BONUS CHAPTER B – MANAGING RISK
LEARNING GOALS
After you have read and studied this chapter, you should be able to:
1.
2.
3.
4.
Identify the environmental changes that have made risk management important.
Explain the four ways of managing risk and distinguish between insurable and
uninsurable risk.
Define insurance policies and explain the law of large numbers and the rule of
indemnity.
Discuss the various types of insurance that businesses can buy to manage risk.
LEARNING THE LANGUAGE
Listed here are important terms found in this chapter. Choose the correct term for each
definition below and write it in the space provided.
Claim
Law of large numbers
Rule of indemnity
Health maintenance
Mutual insurance company
Self-insurance
organizations (HMOs)
Health savings accounts
Preferred provider
Speculative risk
(HSAs)
organizations (PPOs)
Insurable interest
Premium
Stock insurance company
Insurable risk
Pure risk
Uninsurable risk
Insurance policy
Risk
1.
A ______________________is a type of insurance company owned by stockholders.
2.
A written contract known as a(n) _____________________ is between the insured and an
insurance company that promises to pay for all or part of a loss.
3.
The _____________________ says that an insured person or organization cannot collect
more than the actual loss from an insurable risk.
4.
The threat of loss with no chance of profit is called __________________________.
5.
The ______________________is a principle which states that if a large number of people are exposed
to the same risk, a predictable number of losses will occur during a given period of time.
6.
A chance of either profit or loss is called ______________________.
7.
The chance of loss an entrepreneur takes of losing time and money on a business that may not prove to be
profitable is commonly called __________________.
8.
A _________________________is a type of insurance company owned by its policyholders.
9.
Health care organizations known as __________________________require members to choose from
a restricted list of doctors.
10.
The fee charged by an insurance company for an insurance policy is a ___________________.
1
11.
A(n) _____________________is one that no insurance company will cover.
12.
The practice of setting aside money to cover routine claims and buying only “catastrophe” policies
to cover big losses is called ____________________.
13.
A(n) ________________________is a risk that the typical insurance company will cover.
14.
Health care organizations similar to HMOs except that they allow members to choose their own
physicians for a fee are called _________________________.
15.
The possibility of the policyholder to suffer a loss is called __________________________.
16.
Tax-deferred accounts known as _________________ are linked to low-cost, high deductible health
insurance policies.
17.
The insured person sends a statement of loss called ____________ to the insurance company to request
payment.
ASSESSMENT CHECK
Learning Goal 1
Understanding Business Risks
1.
What is ERM?
2.
What are the goals of ERM?
a. ______________________________________________________
b. ______________________________________________________
c. ______________________________________________________
Learning Goa 2
Managing Risk
3.
Describe the two kinds of risk.
a.
__________________________________________________________________________
______________________________________________________________________________
b.
___________________________________________________________________________
______________________________________________________________________________
4.
The kind of risk of most concern to business people is: ______________________________
2
5.
List four methods businesses use to manage pure risk.
a. ________________________________ c.
b. _______________________________
6.
_______________________________
d. _______________________________
What are of examples of how can a firm reduce risk?
a.
___________________________________________________________________
b.
___________________________________________________________________
c.
___________________________________________________________________
7.
_________________________ to threats is critical to risk management
8.
How do some companies avoid risk?
9.
Self-insurance is most appropriate when: _________________________________________
10.
What does it mean for a company to “go bare” with self-insurance, and what is the risk?
11.
What is a BOP?
12
Describe four kinds of uninsurable risk.
a.
__________________________________________________________________________
b.
__________________________________________________________________________
c.
__________________________________________________________________________
d.
_________________________________________________________________________
3
13.
Identify the guidelines used to evaluate whether or not a risk is insurable.
a.
_________________________________________________________________________
b.
_________________________________________________________________________
c.
_________________________________________________________________________
d. _________________________________________________________________________
e.
________________________________________________________________________
f.
________________________________________________________________________
Learning Goal 3
Understanding Insurance Policies
14.
What makes the acceptance of risk possible for insurance companies is: _____________
___________________________________________________________________________
15.
How are appropriate premiums for each policy determined?
16.
Today, many insurance companies are charging high premiums not for expected losses
but for ____________________________________________________________________
17.
Can a person purchase more than one policy to cover the same risk? Explain.
Learning Goal 4
Insurance Coverage for Various Kinds of Risk
18.
19.
What are three types of insurance to cover losses?
a.
_____________________________________________
b.
_____________________________________________
c.
_____________________________________________
What are four major options for health insurance?
a.
________________________________
c.
b.
________________________________
d. ________________________________
4
________________________________
20.
What are the features of an HMO?
21.
What are some complaints about HMOs?
22.
What are some characteristics of a PPO?
23.
Why do most businesses and individuals choose to join an HMO or a PPO?
24.
Describe the features of a health savings account.
25.
A major benefit to you of health saving accounts is__________________________________
______________________________________________________________________________
26.
Describe disability insurance.
27.
Who provides worker’s compensation and what does it guarantee?
28.
Who does professional liability insurance cover?
What is another name for this type of insurance?
29.
What is product liability insurance?
30.
To ensure those left behind will be able to continue the business, entrepreneurs often
buy _______________________________________________________________________
5
31.
What should you do about insurance coverage if you have a home-based business?
32.
What are the issues involved in risk management and the environment?
CRITICAL THINKING EXERCISES
Learning Goal 1
1.
The “environment” changes so rapidly that it is difficult to identify all the changes that
could affect a business in terms of risk management. Evaluate the company for which
you work, or a company with which you are familiar. What is happening today in the
environment (you remember this from chapter 1 - the economic and legal, technological,
competitive, social, global business environments)? How do the changes you have
identified increase the necessity for risk management for this firm? What actions can the
firm take to minimize the risk of loss from these changes?
Learning Goal 2
2.
Businesses have four options to avoid losses stemming from pure risk situations.
Reduce the risk
Avoid the risk
Buy insurance to cover the risk
Self-insure against the risk
Read the following situations, and determine which option the firm is choosing in each case.
Use each option only once.
a. ____________
The president of an asbestos removal firm in Merriam, Kansas closed his firm for four
months.
b. ____________
A group of 27 accounting firms formed its own insurance company to insure
themselves.
c. ____________
Workers and visitors on construction sites are required to wear hard hats.
d. ____________
Senoret Chemical Company experienced a 1600% increase in its liability coverage
premium.
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3.
Many variables determine which risks are insurable. Using your text, determine which
of the following situations would constitute an insurable risk.
a. ____________
TNG Enterprises would like to buy insurance to cover loss of computer equipment
from power surges and possible spills.
b. ____________
Gilmores, Inc. a retail store in Kalamazoo, wanted to insure against losses occurring
when a competitor, Hudsons, implemented an aggressive marketing campaign.
c. ____________
MEMC wants to buy insurance to cover losses created by a breakdown of their
robotic and computer driven manufacturing systems.
d. ____________
PPI, a small manufacturing firm, wants to insure themselves against losses created
by damage from a fire set accidentally.
e. ____________
Residents in Morgan City, Louisiana, East Lansing, Michigan and Valley Park,
Missouri want to buy flood insurance.
f. ____________
Residents of Morgan City, Louisiana, however, face a high risk of flooding, because
the Mississippi River is cutting a new tributary through that city, and floods
regularly.
g. ____________
Boeing has extensive contracts with the government to build fighter planes.
The company wants insurance to cover losses that may occur if Congress cuts
the defense budget by over 20%.
Learning Goal 3
4.
Eric owns a company that makes self-darkening windshields for vehicles, Sun-2-Shade. He is aware of
the risks of owning a business, and is considering various insurance plans. Eric would like to make sure
that he won’t incur any losses, and so is thinking about buying policies from two different companies just
to make sure that not only will he be covered, but could make money while the company was down. Eric
figures that he will be able to make claims on both policies if something happens, and even make money
when both companies pay on the claim. As Eric’s advisor, what would you tell him about this plan?
7
Learning Goal 4
5.
You are a small business owner, currently working out of your home and you are concerned
about the kinds of insurance that you should carry for your business. Currently, your business
consists of yourself, and 3 employees. You have turned to a small business consultant to advise you.
What do you think the consultant will say about the need for insurance?
PRACTICE TEST
MULTIPLE CHOICE – Circle the best answer
Learning Goal 1
1.
Risk management has become an important concern for businesses today because:
a.
insurance companies have done such a good job of marketing their products
b.
rapid environmental changes are becoming a major source of risk for companies..
c.
companies want to insure themselves against potential losses.
d.
lawyers have made insurance claims a part of a company’s legal strategic plan.
2.
An enterprise risk management program has as one of its goals:
a.
define which risks the program will manage.
b.
eliminate the risk of doing business.
c.
insure the company from environmental disasters.
d.
spread the risk of doing business over time.
Learning Goal 2
3.
When Macy’s orders inventory for the Christmas season, the company has to predict what
their customers will want to buy that season. The kind of risk being described is
a. speculative risk.
b. pure risk.
.
c. insurable risk.
d. self-insurance
4.
It is when a company has several widely distributed facilities that ________________ is the
most appropriate.
a. reducing the risk
b. avoiding the risk
c. self-insurance
d. finding another company to take the risk
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5.
An insurable risk is one in which:
a. the loss is a specific amount.
b. the loss is not accidental.
c. the risk is dispersed.
d. the policyholder has no insurable interest.
Learning Goal 3
6.
The law of large numbers states that:
a. a large number of people must make claims before an insurance company will begin to
pay out.
b. if a large number of people are exposed to the same risk, a predictable number of
losses will occur during a given period of time.
c. items that will be covered by an insurance policy must not be above a certain amount,
i.e. the large number which is set by actuaries.
d. if losses from an occurrence are large enough, and insurance company will turn the
policies over to a reinsurance company.
7.
The idea that an insured person or organization cannot collect more than the actual loss
from an insurable risk is called the:
a. law of large numbers.
b. rule of indemnity.
c. disability insurance
d. insurable interest.
Learning Goal 4
8.
A type of insurance that requires members to choose from a restricted list of doctors is
called a:
a. health maintenance organization.
b. preferred provider organization.
c. disability insurance.
d. medical savings account.
9.
Disability insurance
a. replaces all your income if you become disabled.
b. starts immediately after your disability.
c. is required from employers.
d. replaces a portion of your income.
10.
If a person is injured when using a product and sues the manufacturer, the company is
covered by
a. workers compensation.
b. disability insurance.
c. product liability insurance.
d. business interruption insurance.
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11.
Which of the following is true of worker’s compensation insurance?
a. It guarantees payment of wages, medical care, and rehabilitation services for employees who are
injured on the job.
b. Only employers in right to work states are required to provide worker’s compensation
insurance.
c. The insurance does not provide benefits to the survivors of workers who die as a result of workrelated injuries.
d. The cost of insurance is standard in any industry.
12.
Business concern about damage to the environment:
a. is primarily restricted to companies in the United States.
b. is declining as companies add more insurance coverage as part of their strategic plans.
c. has become a global issue because of concerns over issues such as climate changes.
d. is primarily a concern of companies in the European Union and Eastern Europe.
TRUE-FALSE
Learning Goal 1
1. _____
An enterprise risk management system includes determining how risk management efforts
will be coordinated across the firm.
2. _____
New legislation is being passed in some areas which aims to lessen some risk so companies
can obtain insurance coverage at a reasonable price.
Learning Goal 2
3. _____
A firm can reduce risk by establishing loss prevention programs such as fire drills, health
education and accident prevention programs.
4. _____
Pure risk is the threat of loss with no chance for profit.
5. _____
When a company “goes bare” in terms of insurance, the company is getting the bare
minimum insurance coverage from its insurance provider.
One type of risk that cannot be covered is loss from accidental injury.
6. _____
Learning Goal 3
7. _____
The rule of indemnity states that you can have two insurance policies to cover the same risk
of loss.
8. _____
A stock insurance company is one that insures the risk of being a stockholder.
Learning Goal 4
9. _____
One of the complaints about an HMO is that members can’t choose their own doctors.
10. _____
Health savings accounts are tax-deferred accounts that allow you to save money for future
medical expenses.
11. ____
Many professionals other than doctors and lawyers are buying malpractice insurance which
is also known as professional liability insurance.
12. ____
Most homeowner’s insurance policies have adequate protection for a home based business.
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13. ____
Workers’ compensation insurance guarantees payment of wages for employees injured on
the job, but will not cover medical expenses, as those should be covered by medical
insurance programs.
14. ____
Concerns about the environment stem from issues such as global warming and hazards from
nuclear power plants.
You Can Find It on the Net
Visit the website http://www.rmmag.com/ which is the website for Risk Management magazine.
What are the major concerns addressed in the current issue of the magazine? How do those
concerns reflect what we have discussed in this chapter?
What is the RIMS?
Visit the home page of the insurance company you currently use for car, homeowners, or other
insurance policies. What types of products does this company offer? Use this company’s
website to determine if you have adequate insurance to cover your needs.
Can this company insure your small business? What kinds of business insurance do they offer for
your small business?
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ANSWERS
LEARNING THE LANGUAGE
1. Stock insurance company
2. Insurance policy
7. Risk
8. Mutual insurance company
3. Rule of indemnity
4. Pure risk
9. Health maintenance
organizations (HMOs)
10. Premium
5. Law of large numbers
6. Speculative risk
11. Uninsurable risk
12. Self insurance
13. Insurable risk
14. Preferred Provider
Organization (PPO)
15. Insurable interest
16. Medical savings accounts
(MSAs)
17. Claim
ASSESSMENT CHECK
Learning Goal 1
Understanding Business Risks
1.
ERM is an enterprise risk program, designed by executives for their companies.
2.
The goals of an ERM can include:
a. defining which risks the program will manage.
b. what risk management processes, technologies, and investments will be required.
c. how these efforts will be coordinated across the firm.
Learning Goal 2
Managing Risk
3.
a.
Speculative risk involves a chance of either profit or loss. It includes the chance the firm
takes to make extra money by buying new machinery, acquiring more inventory and making
other decisions in which the probability of loss may be relatively low and the amount of loss is
known. An entrepreneur takes speculative risk on the chance of making a profit.
b.
Pure risk is the threat of loss with no chance for profit. It involves the threat of fire,
accident or loss. If such events occur, a company loses money, but if the events do not occur,
the company gains nothing.
4.
The kind of risk of most concern to business-people is pure risk.
5.
Firms can manage risk by
a. Reducing the risk
b. Avoiding the risk
c. Self-insure against the risk
d. Buy insurance against the risk
6.
Examples of reducing risk include:
a. A firm can reduce risk by establishing loss-prevention programs such as fire drills, health
education, safety inspections, equipment maintenance, and accident prevention programs.
b. Retail stores use mirrors, video cameras, and other devices to prevent shoplifting.
c. Manufacturers have safety devices to protect workers from injury.
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7.
Quick response is critical to risk management.
8.
Companies avoid risk by not accepting hazardous jobs and by outsourcing shipping and other
functions. For example, the threat of lawsuits has driven away some drug companies from
manufacturing vaccines, and some consulting engineers refuse to work on hazardous sites. Some
companies are losing outside members of their boards of directors for lack of liability coverage.
Many companies have cut back on their investments to avoid the risk of financial losses.
9.
Self insurance is most appropriate when a firm has several widely distributed facilities.
10.
When a company “goes bare” the company is paying claims straight out of its budget. This is a very
risky strategy for a company. The risk is that the whole firm could go bankrupt over one claim if the
damages are high enough.
11.
A BOP is a business ownership policy. This is a package that includes property and
liability insurance, and reduces the cost of insurance.
12.
Four kinds of uninsurable risk include:
a. Market risks (from price changes, style changes, new products)
b. Political risks (from war or government restrictions)
c. Personal risks (from loss of job)
d. Risks of operation (strikes or inefficient machinery)
13.
An insurable risk is evaluated using the following criteria
a. The policyholder must have an insurable interest.
b. The loss must be measurable.
c. The chance of loss should be measurable.
d. The loss should be accidental.
e. The risk should be dispersed.
f. The insurance company can set standards for accepting risk.
Learning Goal 3
Understanding Insurance Policies
14.
What makes the acceptance of risk possible for insurance companies is the law of large
numbers.
15.
Appropriate premiums for insurance policies are determined by using the law of large
numbers. Once the insurance company predicts the number of losses likely to occur, it
can determine the appropriate premiums for each policy it issues against that loss.
The premium is supposed to be high enough to cover expected losses and still earn a
profit for the firm.
16.
Today many insurance companies are charging higher premiums not for expected losses
but for the costs they anticipate from the increasing number of court cases and high
damage awards.
17.
A person can’t buy two insurance policies and collect from both for the same loss. You
cannot gain from risk management you can only minimize losses
13
Learning Goal 4
Insurance Coverage for Various Kinds of Risk
18.
Three types of insurance include:
a. property and liability
b. health
c. life insurance
19.
Four major options for health insurance are:
a. health care providers, such as Blue Cross/Blue Shield,
b. health maintenance organizations (HMOs)
c. preferred provider organizations (PPOs)
d. medical savings accounts (MSAs)
20.
HMOs offer a full range of health care benefits. Emphasis is on helping members stay
healthy instead of on treating illnesses. Members do not receive bills and do not have to
fill out claim forms for routine service. HMOs employ or contract with doctors, hospitals
and other systems of health care and members must use those providers. HMOs are less
expensive than comprehensive health insurance providers.
21.
Members complain about not being able to choose doctors or to get the care they want or
need. Some physicians complain that they lose some freedom to do what is needed to
make people well and that they often receive less compensation than they feel is
appropriate for the services they provide.
22.
Preferred provider organizations contract with hospitals and doctors, but do not require
members to choose only from those physicians. Members can use outside provides, for
which they pay more. Members pay a deductible before the PPO will pay any bills.
When the plan does pay, members usually have to pay part of the bill. This payment is
called co-insurance.
23.
Most individuals and businesses choose to join a PPO or an HMO because they can cost
as much as 80 percent less than individual health insurance policies.
24.
With a health savings account, you or your employer put part of the money currently
spent on health insurance into a health savings account. You would use the money only
for needed health care services. At the end of the year you get to keep the money you
don’t spend in the account for future medical coverage.
25.
One major benefit to you of a health saving account is that the money grows tax-free until
you take it out.
26.
Disability insurance replaces part of your income if you become disabled and unable to
work. Usually, before you can begin collecting there is a period of time you must be
disabled. The premiums for such insurance vary depending on your age, occupation, and
income.
27.
Workers compensation insurance guarantees payment of wages, medical care, and
rehabilitation services for employees who are injured on the job. Employers in all states
are required to provide this type of insurance. This insurance also provides benefits to
the survivors of workers who die as a result of work-related injuries.
The cost of the insurance varies by the category of business; higher risk jobs cost more to
insure than lower risk types of jobs.
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28.
Professional liability insurance covers people who may be found liable for professional
negligence, such as lawyers, doctors, dentists, mortgage brokers, and real estate
appraisers.
This is also known as malpractice insurance.
29.
Product liability insurance provides coverage against liability arising out of products
sold.
30.
To ensure those left behind will be able to continue the business, entrepreneurs often
buy life insurance that will pay partners and others what they need to keep the firm
going.
31.
Homeowner’s policies usually don’t have adequate protection for a home-based business,
so you may need to add an endorsement, or rider, to increase the coverage.
If clients visit your office and or if you receive deliveries regularly, you may need homeoffice insurance, which protects you from slip and fall lawsuits and other risks associated
with visitors. More elaborate businesses may need other kinds of insurance.
32.
Risk management goes beyond the protection of individuals and businesses from known
risk. It now means evaluating the worldwide risks and prioritizing these risks so that
international funds can be spent where they will do the most good.
CRITICAL THINKING EXERCISES
Learning Goal 1
1.
Your answers to this question will vary. However, some suggestions as to how to minimize risk
may include developing an enterprise risk management program for the company, to determine
what risks pose the greatest danger to the company, and how to manage those risks.
Learning Goal 2
2.
a. Avoid risk
b. Self-insure against the risk
c. Reduce the risk
d. Buy insurance to cover the risk.
3.
a.
b.
c.
Yes, companies can buy insurance against the loss of computer equipment.
No, this would be an uninsurable risk.
No, a company cannot insure against inefficient machinery or machinery that breaks
down or doesn’t work.
d. Yes you can insure against fire damage.
e. Yes, probably, unless the occurrence of loss has been too high.
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f.
g.
No, most likely because the probability of flooding in Morgan City is too high.
No this would be a “political risk” and is uninsurable.
Learning Goal 3
4.
While it is understandable that Eric would be concerned about taking care of losses his
business may experience, the rule of indemnity will prevent Eric from filing claims with
two different insurance companies for the same incident. The rule of indemnity states
that an insured person or organization can’t collect more than the actual loss from an
insurable risk. If a company carries two policies, the two insurance companies would
calculate any loss and divide the reimbursement.
Leaning Goal 4
5.
As a small business owner located in your home, you will need to have a regular
homeowner’s policy, but there will be additional coverage that you should consider.
You may need a rider to cover business equipment, and if customers or clients call on
you, you may need home office insurance. If you manufacture items at your home
business, you should consider a business owner policy. Depending upon the type of
business you own, you may want to consider professional liability insurance or product
liability insurance.
Since you have employees, you may want to check into offering other insurance coverage
for them. Employers often offer life insurance, disability insurance, retirement plans, and
health insurance.
You will probably be required to offer worker’s compensation insurance. The cost of
worker’s compensation insurance will be determined by your company’s safety record,
its payroll and the types of hazards faced by your workers.
PRACTICE TEST
MULTIPLE CHOICE
1.
2.
3.
4.
5.
6.
a
b
a
c
c
b
7.
8.
9.
10.
11.
12.
TRUE-FALSE
b
a
d
c
b
c
1.
2.
3.
4.
5.
6.
7.
T
T
T
T
F
F
F
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8.
9.
10.
11.
12.
13.
14.
F
T
T
T
F
F
T