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Pure captive, Group captive, Risk Retention Group
Which one?
 UPS vs. IRS
Transfer - Insurance
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Advantages
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Less uncertainty
Loss control
services.
Eligible expenses
Non-taxable
insurance proceeds.
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Disadvantages
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High insurance
premium.
Moral and morale
hazards.
Time and effort.
Insurance may not
be available.
Dependable
No benefit of loss
control
Non-Insurance Transfer
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Methods of transferring risk to
another party other than by
insurance
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Contracts
Hold harmless agreements
Leases
Non-Insurance Transfer
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Advantages
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May be able to
transfer losses that
are otherwise not
commercially insurable.
Noninsurance
transfers may cost
less than insurance.
May be able to shift
loss to someone who is
in a better position to
exercise loss control.
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Disadvantages
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Transfer may fail for
legal reasons
Transferee may be
unable to pay the loss
May not reduce
insurance costs if
insurer does not give
credit for the
transferred risk