Presentation
701-RKCN Risk Control
International School of
Management (ISM)
1
Day 1 Principles of Risk Control
Signal and Noise
COSO Short
Jet Blue and U.S. Airways
Insurable Risk
Climbing Mount Everest
Insurance Principles
Property Risks
World Trade Center
Morgan Stanley and 9/11
2
Day 2. Legal Liability
Legal and Tort Liability
Silicosis and Asbestosis
Negligence
General Liability
Directors and Officers (D&O) Liability
Professional Liability
RIsk Control and Loyalty
Bitcoins
3
Day 3. Effective Risk Control
Insurance Contracts
Risk and Uncertainty
Lance Ewing, Risk Manager
Tuscaloosa, Biloxi and Gulfport
BP Oil Spill and Chilean Mine Rescue
Brokers, Agents, and Captives
Lloyd’s of London and Bermuda Insurance
Money Laundering
4
Presentation
Is it a Signal or
is it Noise?
Nate Silver
5
Risk and Uncertainty
• Risk. Something that we attach to a probability.
In many cases, we can also calculate the
financial cost or benefit.
• Uncertainty. Something that can go wrong
without an understanding of the consequences,
likelihood, or cost or benefit.
6
Threats
• National Association of Insurance
Buyers
• Global Association of Risk
Professionals
• Institute of Internal Auditors
• Casualty Actuarial Society
7
Threats
• NAIB. Risk managers primarily buy
insurance.
8
Threats
• NAIB. Buyers of insurance.
• GARP. Financial risk management is
the only risk management.
9
Threats
• NAIB. Buyers of insurance.
• GARP. Only financial risk
• IIA. Risk management is violation of
policies caught on audits.
10
Threats
•
•
•
•
NAIB. Buyers of insurance.
GARP. Only financial risk
IIA. Violations.
CAS. Its all in the numbers.
11
Weaknesses
Internal
Environment
•What is the internal philosophy and
culture?
Objective Setting •What are we trying to accomplish?
Event
Identification
•What could stop us from
accomplishing it?
•How bad are these events?
Risk Assessment •Will they really happen?
Risk Answer
•What are our options to stop those
things from happening?
do we make sure they don’t
Control Activities •How
happen?
Information and
Communication
•How [and from/with whom] will we
obtain information and communicate?
Monitoring
•How will we know that we’ve achieved
what we wanted to accomplish?
Source: Committee of Sponsoring Organizations
of the Treadway Commission www.coso.org.
Used with permission.
12
COSO ERM Framework
Internal
Environment
•What is the internal philosophy and
culture?
Objective Setting •What are we trying to accomplish?
Event
Identification
•What could stop us from
accomplishing it?
•How bad are these events?
Risk Assessment •Will they really happen?
Risk Answer
•What are our options to stop those
things from happening?
do we make sure they don’t
Control Activities •How
happen?
Information and
Communication
•How [and from/with whom] will we
obtain information and communicate?
Monitoring
•How will we know that we’ve achieved
what we wanted to accomplish?
Source: Committee of Sponsoring Organizations
of the Treadway Commission www.coso.org.
Used with permission.
13
COSO Implementation
Multinational Corporation ERM program:
• 800 Business Risks. Consolidated into 20
categories:
• 2100 Common Risks Group-wide exposures.
14
Results of Business Risk Consolidation
- Business risks in the external environment, operational processes, and internal environment External
environment
Country-specific
risks
Natural
disasters
Laws and
regulations
Operational
processes
Business partners
Customers
Technica
Subcontractor Supplier
l
s
s
partners
Delayed
technological
development
Manufacturing
Lack of
differential
technology
Increasing
competition
due to competitors'
products
Falling market
prices
Dependence on
specific business
partners
Inadequate business
partner handling
R&D
Failures to respond
to changing
customer needs
Marketing & Sales
Delayed
production
Failures of sales
channel
strategies
PL and quality issues
Cost increases (increasing inventory, soaring material costs, declining yield)
Delayed collaboration due to insufficient linkage between divisions
Internal
environment
Informatio
n
Organization
Human
resources
Internal
infrastructure and
organization
operations
Staff allocation and
development
Insufficient
manufacturing reforms
and IT innovations
Structural reformrelated issues
Competitors
Failures of sales
promotion
Business Structure
Segment
AVC
Networks
Global
and
Group
Head
Office
Home
Appliances
Business domain
AVC
Panasonic AVC Networks Company
Fixed-line communications
Panasonic Communications Co., Ltd.*
Panasonic Mobile Communications Co., Ltd.*
Mobile communications
Panasonic System Solutions Company
Systems
Panasonic Shikoku Electronics Co., Ltd.*
Home appliances, household equipment,
healthcare systems
Matsushita Home Appliances Company,
Matsushita Refrigeration Company*
Healthcare Business Company
Lighting Company
Matsushita Ecology Systems Co., Ltd.*
Lighting
Environmental systems
CISC
Components
and Devices
Panasonic
Design
Company
R&D divisions
Semiconductor Company
Display devices
Matsushita Battery Industrial Co., Ltd.*
Batteries
Panasonic Electronic Devices Co., Ltd.*
Electronic components
Motor Company
Motors
Solutions
Panasonic Automotive Systems Company
Automotive electronics
Semiconductors
Head Office
Business Domain Companies and Group Companies
FA, Corporate eNet Business Division
Others
Panasonic Factory Solutions Co., Ltd.*, and others
Sales division
Overseas
divisions
MEW and PanaHome
JVC
Matsushita Electric Works, Ltd.*, PanaHome Corporation*
Victor Company of Japan, Ltd.*
Group-wide Risk Management System for General Contro
(2) Establish a G&G Risk Management Committee to address the current problems
After the Committee's
establishment
Establishing and improving Group-wide RM system
Instructing risk assessment
<Roles of the Committee>
[1] Establishing and improving
Group-wide RM system
[2] Conducting Group-wide risk
assessment
[3] Reporting to the President,
and Board of Corporate
Auditors
[4] Studying possible measures
to prepare for major risks;
suggesting such measures to
President and Corporate
Functional Divisions
[5] Improving Group-wide
support systems against
emergencies
Committee
Corporate Functional
Division A
G&G RM
Committee
Domains
Support
Subsidiaries
Committee
Corporate Functional
Division B
Support
Corporate Functional
Division C
Corporate Regional
Management
Divisions /
Regional HQs
Results of Groupwide risk
assessment
Secretariat
Collecting risk information from
across the Group
17
Clarify Sections Responsible for Each Risk
(4) Information systems
1. Disasters and accidents
Earthquakes, typhoons, tsunamis, floods, and
other natural disasters
General Affairs Group, Overseas
Security management Office
Fires, explosions, airplane crashes, terrorist
attacks, and other major destructive or violent
events
General Affairs Group, Corporate
Personnel Group, Overseas Security
Management Office
2. Politics, economy, and society
Shutdown or malfunction of information
systems and communication networks
General Affairs Group, Corporate
Information Security Division
Unauthorized use of information systems
General Affairs Group, Corporate
Information Security Division
Inadequate security measures related to
information systems
General Affairs Group, Corporate
Information Security Division
(5) Environment
Wars, civil wars, conflicts, etc.
General Affairs Group, Overseas
Security Management Office
Corporate threats, abduction, and violent civil
unrest
General Affairs Group, Overseas
Security Management Office
Environmental pollution
Corporate Environmental Affairs Group
Waste treatment
Corporate Environmental Affairs Group
Environmental regulations
Corporate Environmental Affairs Group
(6) International relations
3. Operations
(1) Quality, CS, and intellectual property
PL and recall issues, other quality problems
Corporate Quality Administration
Division
Failure in complaint-handling
Corporate CS Division
Intellectual property right infringements
Corporate Intellectual Property Division
(2) Sales and procurement
Violation of security export control
Corporate Legal Affairs Division
Trade issues
Corporate Legal Affairs Division
(7) Finance
Bad loans and business partner bankruptcy
Corporate Accounting Group
Tax and accounting system changes
Corporate Accounting Group
Exchange rate fluctuations
Corporate Finance & IR Group
Violation of antitrust (competition laws)
Corporate Legal Affairs Division
Interest fluctuations
Corporate Finance & IR Group
Bribery
Corporate Legal Affairs Division
Stock price fluctuations
Corporate Finance & IR Group
Violation of Subcontractors Act
Corporate Procurement Division
Corporate Accounting Group
Soaring raw material prices and unavailability
Corporate Procurement Division
Impairment of long-term assets and deferred tax
assets
(8) Labor issues
(3) Information
Human rights issues, including sexual
harassment
Industrial Relations Group, Corporate
Personnel Group, Overseas Security
Management Office
Corporate Information Security
Division
Employment
Corporate Personnel Group, Industrial
Relations Group
Information security incidents related to products
and services
Corporate Information Security
Division
Industrial accidents
Industrial Relations Group
Health issues such as infectious diseases
Insider trading
General Affairs Group
Industrial Relations Group, Overseas
Security Management Office
Trade secret leakage
Corporate Information Security
Division
Private data leakage and violation of privacy
18
Spreadsheet Risk Listing (1)
• Administration risk.
• Business support
risk.
• Capital budgeting
risk.
• Capital structure
risk.
• Communications
risk.
•
•
•
•
•
•
Compliance risk.
Credit risk.
Design risk.
Distribution risk.
Efficiency risk.
Financial reporting
risk
• Finance risk.
19
Spreadsheet Risk Listing (2)
• Information systems
risk
• Key initiative risk.
• Marketing risk.
• Needs risk.
• Performance risk.
• Portfolio risk.
• Pricing risk.
• Process risk.
• Production risk.
• Records
management risk.
• Supply risk.
• Technology risk.
• Valuation risk.
• Volume risk.
20
So Therefore we Distinguish
• Risk. Something that we attach to a probability.
In many cases, we can also calculate the
financial cost or benefit.
• Uncertainty. Something that can go wrong
without an understanding of the consequences,
likelihood, or cost or benefit.
21
Presentation
Jet Blue Airways
22
Jet Blue Airways
A story about Jet Blue Airways illustrates the
linkage between risk management and liability
exposures.
• Brokers pay careful attention to practices that
increase or decrease the likelihood of lawsuits.
• Carriers assess the liability exposure from
operations.
23
Situation
Jet Blue Airways suffered a humiliating disruption
of operations at New York’s Kennedy Airport on
Valentine’s Day 2007.
• An ice storm left passengers stranded on planes
for up to 10 hours.
• Would a better risk identification process have
helped Jet Blue Airways avoid the liability
exposure?
24
Question (1)
Should the company have had a plan to manage
disruption of operations prior to Valentine’s Day,
2007?
25
Question (2)
What are some examples of disruptions?
26
Answer
Examples:
 Ice storm.
 Police action.
 Terrorist act.
 Congestion.
 Maintenance.
 FAA regulations.
 Technology.
 Fuel shortage.
 Employee absence.
Strike.
Crazy person.
Power outage.
Communications outage.
Airport closing.
Improper training.
Absence of linguists.
Missing parts.
Accident/Crash.
27
Question
Who should be responsible for disruption
risk?
28
Answer
Highest level.
 This risk is assigned to the Executive Vice
President for Flight Operations.
Next level.
 It is further assigned to Kennedy Airport
Operations Center.
29
Question
Jet Blue could have learned that an ice storm hits
New York once every three winters.
• The chance of hitting at a busy time in the
terminal is 33%.
• What is the likelihood of a disruption of
operations?
30
Answer
A disruption is likely to happen one time in a
9-year period.
31
Question
How severe could it be to have a disruption
of operations?
32
Answer
Could be:
 A public relations nightmare if passengers
were stranded on planes for long periods of
time.
 Financially costly if airline had to reimburse
passengers for losses or time spent.
 Harmful to long-term and cherished
reputation for the highest quality of customer
service.
33
Question
What alternatives did Jet Blue have to
mitigate the impact of a disruption at
Kennedy Airport?
34
Answer (1)
Bus Contingency Plan. Backup arrangements
with bus companies to unload planes sitting on
the tarmac.
35
Answer (2)
Additional Personnel. Train nearby
headquarters staff to work the terminal.
Reschedule flights.
36
Answer (3)
Revised Operating Procedures. Implement
crisis procedures for weather or other delays
that mitigate passenger discomfort.
37
Question
What were the consequences of the failure
to identify and prepare for the disruption?
38
Answer (1)
Consequences:
 $30 million in added costs.
 Removed from #4 position in a
customer satisfaction survey published
by Business Week (March 5, 2007).
39
Answer (2)
Consequences:
 $30 million in added costs.
 Removed from #4 position in a
customer satisfaction survey published
by Business Week (March 5, 2007).
 Jet Blue was the cover story in
Business Week on March 5.
40
Answer (3)
More consequences. Jet Blue endangered:
 Top choice in national airline quality
rating (4 years in a row).
 Condé Nast Traveler reader’s choice
award (5 years in a row).
 High J.D. Powers ranking for quality.
41
Question
What happened to Jet Blue in the years
after the Valentine’s Day disruption?
42
Answer
Jet Blue recovered:
 Implemented a Customer Bill of Rights.
 Created a database to track crew locations
and contact information.
 Cross trained employees and had on call in
the event of a crisis.
 Created a Web-based rebooking system to
reschedule flights.
43
Presentation
U.S. Airways
January 2009
44
Question
U.S. Airways flight 1549 landed on the
Hudson River on January 13 with no loss
of life.
• The landing by pilot Sullivan was called
the “Miracle on the Hudson.”
• How did it prepare to a crisis such as
occurred with the emergency landing?
Business Week, March 2, 2009
45
Answer
The airline was prepared:
 “Dry run” Questions. 3 times a year at
every airport it serves.
 “Care Team.” Gates agents, reservation
clerks, and other employees dispatched on a
“moment’s notice.”
 800 Number. For families to call for
information.
46
Question
How did it handle the passengers who were
removed from the plane?
47
Answer
The airline took action:
 Flew 150 employees from headquarters
(Arizona) to New York to help.
 Authorized employees to use their credit
cards to buy medicines, toiletries, and
personal items.
 Brought a bag of cash.
 Brought suitcases filled with prepaid cell
phones and sweat suits (dry clothes).
 Escorted passengers to hotels set up with 24hour buffets.
48
Question
What else did it do?
49
Answer
More action:
 Arranged train tickets and rental cars for
individuals who did not want to get back on a
plane.
 Reached out to high-level executives at Hertz
and Amtrak so no hassle getting the tickets.
 Retained locksmiths to help passengers who
had lost keys for cars and home.
50
Question
Anything else?
51
Answer
Follow-up action:
 Sent letters updating passengers after they
arrived home.
 Refunded the airplane ticket and gave each
passenger $5,000 to replace lost
possessions.
 Paid additional monies to passengers where
$5,000 did not cover losses.
52
U.S. Airways in 2009
U.S. Airways flight 1549 landed on the Hudson
River on January 13 with no loss of life. The
landing by pilot Sullivan was called the “Miracle
on the Hudson.”
Business Week, March 2, 2009
53
Question
Prior to 2009, U.S. Airways had a history of
finishing at the bottom of customer service
rankings. How do you think it handled the
Hudson River landing after the passengers were
removed from the plane?
54
Reply (1)
The airline was prepared:
 “Dry run” Exercises. 3 times a year at every
airport it serves.
 “Care Team.” Gates agents, reservation
clerks, and other employees dispatched on a
“moment’s notice.”
 800 Number. For families to call for
information.
55
Reply (2)
The airline took action:
 Flew 150 employees from headquarters
(Arizona) to New York to help.
 Authorized employees to use their credit
cards to buy medicines, toiletries, and
personal items.
 Brought a bag of cash.
 Brought suitcases filled with prepaid cell
phones and sweatsuits (dry clothes).
 Escorted passengers to hotels set up with 24hour buffets.
56
Reply (3)
More action:
 Arranged train tickets and rental cars for
individuals who did not want to get back on a
plane.
 Reached out to high-level executives at Hertz
and Amtrak so no hassle getting the tickets.
 Retained locksmiths to help passengers who
had lost keys for cars and home.
57
Reply (4)
Follow-up action:
 Sent letters updating passengers after they
arrived home.
 Refunded the airplane ticket and gave each
passenger $5,000 to replace lost
possessions.
 Paid additional monies to passengers where
$5,000 did not cover losses.
58
Presentation
Insurable Risk
59
Tests of Insurable Risk
An insurable risk is a form of pure risk. It meets
two specific tests:
 Financial Loss. The risk must create the
possibility of a decrease in money or a
decline in monetary value.
 Contingent Loss. This is a loss that is not
certain to happen.
60
Question
An individual wants to purchase fire insurance to
cover a house located in a dense forest. Is this
an insurable risk under the following conditions:
 If forest fires are common in the area?
 If a fire is approaching the house?
 If the house is owned by an individual who
has a felony conviction for arson?
61
Answer
Insurable if loss is contingent.
 Yes if forest fires are common in the area.
May have a high premium
 No if a fire is approaching the house (not a
contingent loss).
 Yes. In the subsequent event of a suspicious
fire, the insurer may void the policy and let a
court sort out the impact.
62
Exposure, Peril, and Hazard
An insurable risk can cause a financial loss and/or
disrupt the operations of a business. Three
terms help dimension it:
 Exposure. A condition where risk could
cause a loss.
 Peril. Immediate cause of a loss.
 Hazard. A condition increasing the likelihood
of a loss from a peril.
63
Question
A company purchases a building. With respect to
the possibility of fire, what is:
 An exposure?
 A peril?
 A hazard?
64
Answer
Fire in a building.
 Exposure. Purchase of the building.
 Peril. Electrical fire.
 Hazard. Storing gasoline in the building.
65
Presentation
Climbing Mount Everest
66
Question
Name an exposure, peril, and hazard associated
with climbing Mount Everest.
67
Answer
Exposure. Climb it.
Perils. Snow blindness.
Freezing conditions. Death.
Hypothermia. Hypoxia.
Weight loss. Severe injury.
High altitude cerebral edema (HACE).
High altitude pulmonary edema (HAPE).
Hazard. Carry no oxygen. Do not train in advance.
68
Question
Is life insurance for a climb of Mount Everest an
insurable exposure?
 When did someone first reach the peak?
69
Answer (1)
Mount Everest answers:
 First to succeed:
 Sir Edmund Hilary (1953)
 How many people reached the peak between
the first ascent and 1996?
New York Times, June 4, 2006
70
Answer (2)
Mount Everest answers:
 First to succeed: Sir Edmund Hilary (1953)
 Successful 1953-1996:
615 (43 years)
 How many in 2006?
New York Times, June 4, 2006
71
Answer (3)
Mount Everest answers:
 First to succeed: Sir Edmund Hilary (1953)
 Successful 1953-1996:
615 (43 years)
 How many in 2006?
500
 How many in total?
New York Times, June 4, 2006
72
Answer (4)
Mount Everest answers:
 First to succeed: Sir Edmund Hilary (1953)
 Successful 1953-1996:
615 (43 years)
 How many in 2006?
500
 How many in total?
3,000
 How many died trying?
New York Times, June 4, 2006
73
Answer (5)
Mount Everest answers:
 First to succeed: Sir Edmund Hilary (1953)
 Successful 1953-1996:
615 (43 years)
 How many in 2006?
500
 How many in total?
3,000
 How many died trying?
200
New York Times, June 4, 2006
74
Question
Risk and the risk appetite are framed by people’s
attitudes. What happened to David Sharp and
Lincoln Hall while climbing Mount Everest in
2006?
75
Answer (1)
David Sharp.
 34 years of age.
 Froze to death under a rocky overhang just
below the peak.
76
Answer (2)
David Sharp.
 34 years of age.
 Froze to death under a rocky overhang just
below the peak.
 40 climbers walked past him while he was
still alive.
77
Answer (3)
Lincoln Hall.
 50 years of age,
 Left for dead by his climbing party.
 Survived the night.
78
Answer (4)
Lincoln Hall.
 50 years of age,
 Left for dead by his climbing party.
 Survived the night.
 The next morning, Dan Mazur abandoned
his own climb to help rescue Mr. Hall.
79
Answer (5)
John Delaney, founder and CEO of Intrade, a
prediction market which allows individuals to
take positions (‘trade 'contracts') on whether
future events will or will not occur. Did you hear
about what happened to him?
80
Answer (6)
John Delaney died while trying to climb Mt.
Everest in May 2011:
 He was less than 50 meters from the top.
 He was 42
 It was his second attempt to climb Everest.
 He never heard the news that his wife had
just given birth to a baby daughter, Hope.
81
Presentation
Insurance Principles
82
Insurable Loss
Risks are insurable when the loss has the
following characteristics:
 Arises from a Pure Risk. Speculative risks
are not insurable.
 Loss not Trivial. The administrative costs
make it too expensive to insure minor losses.
 Definite Loss. We can identify the cause,
time, place, and extent of damage.
 Fortuitous Loss. The loss must occur as a
result of chance.
83
Question
A hotel in Russia is partly owned by a group of
European investors. The company has a policy
that will reimburse it if a government body
confiscates the hotel for no valid reason. The
hotel maintained a small cash account in
Germany, in violation of Russian banking laws.
When it was discovered, the government fined
the hotel $25 million. When the investors
refused to pay, the group’s $20 million in stock
was confiscated. Should the policy pay the loss?
84
Answer
It may require a court to make a determination of
fact. Is it a fortuitous loss if a law was violated
and the resulting fine caused the confiscation?
85
Question
If a homeowner snaps under pressure and sets
fire to his house, would damages be covered by
insurance if a court-appointed psychiatrist
certifies that the person suffered from temporary
insanity?
86
Answer
Not likely. A court may be concerned that the
insured can fool the psychiatrist. Thus, the loss
would not be fortuitous.
87
Question
A parent asked an insurance company to insure
the favorite toy of a child. It cost $100. Is this an
insurable risk?
88
Answer
Probably not. The monetary amount is trivial.
89
Question
A company wanted to purchase insurance to send
employees to a restful resort if they suffered
serious depression for more than 60 days. The
insurance would cover travel and living
expenses. Is this an insurable risk?
90
Answer
Not likely. It might be hard to prove that the loss is
definite. Depression may be fortuitous but a
claim of depression is not.
91
Question
An owner keeps a Ferrari in a wooden barn
behind his house. The Ferrari cost $200,000 five
years ago but is worth $300,000 today. The
owner has asked Lloyd’s of London to insure it
for $400,000. Is it likely that Lloyd’s will accept
the risk?
92
Answer
Agree. Tests are:
 Pooling? Yes. Many automobiles and
personal property exposures.
 Indemnification. No. Only for $300,000 if
value is verified.
 Adverse Selection? Check on fire likelihood
and security for breaking and entering.
 Not Trivial, Definite, Fortuitous Loss. OK.
 Probability. With security on building, small
chance of loss.
93
Answer -- News Release (1)
Copyright 2005 News Limited --Where there's smoke
there's fire
A Charlotte, North Carolina, lawyer purchased a box of
rare and expensive cigars, then insured them against
fire and theft. Within a month, having smoked his entire
stockpile of the cigars and without yet having made even
his first premium payment on the policy, the lawyer filed
a claim against the insurance company. In his claim, the
lawyer stated the cigars were lost `in a series of small
fires'. The insurance company refused to pay, citing the
obvious reason: that the man had consumed the cigars
in the normal fashion. The lawyer sued and won.
94
Answer -- News Release (2)
In delivering the ruling, the judge agreed with the insurance
company that the claim was frivolous. The judge stated,
nevertheless, the lawyer held a policy from the company
in which it had warranted that the cigars were insurable
and also guaranteed it would insure them against fire,
without defining what is considered to be unacceptable
fire. The insurer was obligated to pay the claim.
Rather than endure a lengthy and costly appeal process,
the insurance company accepted the ruling and paid
$15,000 to the lawyer for his loss of the rare cigars lost
in the `fires'.
95
Answer -- News Release (3)
After the lawyer cashed the check, the insurance company
had him arrested on 24 counts of arson. With his
insurance claim and testimony from the previous case
being used against him, the lawyer was convicted of
intentionally burning his insured property and was
sentenced to 24 months in jail and a $24,000 fine.
This true story was the first place winner in the recent
National Association of Criminal Defense Lawyers
Contest.
www.NACDL.org
96
Answer (4)
The previous story was a hoax. Some media
outlets ran it. If a person knows the rules of
insurance, the loss was not fortuitous.
 Risk Transfer.
Yes
 Pooling of Losses.
All fire, not all cigars
 Indemnification.
Yes, if for cost
 Fortuitous Loss.
No. Intentional.
Therefore, no collection of damages is possible.
97
Severity and Frequency
Individuals and companies are concerned
primarily with insuring important risks measured
by either:
 Severity. The intensity of a peril.
 Frequency. The likelihood of the occurrence.
Risks can be graphed, as shown on the next slide.
As we move up and to the right, we move into the
area of critical risks.
98
Graphing Risk
High
|
|
|
|
SEVERITY
Increasing
|
Risk
|
|
|
Low
|_____________________________
Low
FREQUENCY
High
99
Risk Strategies
Organizations use a mixture of four strategies to
deal with frequency and severity of risk:
 Reduction. Lower the frequency or severity.
 Avoidance. Do not accept it.
 Retention. Keep it.
 Transfer. Shift the financial burden to another
party.
100
Question
Of the four risk strategies, reduction should always
be tried. Among the others, which one is used
for each of the following?
 Low frequency, high severity.
 Low frequency, low severity.
 High frequency, high severity.
 High frequency, low severity.
101
Answer
Low frequency, high severity.
 Transfer and Reduce
Low frequency, low severity.
 Retain and Reduce
High frequency, high severity.
 Avoid
High frequency, low severity.
 Retain and Reduce
102
Presentation
World Trade Center
103
Question (1)
Larry Silverstein acquired the lease to operate the
New York City World Trade Center two months
before a terrorist attack destroyed the complex
on September 11, 2001. Although the complex
was damaged by a car bomb in its underground
parking space in 1993, Mr. Silverstein did not
foresee a high severity exposure to the WTC.
Thus, he insured the twin towers for $3.6 billion,
half of the replacement cost if both towers were
lost in a single occurrence.
104
Question (2)
Years of litigation followed the loss. Mr. Silverstein
claimed the two hijacked airliners were separate
"occurrences" for insurance purposes, entitling
him to collect twice on the policies.
The problem was compounded by the fact that
no insurance policies had been issued as of the
date of the attack.
105
Question (3)
Two policy forms were under consideration.
 One defined occurrence as any loss from a
single cause within a specified time period.
 The other policy form did not define
occurrence at all.
Was the loss of the twin towers a single
occurrence? Explain your reasoning.
Separately from your general knowledge, what
were the risk management failures associated
with 9/11?
106
Answer
Answers on the number of occurrences will vary.
 Some insurers paid for one occurrence,
some for two. Mr. Silverstein did not receive
full replacement cost for the property.
 The total paid was $4.6 billion.
Risk management weaknesses:
 Failure to insure WTC for replacement value.
 Failure of authorities to discover 20
individuals learning how to fly commercial
airlines but not take off or land.
107
Presentation
Morgan Stanley and 9/11
108
The Event
In 1993 a truck bomb was detonated below the
North Tower of the World Trade Center. It killed 7
people.
Rick Rescorla that there was a need to better
prepare
for future threats. Rescorla, the security chief for
financial services firm Morgan Stanley, began
conducting regular emergency evacuations of the
company's offices there, despite employee
grumbling
about having to walk down dozens of flights of 109
The Event
In 2001 Morgan Stanley was the largest tenant in
the south tower of the World Trade Center.
 Rick Rescorla was the risk manager for Morgan
Stanley.
 After 1993, he began conducting regular
emergency evacuations of the company's
offices.
 Employees complained about having to walk
down dozens of flights of stairs.
110
The Event
On 9/11:
 Rescorla ignored building officials' advice to
stay put.
 3,700 Morgan Stanley employees evacuated
20 floors in the South Tower.
 Rescorla] went back in one last time to make
sure everybody got out.
 The tower collapsed and he was lost.
111
Presentation
Day 2 Legal Liability
112
Question
A contractor was building a home for a man who
just lost his mother.
• The owner gave him $1,000 and an urn that
contained his mother’s ashes.
• “I want her ashes buried in the concrete.”
• The contractor agreed but forgot.
• He gave the owner back the ashes.
• The owner sued for breach of contract.
What are the damages?
113
Question
In the previous question.
• Assume the court awarded damages for breach
of contract.
• Could the court also award additional money
because the contractual violation caused
emotional distress?
114
Question (1)
• A French company built a factory in Shanghai
to produce televisions.
• A Chinese company agreed to a 3-year
contract to supply cardboard.
• A month before the start of, the Chinese
company said it would not supply cardboard.
• A more profitable contract to sell to Australia.
• The French company signed with a Korean
company.
115
Question (2)
• Six months later the Chinese company said it
would start delivery.
• The French company said no.
• A local municipal court ruled that the contract
was valid.
• What happens now?
116
Question
An antiques dealer restored an 1898 oil painting.
• It sold advertised as “perfect original condition
with no repairs.”
• The buyer learned about the restoration.
• Can the buyer get a refund?
117
Question (1)
Dictionary definitions of a sandwich are:
 Two slices of bread or a rol with a filling in
between.
 Two pieces of leavened bread with meat,
vegetables, or cheese.
 One slice of bread covered with food.
118
Breaking News
Russian forces completed their take over of the
Ukrainian navy’s assets in Crimea.
The Ukrainian navy has been reduced from 51 to
10 vessels.
119
Breaking News
Russian forces completed their take over of the
Ukrainian navy’s assets in Crimea.
The Ukrainian navy has been reduced from 51 to
10 vessels.
Ukrainian Army dolphins, which have been
trained to plant bombs and kill frogmen, will
be transferred to Russia
120
Presentation
Tort Liability
121
Tort
A wrongful act where the wronged party can
obtain relief in a court of law.
122
Question
Ernie Chambers sued God in a Nebraska court.
• He said God caused fear and “widespread
death, destruction and terrorization of the
Earth‘s inhabitants.”
• What did the court do?
123
Answer (1)
The judge dismissed the lawsuit.
• He said God wasn't properly served because
of his unlisted home address.
124
Answer (2)
Chambers appealed.
 The court acknowledges the existence of
God.
 This is a recognition of God's omniscience.
 Since God knows everything, God has notice
of this lawsuit.“
 Did Chambers win on appeal?
125
Answer (2)
No. The Court of Appeals ruled that courts decide
real controversies and do not address abstract
questions or hypothetical or fictitious issues.
126
Presentation
Silicosis and Asbestosis
127
Silicosis (1)
In 2005, “Silicosis was a big deal in the United
States.
 An lung disease caused by silica dust.
 Coughing , chest pain, fever, and death.
 Lawsuits began in 2001..
 In 2005, a federal judge consolidated 9,000
lawsuits.
128
Silicosis (2)
The judge learned;
 A small number of doctors diagnosed
Silicosis.
 Lawyers never met with patients.
 Doctors never met with patients.
 Secretaries completed the paperwork.
129
Silicosis (3)
 Two-thirds of the victims were in earlier
lawsuits for asbestosis.
 The lawsuits forced 70 companies into
bankruptcy and created billions of dollars of
legal fees.
130
Silicosis (4)
Most asbestosis and silicosis lawsuits.
 Contained the same doctors and patients. .
 Plaintiffs had asbestosis but not silicosis in
the earlier lawsuits.
 Now they were had silicosis but not
asbestosis.
131
Silicosis (5)
The judge:
• Dismissed the cases.
• Accused the doctors and lawyers of committing
fraud.
• Forbid future lawsuits.
• Required some lawyers to pay legal costs of
the defendants.
132
Silicosis (6)
5,500 silicosis claims were filed in Texas after
2005:
 Texas 2005 tort reform requires "minimum level
of impairment.”
 54 plaintiffs attempted to meet the standard.
 24 did so.
 99 percent of the lawsuits were likely fraud.
 None of the trial lawyers have been charged
with attempted fraud.
133
Presentation
Negligence
134
Elements to Prove Negligence
Negligence is proved by:
 Unreasonable Behavior.
 Duty and Failure to Act.
 Occurrence of Loss.
 Proximate Cause. A cause-effect
relationship between the act and the loss.
135
Question (1)
A limousine driver waited in a hotel entrance for a
passenger.
• Two hotel bellmen were smoking, as was the
driver.
• The driver tossed a lighted cigarette to the
ground near an oxygen container left by a
guest in the hotel.
• A fire started under the oxygen container.
• The container exploded.
136
Question (2)
• The three men ran into the street.
• One of the bellman was hit by a bus and
knocked to the ground.
• The second bellmen stopped to call his wife on
a cell phone. Then, he went to help his fellow
employee.
• While he was helping the injured man, a car
struck the uninjured bellman and killed him.
• Was there any negligence?
137
Answer
Issues:
 Negligent Behavior. Was it negligent to toss
the cigarette?
 Existence of Loss. A loss certainly occurred.
 Proximate Cause. Did the cigarette cause
the fire? Was the reaction to the explosion the
cause of the death?
 Linkage. Does the cell phone call break the
natural and continuous sequence of events?
138
Question
• A man walking through a parking garage was
attacked by two large dogs.
• An employee saw the attack but did nothing.
• A pedestrian saw the attack but walked away.
• The man sued the garage owner, the
employee, and the pedestrian.
• Did negligence occur?
139
Question
• A restaurant left rat poison next to a dumpster
on the property of an adjacent grocery store.
• A neighbor’s cat ate the poison.
• The cat wandered away from the poison and
was hit by a car.
• The owner of the cat filed a criminal complaint
against the grocery store and restaurant.
• Is either complaint valid?
140
Question
A teenager purchased a lift ticket and signed a
waiver of all rights.At the top of the mountain, a
sign read “Closed Trail. Dangerous Area. Do
not Enter.” The sign had been knocked over
and was lying the snow. The teenager entered
the closed area and was seriously injured.
She filed a lawsuit against the ski area, alleging
negligence. Is the lawsuit valid?
141
Presentation
General Liability
142
Utmost Good Faith
Contracts may have two different legal standards for
disclosure:
 Let the Buyer Beware. A legal concept that each
party to a contract should investigate the situation
and be responsible for knowing all terms and
conditions before reaching agreement.
 Utmost Good Faith. A legal requirement that both
parties must make a full and fair disclosure of all facts
affecting a contract. This is the requirement for
insurance policies.
143
Coverage Forms
A liability insurance policy can be issued using
two coverage forms:
 Occurrence. The policy covers an injury or
damage that occurs during the policy period.
 Claims-made. The policy covers claims
made during the policy period regardless of
when the injury occurs.
144
Question
A summer resort closes each year in October and
reopens in May.
• In September 2008 a guest was severely
injured.
• The incident was reported until April 2009.
• The resort had a claims-made policy in 2008.
• It had an occurrence policy in 2009.
Which policy covers the loss?
145
Answer
Neither. The claim was not filed during the period
of claims-made coverage. The occurrence did
not occur during the time period of the
occurrence policy.
146
Judicial Hell Holes (2010)
 1 Philadelphia, Pennsylvania
 2 California. Particularly Los Angeles and
Humboldt Counties
 3 West Virginia
 4 South Florida
 5 Cook County, Illinois
 6 Clark County, Nevada
147
Presentation
Lloyd’s of London
148
Lloyd’s of London
In 1687 Edward Lloyd:
•1687. Opened a coffee house in London.
•1696. Posted Lloyd’s List with ship arrivals and
departures.
•1771, Formed the Society of Lloyd’s with 79
underwriters and worked with correspondents in
foreign ports.
•1871. Incorporated as Lloyd’s of London.
149
Question
What type of insurer is Lloyd’s?
150
Answer
Lloyd’s is not an insurance company:
 It is a marketplace for insurance carriers.
 It does not underwrite insurance business.
 It acts as an administrator of the placement of
insurance.
 It sets rules for the underwriters.
 It is self regulating.
151
Lloyd’s Operations
Lloyd’s operations include.
 A Market. For property and casualty
insurance for clients in 120 countries.
 Syndicates. Insurance is written by 66
syndicates and 1,300 specialist underwriters.
 Brokers. Bring coverage requests to
underwriting syndicates.
 Specialists. Particularly active in aviation,
marine, energy, and motor insurance.
152
Answer (1)
Is a person’s hair insurable as property
insurance?
153
Answer (2)
Ask Troy Polamalu of the Pittsburgh Steelers.
 Spokes person for Head and Shoulders.
 $1 million policy on hair.
154
Answer (2)
• Michael Flatley. Legs.
• Whitney Houston and Bruce Springsteen. Vocal
cords.
• Grain of Rice. Contains portrait of the Queen
Elizabeth and Prince Phillip engraved on it.
• Comedy Theatre Group. Liability coverage if a
member of its audience dies of laughter.
155
Trauma at Lloyd's
Late 80s, Early 90s:
• Had written long-tail policies.
• Large legal awards in U.S.
• Punitive damages on asbestos, pollution and
medical malpractice.
156
Question
Characteristics of insurers are:
 Corporate system sets the rules.
 Manager is king
 Off-the-shelf products
How does this compare with Lloyd’s?
157
Answer (1)
Very different at Lloyd’s:
 Corporate system sets the rules.
At Lloyd’s the individual underwriter
makes the decision without rules.
158
Answer (2)
Very different at Lloyd’s:
 Corporate system sets the rules.
At Lloyd’s the individual underwriter
makes the decision without rules.
 Manager is king.
At Lloyd’s, underwriter is king.
159
Answer (1)
Very different at Lloyd’s:
 Corporate system sets the rules.
At Lloyd’s the individual underwriter
makes the decision without rules.
 Manager is king.
At Lloyd’s, underwriter is king.
 Off-the-shelf products.
At Lloyd’s, products are bespoke
(custom-made to the buyer's
specification).
160
Lloyds Today
Home to skilled and experienced specialists
creating new areas of insurance:
• Kidnap and ransom.
• Space and aviation.
• Cyber-liability.
Lloyd’s Competitive Advantage
• Capital advantages.
• Security and ratings attracts specialist
insurance business.
• Market access.
• Cost effective operating environment.
• Potential for higher operating returns.
Legal Trouble at Lloyd's (1980s)
• Members (Names). Rich individuals backed
policies written at Lloyd's with all of their
personal wealth.
• Losses. In 1990s, 1,500 of 34,000 members
declared bankruptcy.
• American Members. Fraud accusations that
they were misled on risks.
• U.S. Government Officials. Eleven U.S. states
joined action against Lloyd's.
163
Basis for the Legal Issue
Lloyd's used "reinsurance-to-close” accounting.
• Membership. Syndicate disbanded every year.
• Renewal. Same members n new syndicate.
• Syndicate Closing. Results posted after 3
years.
• Profits or Losses. Calculated at closing.
• Reinsurance. Future claims obligation
transferred to reinsurers.
• Reinsurers. Usually another Lloyd's syndicate
with obligations for all future claims.
164
The Problem
Liability losses produced long-tail losses and
claims.
• Reinsuring Syndicate. Accepted responsibility
for long-term claims.
• Closure. For one syndicate liability ended.
• Non-closure. For next syndicate with same
members, liability remained.
165
Allegation Against Lloyd’s
Lloyd's was accused to "Recruit to Dilute."
• Liability for Prior Members. Forwarded to
new syndicates they joined.
• Liability for New Members. Became liable for
losses on historical policies.
• Accusation. Lloyd's committed fraud recruiting
new members to pay past losses.
• Critical Point. Asbestosis losses in early
1990s.
• Reaction. Members to refuse to pay.
166
Outcome of Crisis
Conclusion to Crisis.
• Lloyd's 1996 Response. All pre-1993 business
was settled for $21 billion.
• Outcome of Lawsuits. In 2002 Lloyd's was
released from further liability.
167
Response to the Crisis
Lloyd's:
• Ceased accepting members with unlimited
liability.
• Recruited corporate members with limited
liability.
• Tightened underwriting requirements.
• Changed accounting practices.
168
Presentation
Directors and Officers (D&O)
Liability
169
D&O Exposures
Companies cover liability:
 Covers damages and defense costs.
 Common lawsuits are filed by shareholders,
customers, regulators, and competitors.
 Common allegations are:
Violations of anti-trust laws.
Unfair trade practices.
170
D&O Insurance
A D&O policy provides liability coverage:
 Official Capacity. Actions taken as an officer
or director of an organization.
 Wrongful Act. Triggered by a claim of an
improper behavior.
171
Side A Only Coverage
Purchased by directors and officers:
 Coverage. Drops down and becomes primary
insurance when the primary carrier cancels or
rescinds coverage or when the corporation
refuse to indemnify a director or officer.
 Follow-form. Important to avoid gaps.

172
Examples of Awards (1)
1. Madoff. Ponzi Scheme. Several cases.
2. Bank of America.
• Merrill Lynch takeover.
• Judge found SEC settlement unfair and
unreasonable.
• Lawyers went after individuals rather than
corporation.
173
Presentation
Professional Liability
174
Coverages
Many professions including:
 Health Care Workers.
 Accountants.
 Architects.
 Real estate agents.
 Stockbrokers.
Lawyers.
Engineers.
Insurance brokers.
Consultants.
Travel agents.
175
Medical Malpractice Insurance
Characteristics:
 Covers physicians, surgeons, dentists.
 Is basis for coverage of medical incidents.
 Is not uniformly used by all insurers.
176
Question
Is a medical malpractice insurer allowed to settle a
claim without the permission of the physician or
other covered person?
177
Answer
Current forms usually allow the insurer to settle
without the physician’s consent.
178
Question
Dentist Robert Woo used anesthesia to make a
patient unconscious.
• He inserted fake boar tusks into her mouth and
took pictures.
• He revealed the practical joke.
• The patient sued for damages.
Is this covered by a professional liability policy?
179
Answer
The lower court awarded dentist Robert Woo
$750,000 from Fireman's Fund Insurance.
• An appeals court overturned the decision.
• Putting fake boar tusks in a patient's mouth as
a joke "could not conceivably be considered"
professional liability.
180
Question
While medical malpractice policies are generally
claims-made coverage, an extended
endorsement period can be added. Who needs
such an endorsement?
181
Answer
An extended reporting period endorsement is
needed by:
 Physician that retires.
 Individual or group that changes insurers.
 Individual or group that drops malpractice
coverage.
182
Errors and Omissions Insurance
Available to non-medical professionals, this
insurance is structured similar to medical
malpractice coverage.
183
Presentation
Risk Control and Loyalty
184
Boss: Yes or No
If you are loyal to your boss, do you have to
defend that person when he or she is wrong?
185
Subordinate: Yes or No
If you are loyal to a person you manage, do you
have to defend that person when he or she is
wrong?
186
Co-Worker: Yes or No
If you are loyal to a fellow worker, do you have to
defend that person when he or she is wrong?
187
Maria or Lucia?
You must lay off an employee. Either Maria and
Lucia. Which impacts risk control the most?
 Maria. A truly a loyal employee, often making
sacrifices of her time to help out. She follows
all instructions and praises her boss.
 Lucia. Is far more effective than Maria at
achieving important company goals. She is a
big help to you. She is also critical of
management and sometimes causes
problems.
188
Presentation
WordPerfect Helpdesk
189
Question (1)
The WordPerfect Help Line got a call:
 Customer Support: "Ridge Hall computer
assistant; may I help you?"
 Caller: "Yes, well, I'm having trouble with
WordPerfect."
 Ridge Hall: "What sort of trouble?"
 Caller: "Well, I was just typing along, and all
of a sudden the words went away."
 Ridge Hall: "Went away?"
 Caller: “They disappeared.”
190
Question (2)
 Ridge Hall: "Hmm. So what does your screen
look like now?"
 Caller: "Nothing."
 Ridge Hall: "Nothing?"
 Caller: "It's blank; it won't accept anything
when I type."
191
Question (3)
 Ridge Hall: "Are you still in WordPerfect, or
did you get out?"
 Caller: "How do I tell?“
 Ridge Hall: ”Can you move the cursor around
on the screen?"
 Caller: "There isn't any cursor, I told you, it
won't accept anything I type.”
192
Question (4)
 Ridge Hall: "Does your monitor have a power
indicator?"
 Caller: "What's a monitor?"
 Ridge Hall: "It's the thing with the screen on it
that looks like a TV. Does it have a little light
that tells you when it's on?"
 Caller: "I don't know.“
193
Question (5)
 Ridge Hall: "Well, then look on the back of
the monitor and find where the power cord
goes into it. Can you see that?"
 Caller: "Yes, I think so."
 Ridge Hall: "Great. Follow the cord to the
plug, and tell me if it's plugged into the wall."
 Caller: ".......Yes, it is."
194
Question (6)
 Ridge Hall: "When you were behind the
monitor, did you notice that there were two
cables plugged into the back of it, not just
one?"
 Caller: "No.“
 Ridge Hall: "Well, there are. I need you to
look back there again and find the other
cable."
 Caller: ".......Okay, here it is."
195
Question (7)
 Ridge Hall: "Follow it for me, and tell me if it's
plugged securely into the back of your
computer."
 Caller: "I can't reach."
 Ridge Hall: "Uh huh. Well, can you see if it
is?"
 Caller: "No."
196
Question (8)
 Ridge Hall: "Even if you maybe put your knee
on something and lean way over?"
 Caller: "Oh, it's not because I don't have the
right angle - it's because it's dark."
 Ridge Hall: "Dark?"
 Caller: "Yes - the office light is off, and the
only light I have is coming in from the
window."
197
Answer (1)
 Ridge Hall: "Well, turn on the office light
then."
 Caller: "I can't."
 Ridge Hall: "No? Why not?"
 Caller: "Because there's a power outage.”
198
Answer (2)
 Ridge Hall: "A power... A power outage? Ah,
Okay, we've got it licked now. Do you still
have the boxes and manuals and packing
stuff your computer came in?"
 Caller: "Well, yes, I keep them in the closet.”
 Ridge Hall: "Good. Go get them, and unplug
your system and pack it up just like it was
when you got it. Then take it back to the store
you bought it from.”
199
Answer (3)
 Caller: "Really? Is it that bad?"
 Ridge Hall: "Yes, I'm afraid it is."
 Caller: "Well, all right then, I suppose. What
do I tell them?”
200
Answer (4)
 Ridge Hall: "Tell them you're too stupid
to own a computer."
201
Action: Fire, Punish
This is a true story and Ridge Hall is a real person.
What would you do if you were his manager?
202
Lawsuit: Fire, Punish
Whatever your answer:
• Ridge Hall sued Word Perfect for "Termination
without Cause.”
• Would the knowledge of a possible lawsuit
affect your decision?
203
Loyalty: Fire, Punish
Whatever your answer:
• Ridge Hall is your best technical support
person.
• He always supports your decisions.
• He does extra work at home.
• His work is important to your success as
manager.
204
Presentation
Bitcoins
Cyber Risk with
Digital Currency
205
Digital Currency
•
•
•
•
Electronically created form of money.
Can buy physical goods and services.
Can be converted into dollars or Euros
Value is derived from a willingness of others to
accept it.
• Trades on the Internet.
206
Electronic Payment
E-commerce where someone buys a product or
service on the Internet.
Transfer of funds using the Real Time Gross
Settlement (RTGS) systems and SWIFT
network.
207
Electronic Network
Infrastructure of institutions, instruments, rules,
procedures to transfer monetary value.
Links bank accounts.
Facilitates deposits, withdrawals, and conversions
into a digital currency.
208
Cryptographic Protocol
Rules for exchange of payments between
computers in the electronic network.
• Single country or global.
• Exchange money for products.
• Credit card and automated teller machine
networks.
• Trade common stock, bond, currency, futures,
derivatives, and options markets.
209
Bitcoin
A digital currency introduced in 2009.
• Exists online.
• Is not controlled by any government.
• Developed by “Satoshi Nakamoto,” an
anonymous individual, who posted no new
communications between 2010 and 2014.
• Speculation exists that his real identity.
210
Bitcoin Terms
Digital currency (2009).
Cryptocurrency. Encrypted so it cannot be found
by someone who does not know a special code.
Block. A group of bitcoins.
Wallet. A virtual storage area on a website, the
Cloud, or your computer.
211
Block Chain and Public Ledger
Block Chain. Confirms all transactions.
Public Ledger. Displayed online all block chains
for everyone to see.
Market Transparency. If you buy or sell bitcoins,
everyone can see the transaction.
Anonymous Transactions. All identities are
hidden in the encrypted accounts.
212
Mining for Bitcoins
Mining. Process to create new bitcoins.
• Established in the Bitcoin Protocol.
• Periodic release of complex mathematical
puzzle.
• First party to find the solution wins new
Bitcoins.
213
Total Bitcoin Market
New Bitcoins. Added at current rate of 25 every
10 minutes.
• 12.5 million bitcoins in 2014.
• Rate will decline in the future
• Total protocol limit is 21 million.
214
Purchase and Sale of Bitcoins
Bitcoin Exchanges. http://bitcoinwatch.com/
Cash Purchase. Electronically transfer money
from a bank account.
ATMs. Bitcoins can be purchased.
Irreversible Transactions. Cannot be changed
after purchase or sale.
215
Bitcoin Prices (2009-2012)
Date
January 2009
February 2010
June 2010
February 2011
July 2011
December 2011
December 2012
Price
$0.00
$0.01
$0.08
$1.00
$31
$2
$13
216
Bitcoin Prices (2013-2014)
Date
January 2013
April 2013
September 2013
November 2013
December 2013
January 2014
March 2014
Low
13
91
99
173
425
653
545
High % Change
14
8%
158
74%
128
29%
434
151%
1009
127%
874
34%
710
30%
217
Size of the Market (early 2014)
The sizes of the bitcoin market:
Bitcoins in Circulation 12.5 million
Total Market Value
$7.8 billion €5.7 billion
Daily Transactions
60,000
Daily Bitcoins Traded 625,000
218
Presentation
Day 3
Effective Risk Management
219
Presentation
Insurance Contracts
220
Basic Requirements of Contracts
All contracts require the following:
 Offer and Acceptance. One party must
make an offer. Another must accept it.
 Consideration. An inducement to enter into
an agreement. Value to each party.
 Competent Parties. Must have legal capacity
to enter binding contract.
 Legal Purpose. Cannot violate a law or be
contrary to public interest.
221
Question
A company purchased a $300,000 fire insurance
policy on a warehouse and paid a premium of
$3,000. After binding the contract, the agent
said the company would also cover $20,000 of
the inventory stored in a nearby barn. Later, the
barn burned down. Does the insurer have to pay
for the inventory loss? Why or why not?
222
Answer
No. It appears that no consideration exists. If the
additional coverage had been an inducement to
sell the larger policy, the answer would have
been yes.
223
Three Approaches to Indemnity
Insurance policies are also indemnity contracts:
 Actual Cash Value. Replacement value
minus ordinary wear and tear on a damaged
asset.
 Replacement Value. Cost to replace a
damaged asset with a new asset.
 Agreed Upon Value. Amount of insurance
coverage when the insured and insurer agree
upon the coverage in advance.
224
Question
A shipyard just delivered a new vessel to an
owner. It cost $40 million but the current market
value is only $25 million. The mortgage on the
ship is $35 million. To construct it today would
take 3 years and cost $45 million. The owner
has applied for insurance. In line with the
indemnity principle, how much insurance would
an insurer be willing to provide?
225
Answer
The issue is what does it mean to restore the
owner to the pre-loss position.
 A market value limit would allow the buying of
another ship.
 It would leave the company to report an
immediate loss on the mortgage.
 Also, the company may not have the cash to
pay the mortgage.
 $35 million is a likely limit for most insurers.
226
Question
A marketing, financial, and technical executive
formed a company to develop a computer
system for a hospital. In three years, the group
plans to sell the finished system to IBM for $6
million. All three people are needed to build it
correctly but none will receive any money for
work during the three years. What is the
insurable interest of each person in each other
person?
227
Answer
Insurable interest is $2 million maximum for each
person. The loss of any one person causes a
future loss of one third of $6 million. Factors
affecting the financial value of insurable interest:
 Can a lost partner be replaced?
 Can the person be paid cash rather a partner
share?
 How long will it take to find a new person?
 What is the impact of a delay?
228
Assignment and Consent
An insurance policy is a personal contract:
 Assignment. The right of a party to transfer a
claim, right, or property to another party.
Consent. Permission to assign a contractual
right.
 Personal Contract. Assignment of the rights
under an insurance policy requires
permission of other party.
229
Question
A shipping company owns a warehouse in a
coastal city. The company has a $2 million
windstorm insurance policy. The company
agrees to sell the warehouse to the port. Two
days after transferring the title, a tornado causes
$300,000 of damage to the warehouse. Does
the insurance policy cover the loss?
230
Answer
More information is needed.
 Did the company obtain insurer approval to
assign the policy?
 Did the policy contain a provision to assign
coverage to another party without approval?
If no to both questions, the personal contract
insurance policy does not cover the loss.
231
Void
An agreement that has no legal force.
• A party may void a contract.
• A court will decide if the voiding is allowed.
232
Utmost Good Faith
Some contracts require utmost good faith which is
a legal requirement that both parties must make
a full and fair disclosure of all facts affecting the
agreement. An insurance policy is such a
contract. It differs from non-insurance contracts
where utmost good faith is not required and
caveat emptor prevails.
233
Material Fact
An aspect of a risk that is significant when
assessing the risk in an insurance policy. The
risk can be sufficient to cause an insurer to deny
coverage. The risk can be sufficient to affect the
terms of an insurance policy.
234
Representation
A statement made by an applicant in the process
of obtaining an insurance policy. It deals with a
material fact and is made to induce the insurer
to provide coverage. Oral or written, it must be
true to the best knowledge of applicant.
235
Misrepresentation
A statement that is false with respect to a material
fact. If intentional, it can be the basis for an
insurer to void a policy at a future time.
236
Concealment
Failure to voluntarily disclose a material fact.
Goes beyond simply answering questions that are
asked. Insured has affirmative burden to
disclose material facts that can affect coverage.
Courts will allow uphold an insurer’s right to void
a policy as a result of the insured’s
concealment.
237
Question
A company operates refineries in Kuwait and
Qatar. It applied for insurance coverage on the
Qatar facility and completed a 6-page form
provided by the insurer. The form did not ask
about the safety record of other refineries and
the company did not report the suspension of
Kuwait refinery operations due to poor safety
practices. An explosion resulting from apparent
employee negligence damaged the Qatar
refinery. Will a court enforce the policy?
238
Answer
Not necessarily. Issues are:
 Is the information a material fact related to the
Qatar refinery?
 Is it concealment to be silent on the Kuwait
situation?
 Is a failure to add to the questions on the form
a violation of utmost good faith required for
insurance contracts?
239
Strict Compliance Rule
States that a contract is enforced in accordance
with its terms.
If terms are clear, meaning may not be distorted
by interpretations.
Rule covers insurance policies.
240
Question
Prudential provided financing for eight ships
owned by United States Lines. The law firm that
processed the agreement wrote down $92,885
instead of $92,885,000. USL went bankrupt and
sold the ships for $67 million. How much of the
$67 million could be claimed by Prudential
based on the contract.
241
Answer
The dispute raged for a long period of time before
the shipping company eventually agreed to give
Prudential the proceeds, but deducted $11
million. Prudential sued the law firm that made
the error and also settled out of court.
Time, January 2, 1989
242
Contract of Adhesion
An agreement prepared by one party and
accepted or rejected by another party without
modification.
An agreement not reached by negotiation.
As insurance companies draw up the insurance
policy, courts treat them as contracts of
adhesion.
243
Expectations Principle
Refers to the interpreting a contract of adhesion to
the meet the expectations of the party that did
not draw it up.
Impact. Fine print or tricky language will not
invalidate insurance coverage.
244
Question
A city bought standard fire coverage on its
properties. On page 19, the policy contains the
wording “Coverage will not be provided if the
employer hires anyone with a prior criminal
conviction.”
A fire occurs. It was started by a convicted felon
who was employed by the city. The insurance
company declined the claim for the loss. Is it
likely that a court will uphold the denial?
245
Answer
No. It is likely that the court will uphold the
expectations principle and require payment. The
city expects insurance coverage separately from
having to audit all its hiring practices.
246
Question
A hotel had labor problems and locked out
employees. Union members picketed the hotel
and engaged in aggressive actions with guests,
security guards, and local police.
After 23 days, an employee tossed a bottle of
gasoline into the kitchen. A fire destroyed the
restaurant. The insurer denied coverage
because the loss was caused by intentional
behavior of an employee of the insured. Does
the policy cover the loss?
247
Answer
Yes. The insured does not benefit from a
renegade employee committing a criminal act.
248
Presentation
Risk or Uncertainty
249
Question
When AIG declared its potential collapse in
September 2007, a University wanted to know the
impact on its enrollments for the 2008 spring term.
The request was for the most likely, best, and
worst possibilities. Is this a sound request?
250
Answer
Not at all. It fails to recognize that the impending
financial crisis produced an uncertainty, not a risk.
• Most Likely. The prior forecast based on
historical data was no longer likely.
• Best Case. No information existed on what
would be best under unknown circumstances.
• Worst Case. Bankruptcy if the whole system
collapsed?
251
Question
A stranger asks if you want to buy his car for the
blue book value. He refuses to allow you to take a
test drive. Would you buy the car? Why or why
not?
252
Answer
You should not buy the car.
• Uncertainty trumps risk.
• The seller knows more than you.
• Even with a discount from the blue book value,
you cannot determine a fair price without more
information.
253
Question
The stranger tells you that your good friend will
vouch for him. The friend is trustworthy and
reliable. Would you reconsider?
254
Answer
Of course. But the risk is still largely unknown due
to other factors.
• Rating agencies vouched for toxic assets in the
2008 financial crisis.
• If the friend does not know the individual is a
crook, the testimony of honesty is worthless.
255
Question
A man has made 25,000 automobile trips as a
driver in the past 10 years. He never drank alcohol
before driving and he never had an accident.
Tonight, he is leaving an office party after a
stressful two weeks of work. He has been drinking
moderately. What are the odds of having an
accident while driving based on the past statistics?
256
Answer
Who knows. The past statistics for the number of
instances driving while stressed and intoxicated is
zero.
257
Question
Hedgehog. Believes in big ideas.
Fox. Believes in lots of little ideas.
Which of these individuals makes more accurate
predictions.
258
Hedgehogs
•
•
•
•
•
Specialized. Experts in one area.
New Knowledge. Does not changed much.
Mistakes. Not acknowledged. Not possible?
Simplicity. Abide by orderly processes.
Confident. Firmly believe they are right.
Weak forecasters.
259
Foxes
•
•
•
•
•
Specialized. No. Ideas from in many areas.
New Knowledge. Pursue it.
Mistakes. Acknowledge them.
Simplicity. The world is complex.
Confident. Cautious that they are right.
Better forecasters.
260
Presentation
Modern Risk Management
261
Evolution of Risk Management
Risk management evolved as follows:
 Insurance -- The 1950s and 1960s. Risk
was defined in terms of insurance to protect
people, property, or assets. The risks were
transferred to insurance companies.
 Risk Managers – The 1970s and 1980s.
New tools were used to assess insurable risk.
They included non-insurance alternatives.
 Risk Managers -- The 1990s and Today.
Risk management address all risks.
262
Risk Management Roles
The Marsh-RIMS survey found 3 distinct roles:
 Strategic Player. Works with the CEO and
board to design risk management programs.
 Competent Risk Manager. Reduces or
transfers hazard risks, advises managers,
and buys insurance.
 Risk Specialist. Performs a technical risk
management role such as purchase
insurance, manage claims, and supervise
employee safety and physical security.
263
Strategic Player
A strategic player is likely to have:
 Significant responsibilities for activities with a
major impact on bottom line.
 Broad experience in production, marketing,
finance, or other areas outside of risk
management.
 The confidence of the CEO and board and
personal chemistry with C-level executives.
 Senior management interaction and clout.
264
Competent Risk Manager
A competent risk manager is likely to have:
 Significant insurance and risk management
experience.
 Skills in risk identification, assessment, and
mitigation.
 Organizational buy in from managers in other
units including production, finance, human
resources, and legal.
265
Risk Specialist
A risk specialist is likely to have:
 Technical skills in an area of responsibility.
 Prior experience in an insurance, brokerage,
or engineering environment.
 Knowledge of best practices for managing
risks in the area of responsibility.
 Good analytical skills and the ability to
prepare detailed management reports.
266
95% Confidence
We are trained to assess exposure in
normal times.
 95% of possibilities are almost two
standard deviations from a likely
outcome.
 Statistical analysis creates unwarranted
confidence ignoring 5% extremes.
267
95 Percent Scenarios
Many people need to think they have reduced
uncertainty when we are dealing with risk.
 Maybe not in the real world.
 How about in our own minds?
 Three scenarios:
(1) Likely.
(2) Best case.
(3) Worst case.
268
Question
What is the exposure with the following data when
we have a 95% chance of a “normal” market. ?
 A company borrowed $30 million.
 It had $40 million as receivables.
 90% of the receivables are collectable.
269
Answer
The risk is hedged:
 Debt:
 Receivables:
 Collection:
 Likely to collect:
 Exposure:
30 million
40 million
times 90%
36 million
6 million
270
Question
This occurs in a “normal market.” What
does common sense tell us about
“normal?”
271
Answer
It is not “normal” to be “normal.”
272
Confidence Level
Five percent outside 95% confidence limit.
 Random economic or political
conditions.
 Liquidity crisis.
 Reverse the collection number.
90% percent default,
The calculation quickly changes
273
Answer
Exposure
 Debt:
 Receivables:
 Collection:
 Likely to collect:
 Exposure:
30 million
40 million
times 10%
4 million
26 million
274
95 Percent Confidence
It is dangerous to rely too heavily on quantitative
techniques.
 We are trained to estimate outcomes in
“normal” times.
 95% of possibilities are approximately within
two standard deviations from a likely
outcome.
 Statistical analysis creates unwarranted
confidence ignoring 5% extremes.
275
Question
A public company has the following. Estimate the
likely, high, and low values for 2007 and 2008.
Year
Net Income EPS Share Price
2003
$72
2004
$ 9.9B
$3.73
$64
2005
$10,5B
$3.99
$67
2006
$14.0B
$5.36
$70
2007
$____B
$____
$___
2008
$____B
$____
$___
276
Answer
Year
2003
2004
2005
2006
2007
2008
Net Income
$ 9.9B
$10,5B
$14.0B
$ 6.2B
EPS
$3.73
$3.99
$5.36
$2.39
Share Price
$72
$64
$67
$70
$47
$ 1.30
277
Pursuing the 5% Solution
Create a central risk function. It:
 Should occupy a high position in the
organization.
 Should identify and share risk.
 Should not manage risk.
278
Scanning
A central risk function should scan
 Externally. Search the horizon for
operating, market, regulatory,
political, and other exposures.
 Internally. Examine the organization
for cultural, management,
leadership, human resources, and
unit life cycle risks.
279
Presentation
Lance Ewing, Risk Manager
280
Meet Lance Ewing
Lance Ewing is hardly an unknown individual in
the world of risk management:
 High profile vice president of risk
management of Harrah’s Entertainment.
 Former president of the Risk and Insurance
Management Society (RIMS).
 Instructor for Austin-based National Alliance
for Insurance Education & Research.
 Two master’s degrees: Law & Justice and
Occupational Safety.
281
Question
Lance started his career working for an insurance
company assessing risks in high hazardous
industries such as sawmills, logging companies,
hospitals, trucking companies and mobile home
manufacturers:
 Noted that clients did not want insurance.
 Goal was to bring down losses.
Is fire much of a problem in a sawmill?
282
Answer
According to Lance:
 “In the case of sawmills, it is not a question of
if it will burn but when it will burn.”
283
Question
Lance took the position of risk manager of the
Philadelphia School District with 300 schools and
facilities.
• He implemented a roof top to boiler room
inspection of every building.
• What did he find?
284
Answer
Lance discovered:
 Unknown assets that needed to be secured.
 Unknown exposures, such as storage tanks
without overflow shut off valves.
 Rotten electrical systems.
 Collapsing water towers on roof tops.
285
Question
Lance moved to become Senior Director of Risk,
GES Exposition Services.
• The company provided logistical support to
conferences and exhibitions.
• Was this a risky business?
286
Answer
Logistical support to conferences and exhibitions
had dangers everywhere. Lance handled:
 Trucks, and people operating in tight spaces.
 Forklifts racing around convention centers.
 Environmental hazards, contract reviews, and
compliance.
He sought ways to say “yes” when conditions
seemed to say “no.”
287
Question
GES downsized Lance.
•He interviewed with Park Place Entertainment
(later Caesar’s Entertainment).
•Did he get the position of Director of Risk
Management?
288
Answer
No. The story is:
 October 2002. Offered position as Director of
Risk Management?
 November 2002. Pressed for the title of
Executive Director and got it.
 Nov 2002 to June 2003. Implemented real
risk management. Saved millions.
 July 2003 . Promoted to Vice President of
Risk Management.
289
Question
Harrah’s bought Caesar’s in 2005.
•Harrah’s already had a risk manager.
•Lance was offered a severance package.
•Did he take it?
290
Answer
Lance did not get a chance to accept the package.
•After Harrah’s learned of his work at Caesar’s,
the company created the position of Vice
President Risk Management.
•It was created for Lance.
•He accepted it.
291
Question
Four weeks after Lance arrived at Harrah’s,
Hurricane Katrina hit the Gulf coast.
 Result was mass destruction of 3 Harrah’s
casinos.
Thirty days later, hurricane Rita hit Louisiana.
 Major damage to a fourth casino.
What did Lance do?
292
Answer
Lance did a wide range of risk and crisis
management for:
•Employees.
•Guests.
•Clients.
•Local Gulf coast communities.
His philosophy about the crisis?
 “Whatever does not kill you only makes you
stronger.”
293
Presentation
BP Oil Spill and
Chilean Mine Rescue
294
Two Stories in Extreme Times
Two lessons:
 BP Horizon Deepwater Oil Spill.
 Chile’s Copiapó Mining Accident
295
The BP Crisis
Day 1. (April 20, 2010)
Transocean is preparing to move the Deepwater
Horizon:
 Leased to the BP Group.
 Finished drilling a high pressure well for BP.
 Explosion creates an out-of-control sea-floor
oil gusher.
 The oil rig sinks.
296
In Fairness to BP
Horizon Deepwater was a very successful rig until
April 20, 2010:
 Seven-year safety record.
 Drilling some of the deepest wells in the
world.
 Never fail or mostly working?
 Should BP have known?
297
Mostly Working in Normal Times
2005: Texas City Refinery explosion.
 15 deaths.
 180 injuries.
 Cause: Hydrocarbon overflow. Maintenance
was cut as a cost-saving measure.
2009 post-disaster inspection findings:
 270 unfixed safety violations.
 439 new violations.
298
Mostly Working
At the BP Texas City refinery in :
 2006. Worker crushed between a pipe stack
and mechanical lift.
 2007. Worker electrocuted.
 2008. Worker killed by a 500-pound piece of
metal.
In the North Sea in good weather:
 2009. BP helicopter ferrying workers from BP
oil platform crashed killing all 16 on board.
299
Mostly Not Working
From 2007 to 2010, (Occupational Safety and
Health Administration) OSHA reported:
 851 willful safety violations by U.S. oil
refiners.
 829 by BP.
February 2010. OSHA reported that “BP has a
serious, systemic safety problem in their
company."
300
Information not Shared
On the Horizon Deepwater, workers were
surveyed prior to the oil spill:
 Concerned about safety practices.
 Feared reprisals if they reported problems.
 Unreliable equipment.
 “Run it, break it, fix it.”
 Did BP have access to the information?
301
Failure to Collaborate
On the Horizon Deepwater, Transocean did a 112page equipment assessment report:
 Unsafe conditions and practices.
 Rig had never been in dry dock.
 Blowout preventer rams and fail-safe valves
not inspected.
 26 components and systems in “bad” or
“poor” condition.
302
Lacey Resignation
Kevin Lacy was a drilling engineer who had
implemented a rigorous drilling safety program
at Chevron.
 He was hired by BP in 2007 senior vice
president for drilling operations.
 He tried to improve and standardize the BP
drilling policies and practices.
 He resigned in 2009 believing BP was not
committed to improving safety in offshore
drilling.
303
Ready to Respond?
Slow progress.
 It was one thing to be surprised.
 It is another thing to not be ready to respond.
 The crisis was attacked in stages.
 Close blowout preventer valves.
 Add a containment dome.
 Pump in heavy fluids
 Pump in mud and cement.
304
Outcome
Day 86. July 15, 2010 – Gusher was capped after
releasing 5 million barrels of oil.
305
Copiapó Mining Accident
A quite different picture
Day 1. August 5, 2010
 Copiapó, Chile.
 Collapse of San José copper-gold mine
 Trapped: 33 miners 770 meters below
ground.
 Did they survive?
306
Quick Response
Day 4.
 Chilean President Sebastián Piñera took
charge.
 Andre Sougarret, head of El Teniente mine
put in charge.
 Flew immediately to Copiapó.
 Took charge.
 Did they survive?
307
Situation at the Mine
Day 5.
Sougarret:
 Found a nest of confusion with rescue
workers, firefighters, police officers,
volunteers and relatives.
 Sent rescue workers home.
 Talked to escaped workers.
 Inspected the mine.
 Gathered maps.
308
Gathering Information
Day 6.
Findings:
 Huge block of stone closed the 4-mile
corkscrew shaft to the miners.
 Collapse involved 700,000 tons of rock.
 Reopening the shaft could cause another
collapse.
 Nobody knew if the miners were still alive.
309
Hope for the Miners
Day 7.
Sougarret talked to miners who had escaped the
collapse. Learned:
 Maps were not up-to-date.
 Likely location of trapped miners.
 Safe room with 48-hour supply of food and
water. Also repair shop.
 Ventilation shaft..
 Miners had a chance to be alive.
310
Find the Miners.
Green. 4 drill
shafts to galley
near shelter.
Blue. 4 drill shafts
to shelter.
2 points of
collapse
Repair shop.
Shelter.
311
Start of Success
Day 17.
 The 8 drills are getting close.
 One drill broke through into the shaft near the
safe areas.
 Rescue team heard banging on the drill head.
 Rescue team retrieved note.
312
Step 2. Prepare for the Rescue.
Days 18 to 69
 Drill two 28-inch wide shafts.
 Send food, water, oxygen, messages,
progress reports.
 Monitor health conditions.
313
Successful Rescue
Day 70. October 13, 2010
 From midnight to 11 pm.
 One at a time.
 33 times.
314
BP Weakness Before the Event
Before the extreme event:
 Safety information identified but not shared.
 Failures to comply with regulations not in
organized systems.
 Collaboration not encouraged.
315
BP Weakness after the Crisis
Weaknesses include:
 Failure to respond decisively to spill.
 Failure to respond decisively to clean up.
316
Copiapó Situation
Copiapó was different:
 Good. Local risk management.
 Bad. Central risk management.
317
Local Risk Management
Two safety features:
 “Safe” room.
Stocked with provisions.
 Ventilation shaft.
Separate escape route.
318
Central Risk Management
Weakness before the crisis:
 Failure to maintain safety standards in a
dangerous place.
 Failure to install ladders after failing a safety
inspection that closed the mine.
 Opportunity lost. A second collapse closed
the shaft.
319
Lesson Learned
The value of risk management is not determined
by the occurrence or outcome of extreme
events.
 With no such events, risk management may
be working.
 Or we may just be lucky.
 Who knows?
 But we should be ready.
320
Lesson Learned
The value of risk management is not determined
by the occurrence or outcome of extreme
events.
 With no such events, risk management may
be working.
 Or we may just be lucky.
 Who knows?
 But we should be ready.
321
Question
Did BP have the big picture in 2010?
322
Big Picture
Safety
Practices in
Texas
Cost
Cutting
Kevin Lacy
Resignation
Maintenance
of Oil Rig
itself
Board of
Directors
OSHA
Violations
Concerns of
Rig Workers
Big Picture
High pressure
well
Rig
needs
overhaul
Everybody
not ready
Top
Management
Rushing to
complete
drilling
41 miles from
Louisiana
wetlands
Interrelationship of Risk
Linkages.
Cost
Cutting
leads to
Poor
maintenance
of oil rig
41 miles from
Louisiana
wetlands
for a big loss
creating
Unsafe
practices
while
Everybody is
not ready
when
Rushing to
complete
drilling
325
Conclusion
Risk management has value.
 We cannot predict extreme events.
 We can look for the big picture.
 We can avoid some situations.
 We can prepare for others.
326
Presentation
Brokers, Agents, and Captives
327
Characteristics of a Broker
A broker is:
 Licensed. Authorized by a jurisdiction to
place insurance. (agents are also licensed)
 Independent. Can work with insurance
buyers and insurers.
 Representative of Buyer. Is accountable to
the buyer, not the insurer.
328
Characteristics of an Agent
An agent represents insurers and is accountable
to the insurer.
 Exclusive Agent. Works for one insurer.
 Independent Agent. Works for multiple
insurers.
An agent can make a policy effective (bind the
policy).
A broker cannot bind a policy.
329
Question
The Gilbert Insurance Services Company
arranges insurance coverage for wind and glass
damage to commercial buildings and structures.
Most of the coverage is placed with three
insurers, one each in London, Birmingham, and
Paris.
 How would you tell whether Gilbert is a broker
or agent?
 Why would you care?
330
Answer
Ask Gilbert.
You care because you want to know whether the
party is working for you or an insurer.
You might also care because an agent can make
a policy effective immediately.
You might also care because when you are talking
to an agent, you are talking to the insurer.
“I am an employee of the insurer.”
331
Captive Defined
A captive is an insurance company that provides
insurance coverage and services to one or more
organizations that own it.
332
Purposes of a Captive
Purposes are:
 Partial Retention. Useful to retain part of a risk and
reinsure losses above a specific level.
 Lower Cost of Insurance. Achieve tax benefits and
lower costs, allowing coverage at lower premiums.
 Tailored Coverage. Specialized coverage designed
to meet exact needs of owner (s).
 Coverage of Gaps. Fill in exclusions in other
policies. Example: exposures in countries with
currency restrictions or other regulations.
333
Categories of Loss
Expected Business Risk (EBR). EBR covers the
forecasted losses of customers and markets as
a result of operational problems. It also covers
hazards with low severity and high frequency,
such as accidents and theft.
Catastrophic Occurrence Risk (COR). These
are unexpected, low frequency, and high
severity losses.
334
Captives and Expected Business Risks
Expected business risks can be accepted by a
captive up to a point:
 These risks can be expressed as costs:
 They are known.
 They vary, often in random patterns, each
year.
 They can be benchmarked to industry
averages.
 They can be financed as part of the budget.
335
Question
How often do “once in a hundred years” events
happen?
336
Question (2)
Mount Etna is an active volcano in Sicily.
Characteristics of the mountain include:
 575,000 square kilometer mountain.
 140 major eruptions since 400 B.C.
 Fertile land supports intensive agriculture
(fruit, citrus, vineyards, vegetables).
 The city of Catania is in its shadow.
What is a once in a hundred years eruption event
for Catania?
337
Answer
Does anybody really know?
 Catania (pop. 700,000) destroyed in 122 B.C.
and 1669 A.D.
 Catania not affected in 1971, 1981, 1983,
1986, 1989, 1993, and 1998.
338
Presentation
Lloyd’s of London
339
Lloyd’s of London
In 1687 Edward Lloyd:
•1687. Opened a coffee house in London.
•1696. Posted Lloyd’s List with ship arrivals and
departures.
•1771, Formed the Society of Lloyd’s with 79
underwriters and worked with correspondents in
foreign ports.
•1871. Incorporated as Lloyd’s of London.
340
Question
What type of insurer is Lloyd’s?
341
Answer
Lloyd’s is not an insurance company:
 It is a marketplace for insurance carriers.
 It does not underwrite insurance business.
 It acts as an administrator of the placement of
insurance.
 It sets rules for the underwriters.
 It is self regulating.
342
Lloyd’s Operations
Lloyd’s operations include.
 A Market. For property and casualty
insurance for clients in 120 countries.
 Syndicates. Insurance is written by 66
syndicates and 1,300 specialist underwriters.
 Brokers. Bring coverage requests to
underwriting syndicates.
 Specialists. Particularly active in aviation,
marine, energy, and motor insurance.
343
Answer (1)
Is a person’s hair insurable as property
insurance?
344
Answer (2)
Ask Troy Polamalu of the Pittsburgh Steelers.
 Spokes person for Head and Shoulders.
 $1 million policy on hair.
345
Answer (2)
• Michael Flatley. Legs.
• Whitney Houston and Bruce Springsteen. Vocal
cords.
• Grain of Rice. Contains portrait of the Queen
Elizabeth and Prince Phillip engraved on it.
• Comedy Theatre Group. Liability coverage if a
member of its audience dies of laughter.
346
Trauma at Lloyd's
Late 80s, Early 90s:
• Had written long-tail policies.
• Large legal awards in U.S.
• Punitive damages on asbestos, pollution and
medical malpractice.
347
Question
Characteristics of insurers are:
 Corporate system sets the rules.
 Manager is king
 Off-the-shelf products
How does this compare with Lloyd’s?
348
Answer (1)
Very different at Lloyd’s:
 Corporate system sets the rules.
At Lloyd’s the individual underwriter
makes the decision without rules.
349
Answer (2)
Very different at Lloyd’s:
 Corporate system sets the rules.
At Lloyd’s the individual underwriter
makes the decision without rules.
 Manager is king.
At Lloyd’s, underwriter is king.
350
Answer (1)
Very different at Lloyd’s:
 Corporate system sets the rules.
At Lloyd’s the individual underwriter
makes the decision without rules.
 Manager is king.
At Lloyd’s, underwriter is king.
 Off-the-shelf products.
At Lloyd’s, products are bespoke
(custom-made to the buyer's
specification).
351
Lloyds Today
Home to skilled and experienced specialists
creating new areas of insurance:
• Kidnap and ransom.
• Space and aviation.
• Cyber-liability.
Question
Three Christian women requested an insurance
policy to cover expenses they would incur if one
of them immaculately conceived a baby and
could prove that it was the child of God. The
women, who were in the age range of 50 years,
were members of a Christian group. Would an
insurance company issue such a policy?
353
The Center for
Professional
Education
Answer
One did. www.Britishinsurance.com issued a
policy in 2000 with a payout of one million
pounds. The premium was 100 pounds year. In
2006, the company cancelled the policy after it
was flooded with complaints from Catholics
when the story appeared in a newspaper.
Scottish Record & Sunday Mail Limited, June 23, 2006
354
The Center for
Professional
Education
Presentation
Bermuda Insurance
355
Political and Economic Stability
Bermuda has a long history of:
• Political Stability. House of Assembly dates
from 1620.
• Economic Stability. One of highest standards
of living in the world.
• Social Stability. Relaxed and easy-going
culture.
356
Legal and Regulatory System
Bermuda’s system:
• Builds upon English common law.
• Supports legislation favorable to business.
• Quickly resolves commercial disputes.
• Provides prudent and credible regulation of
insurance companies.
357
Business Environment
The Bermuda environment for insurance
companies is characterized by:
• Government Openness. Commercial
objectives can be achieved quickly.
• Lack of Red Tape. Approvals and permissions
without delay.
• Strict Regulation. Inspires confidence and
high-quality insurers and practices.
358
Professional Expertise
Bermuda has world-class capabilities in.
• Banking. Major international banks and
communications.
• Accounting. Automated recordkeeping and
transactions.
• Law. Supports legal aspects of insurance
agreements.
• Actuarial Science. Quantitative assessments
of risk.
359
Communications Infrastructure
Bermuda has world-class capabilities in.
• Telecommunications. Modern and reliable.
• E-commerce. Cutting edge support systems
for transactions.
• Technology. Satellite and fixed-link
communications with speed and ample
capacity.
360
Transportation
Daily flights to:
• London.
• New York.
• Other cities.
361
Taxes
The tax structure is:
• Simple. Easy to understand and comply with
requirements.
• Reliable. Stable and consistent.
• Relatively Low. Tax savings compared to
other jurisdictions.
362
Tax Specifics
In Bermuda there are no taxes on:
• Profits.
• Corporate income.
• Dividend Remittances.
• Capital gains.
363
Bermuda Market Size
Bermuda is an important factor in world insurance
markets:
 1,600 insurance companies.
 Assets $200 billion.
 Annual premiums $50 billion.
 20% of Lloyd’s capacity.
 World’s second largest reinsurance market
after New York.
364
Presentation
Money Laundering
365
Question
What is money laundering?
366
Answer
Money laundering:
 Is the practice of engaging in financial
transactions to conceal the identity, source, or
destination of money.
 Covers any transaction that creates a “clean”
asset from an illegal act.
 A major action of underground and illegal
economies.
367
Question
Who launders money?
368
Answer
Money is laundered by:
 Individuals.
 Small and large businesses.
 Tax evaders.
 Corrupt officials.
 Members of organized crime.
 Cults.
 Corrupt states.
369
Question
What are examples of “clean assets?”
370
Answer
The same assets that move in outlaw trade.
Untraceable cash, gold, diamonds, seafood,
timber, people, industrial equipment, medicines,
computers, weapons, food, appliances, chemicals,
vehicles, counterfeit fashions, compact disks,
digital video disks, cell phones, and various
electronics.
371
Question
How does it get laundered?
372
Answer
Money is laundered through a complex network of
shell companies and trusts based in offshore tax
havens.
 What is the annual volume of laundered
money?
 What country is the largest in terms of
laundering?
373
Answer
Over $1 trillion is annual volume.
According to the International Monetary Fund, the
biggest money laundering centers in the world:
 United States (50%)
 5 Caribbean countries (20%).
Source: Daniel J. Mitchell (Heritage Foundation), 2002, Center for
Freedom and Prosperity Foundation, P.O. Box 10882, Alexandria, Va.
22310
374
Question
Churning refers to making an account excessively
active by frequent purchases and sales: It is used
two places. What are they?
375
Answer
Two kinds of churning:
 Broker Commissions. Brokers churn
accounts to generate commissions on each
transaction.
 Money Laundering. Individuals churn
accounts to make it difficult to follow a trail of
illegal money.
376
Question
What group has the most difficulty laundering
money?
377
Answer
Drug traffickers because they deal almost
exclusively in cash:
 Cash draws the attention of law-enforcement
officials.
 Cash is heavy.
378
Presentation
Currency in Outlaw Trade
379
Question
In circulation, totaled $1100 billion in 2012.
Bill
Dollar Value
Percent
$1
$ ____ billion
____%
$5
$ ____billion
____%
$10
$ ____ billion
____%
$20
$ ____ billion
____%
$50
$ ____ billion
____%
$100
$ ____ billion
____%
Total
$ 1,100 billion
100%
380
U.S. Paper Currency
In circulation, totaled $1100 billion in 2012.
Bill
Dollar Value
Percent
$1
$ 11 billion
1%
$5
$ 11 billion
1%
$10
$ 22 billion
2%
$20
$ 143 billion
13%
$50
$ 66 billion
6%
$100
$ 847 billion
77%
Total
$1100 billion
100%
381
Question
What percent of $100 bills are outside the United
States?
382
Answer
Outside the United States.
• $735 billion
• 2/3rd of all
• $100 bills.
383
Currency
$100
384
Currency
$10,000
385
Currency
One million dollars.
386
Currency
0ne hundred million dollars.
387
Currency
388
Question
How much gold is hidden each year from
government authorities that regulate and tax
South African gold mines?
389
Answer
One estimate is 5 tons.
390
Steps in Money Laundering
The three steps of money laundering are:
 Placement. Deposit the dirty money in a
legitimate financial institution.
 Layering. Send the money through various
financial transactions to change its form and
make it difficult to follow.
 Integration. Move the money into the
mainstream economy in a way that makes it
appear to come from a legal transaction.
391
Question
Which step is the most dangerous for the entity
laundering money?
392
Answer
Placement is the most risky:
 Large amounts of cash are conspicuous.
 Banks are required to report high-value
transactions.
393
Question
Dirty money is deposited in 5 banks in the
Caribbean. The owner sets up an online business
in the United States. How can the money be
“clean” in a New York bank?
394
Answer
 Create invoices in the U.S. business and bill
“clients” in the Caribbean.
 Accept credit card payments from the
“clients.”
 Deposit the credit card receipts in the New
York bank.
 Pay for the credit card obligations using
money in the Caribbean banks.
395
Question
What are some forms of monetary layering?
396
Answer
Monetary layering may consist of:
 Bank-to-bank transfers among:
Different accounts.
In different names.
In different countries.
 Making deposits and withdrawals to
continually:
Vary the amount of money in accounts.
Changing the money's currency,
397
Question
What is the best but most complex approach to
layering?
398
Answer
Purchase high-value items (boats, houses, cars,
diamonds) to change the form of the money. This
takes the money out of the banking system and
breaks the monetary chain from dirty to clean.
399
Question
During 1995-1999, two Russian banks deposited
more than $7 billion in their accounts at the Bank
of New York. Then, the funds were transferred to
3 shell corporations who further used 160,000 wire
transfers to distribute the money to many other
bank accounts. Why did the bank engage in the
business?
400
Answer
To help Russian individuals and businesses
transfer funds in violation of Russian currency
controls, custom duties, and taxes.
401
Question
In 2005 a U.S. Department of Justice investigation
ended with a non-prosecution agreement forcing
the Bank of New York to pay $38 million to the
U.S. government to settle two criminal probes
involving a failure to report $7.5 billion in illegal
Russian transactions. Did the Bank get off too
easy?
402
Answer
Not necessarily. In May of 2007, the Russian
Federal Customs Service filed a lawsuit in
Moscow alleging the bank owes Russia $22.5
billion. The case moved into hearings in early
2008 and settlement talks began in late 2009.
403
Hawalas
Hawalas are informal networks of money brokers
located primarily in the Middle East, Africa, and
Asia. Hawalas are:
 Centuries-old remittance systems based on
trust.
 Located in ethnic communities.
 Located where modern financial services are
unreliable.
 Used by immigrants remitting money home to
family members.
 Useful for laundering money.
404
Question
How does a hawala work?
405
Answer
The steps are:
 Customer gives a hawala broker money to be
transferred to a recipient in another city.
 Hawala broker calls broker in the destination
city and requests funds to be given to
recipient.
 No money moves. Offsetting obligations
settled later.
 Both brokers take a fee.
406
Question
Why is the Hawala system attractive for money
laundering?
407
Answer
Hawalas are attractive because:
 System is entirely based on honor.
 No records are created for individual
transactions.
 Each broker keeps a running tally of amounts
owed.
 Money can be safely transferred without a
reliable legal and judicial environment.
408
Question
What is a shell bank?
409
Answer
A shell bank is a bank that exists without a
physical presence in any legal jurisdiction. They
are:
 Licensed in a specific country.
 Not likely to have a staff.
 Often operate as part of another business.
 May operate from an individual’s personal
residence.
410
Question
What is the goal of a shell bank?
411
Answer
 A shell bank is created to allow anonymous
transfer of money.
 Shell banks provide the largest tax haven for
money laundering.
 The US Patriot Act prohibits U.S. banks from
transferring money through unregulated shell
banks.
412
Black Market Peso Exchange (1)
This is a system by which drug money profits are
laundered through international trade and blocked
currency accounts. A U.S. example.
 Columbian drug dealers sell drugs to the U.S.
 Receipts are deposited in a U.S. bank.
 The U.S. bank account is controlled by a
peso broker in Columbia.
 The peso brokers gives pesos to the
Columbian drug dealer.
 The drug dealer is now out of the picture.
413
Black Market Peso Exchange (2)
 The broker advertises to Colombian importers
that foreign funds are available for the
purchase of foreign products.
 Colombian importers place their orders.
 The broker makes purchases for the
Colombian importers.
 The importers pay the broker in pesos.
 The importers smuggle the goods into
Columbia avoiding taxes.
414
Casinos
Casinos are cash-intensive businesses that often
provide money laundering opportunities:
 Cash is exchanged for casino chips.
 Casinos transfer money.
 The number of gaming establishments in the
U.S. is growing.
 Casinos on Indian reservations today handle
more money than Las Vegas and Atlantic City
combined.
415
Question
Two men have $300,000 of dirty money that they
need in France as clean money. They go to a
casino and play roulette. How do they launder the
money?
416
Answer
Bet equal amounts of money on odd and even
numbers. After a number of bets, ask for a receipt
to show “winnings.” Report the winnings to tax
authorities.
417
Money Services Businesses
A money services business (MSB) is any nondepository entity offering formal or informal
financial transfer services. MSBs:
 Include money transmitters, check cashers,
currency exchangers, and sellers of money
orders and traveler’s checks.
 Present challenges for regulation and
oversight.
418
Question
A relatively recent development is likely to replace
many prior forms of money laundering. What is it?
419
Answer
The Internet. Cybercash refers to Internet
transfers of money. The Internet allows transfers:
 Of large sums of money from one location to
another.
 Without using a bank.
 To be totally anonymous.
 From a jurisdiction where the transfer is not
illegal.
420
Question
What is Digicash?
421
Answer
Digicash is a company that allows individuals and
businesses to transfer money over the Internet
using encryption, authentication, and digital
signatures.
Founded in 2005 by veterans and members of elite technology units of
the Israeli Army.
422
Question
A stored-value card has money loaded on to it in
advance of usage. It works like a credit card with
the additional feature of allowing anonymous
purchases. Who would want to use such a card?
Do many people use such a card?
423
Answer
People seeking to make anonymous purchases?
Transactions amounted to $50 billion in 2009.
424
Question
Knowing that a local issuer of Visa stored-value
cards required identification for a single purchase
of more than $2,000 of cards, members of a
criminal organization fanned out in New York City.
Each purchased a maximum of seven cards with a
$250 limit. What happened to the cards?
425
Answer
Ten days later the $250 cards were being sold on
the street in Medellin, Colombia for the peso
equivalent of $225. Others were used at ATMs
where the total cash was removed from the cards
after payment of an ATM fee.
426
Question
Madhu Koda was Minister of Mines and Geology
and then the Chief Minister in Jharkhand from
2006 to 2008. In these posts in an East Indian
state of some 20 million residents, Mr. Koda had
control over iron ore, coal, copper, bauxite,
uranium, and more. This was a fortunate position
as he accepted bribes exceeding $3 million a
month. What did he do with his estimated one
billion dollars?
427
Answer
How on earth did he launder so much money?
His story is testimony to the pervasive and
sophisticated global mechanisms of outlaw trade
and money laundering.
428
Role of Banks
Banks are the focus of most government efforts to reduce
money laundering. In the U.S.
 Bank Secrecy Act (BSA). Requires currency
transaction reports (CSRs) and record keeping for
wire transfers.
 Money Laundering Control Act. Money laundering
is a criminal offense.
 Anti-Money Laundering Act. Penalizes banks who
fail to report suspicious transactions.
 USA PATRIOT Act. Tighter banking rules on
customer identification, dealings with foreign banks,
and sharing information.
429
Question
Governments and international agencies have
declared war on money laundering. What percent
of illegal transactions have been uncovered and
halted in 2007?
 More than 10%
 5%-9%.
 1%-4%.
 Less than 1%.
430
Answer
Less than two-tenths of one percent.
431