Associate in Risk Management 54
Exam Review Session
April 16, 2012
2:00 – 4:00PM
Presented by: Rich Berthelsen, Esq., MBA,
CPCU, ARM
Senior Director of Content for the Institutes
610-644-2100 ext. 7995
Berthelsen@TheInstitutes.org
Overview
What to Expect
•
•
•
•
Exam experience
Top 25 most challenging parts
Disclaimer
Practice exam questions per chapter are available on-line
Challenging Part 1 – Ch.1
Earnings Stability
Post-Loss Goals:
Six possible post-loss goals include the following:
1. Survival
2. Continuity of operations
3. Profitability
4. Earnings stability
5. Social responsibility
6. Growth
Challenging Part 1 – Ch.1
Earnings Stability
Rather than strive for the highest possible level of profits (or
surpluses, for not-for-profits) in a given period, some
organizations emphasize earnings stability over time. Earnings
stability requires precision in forecasting risk management
costs, such as insurance or loss prevention.
Challenging Part 2 – Ch.1
Internal Structure
Risk Management Department Structure
The head of the risk management department should assess the
organization’s operations and the capabilities of the existing
risk management staff to determine the proper internal
structure that is needed.
Challenging Part 2 – Ch.1
Internal Structure
In small risk management departments, there may be only one
person. The rate at which staff are added depends on the
organization’s operations and its management’s attitudes about
risk management’s role in the organization. Some
organizations pride themselves on having minimal corporate
staffing to serve decentralized branches or departments. Others
prefer a large staff, centralized to perform many tasks for each
branch or department. For a small risk management
department, additions to personnel often begin with a safety
and loss prevention manager and a claim manager.
Challenging Part 2 – Ch.1
Internal Structure
In medium-sized risk management departments, more
assistance is required when:
• insurance is used to finance risk
• more complex aspects of safety and loss prevention emerge
• volume of claims increase
Challenging Part 2 – Ch.1
Internal Structure
In large risk management departments, the director becomes
less involved in implementing the technical aspects of risk
management and more involved in managerial functions. The
large department may also contain several positions in
safety/loss prevention, health, and specialized claim
personnel—some specializing in property claims, others in
liability claims, and some in employee benefits. High
frequency of particular types of retained losses, such as
workers’ compensation claims or products liability claims,
increases the need for specifically trained claim personnel.
Challenging Part 3 – Ch.2
Financial Statements and Underlying Accounting
Records
Methods of Identifying Loss Exposures
• Risk assessment questionnaires
• Loss histories
• Financial statements and underlying accounting records
• Other records and documents
• Flowcharts and organizational charts
• Personal inspections
• Expertise within and beyond the organization
Challenging Part 3 – Ch.2
Financial Statements and Underlying Accounting
Records
Financial statements include:
• A balance sheet is a statement of an organization’s financial
condition as of a particular date.
• An income statement (also called a profit and loss statement)
is a financial report that shows the profit or loss for a specific
period.
• A statement of cash flows (also called the statement of changes
in financial position or the statement of sources and uses of
funds) is a financial statement that shows an organization’s
cash receipts and cash payments during a specified period.
Challenging Part 4 – Ch.2
Separation, Duplication, and Diversification
Risk Control Techniques
Risk control is a conscious act or decision not to act that
reduces the frequency and severity of losses or makes losses
more predictable. Risk control techniques include the
following:
• Avoidance
• Loss prevention
• Loss reduction
• Separation, duplication, and diversification
Challenging Part 4 – Ch.2
Separation, Duplication, and Diversification
Separation is a risk control technique that disperses a particular
asset or activity over several locations and regularly relies on
that asset or activity as a part of the organization’s working
resources.
Duplication is a risk control technique that uses backups,
spares, or copies of critical property, information, or
capabilities and keeps them in reserve.
Diversification is a risk control technique that spreads loss
exposures over numerous projects, products, markets, or
regions.
Challenging Part 5 – Ch.3
Economic Value
Methods of Valuing Property
After indentifying the property exposed to loss, its value needs
to be determined using one of these approaches:
• Historical cost
• Tax-appraised value
• Book value
• Replacement cost
• Reproduction cost
• Functional replacement cost
• Market value
• Actual cash value
• Economic value
Challenging Part 5 – Ch.3
Economic Value
Economic value is the amount that property is worth based on
the ability of the property to produce income. Unlike other
valuation methods, economic value is not affected by the cost
of the property or the expense that would be incurred to repair
or replace it.
Challenging Part 6 – Ch.3
Bailee’s Interest
Legal Interests in Property
Can be categorized as:
• Ownership interest
• Secured creditor’s interest
• Seller’s and buyer’s interest
• Bailee’s interest
• Landlord’s interest
• Tenant’s interest
Challenging Part 6 – Ch.3
Bailee’s Interest
A bailee is a person or entity who receives property from
another (the bailor) under a bailment contract.
A bailment contract requires the bailee to keep the property in
safekeeping for a specific purpose and then to return the
property to the bailor when the purpose has been fulfilled.
Bailments frequently arise in business transactions involving
repair, storage, or transport of personal property.
Challenging Part 7 – Ch.4
Elements of Negligence
Legal Liability Based on Torts
A tort is a wrongful act or omission, other than a crime or
breach of contract, for which the remedy is money.
Torts can be classified into three types: (1) negligence, (2)
intentional torts, and (3) strict liability torts.
Negligence is the failure to exercise the degree of care that a
reasonably prudent person would have exercised under similar
circumstances to avoid harming another.
Challenging Part 7 – Ch.4
Elements of Negligence
A plaintiff must prove all four elements of negligence:
1. The defendant owed a legal duty of care to the plaintiff.
2. The defendant breached the legal duty of care owed to the
plaintiff.
3. The defendant’s breach of duty was the proximate cause of
the plaintiff’s injury or damage.
4. The plaintiff suffered actual injury or damage.
Challenging Part 8 – Ch.5
Legal Duty Owed
Basis for Premises and Operations Liability
The basis for this liability usually stems from negligence.
Property owners and occupiers (renters) have a legal duty
owed to other persons on the premises.
Challenging Part 8– Ch.5
Legal Duty Owed
The degree of care a property owner or occupier owes to others
depends on their reason for being on the property. Individuals
who enter onto the property of others fall into one of three
categories:
1. Business invitees
2. Licensees
3. Trespassers
Challenging Part 8 – Ch.5
Legal Duty Owed
A business invitee is an individual who has permission to be
on the property of another for the purpose of doing business.
Business invitees are owed the highest degree of care. It is not
sufficient simply to warn the invitee of unsafe conditions. The
law requires a reasonable effort to discover and correct
hazardous conditions before they cause injury. Discovery of a
hazardous condition can be by actual or constructive notice.
Challenging Part 8 – Ch.5
Legal Duty Owed
A licensee is an individual who has permission to go onto the
property of another for his or her own purposes. Although
licensees have permission to be on the property they do not
necessarily have a specific invitation.
Licensees generally must accept the condition of the property
as it exists, and are owed a degree of ordinary care, such as
warnings of known dangers.
Challenging Part 8 – Ch.5
Legal Duty Owed
A trespasser is an individual who intentionally goes onto the
property of another without permission or any legal right to do
so.
The only duties owed to trespassers are to not intentionally
harm them. Generally, a trespasser assumes the risks inherent
in entering the land, except:
• When young children are lured onto the land by an
attractive nuisance
• When the land possessor knows and tolerates trespassers
Challenging Part 9 – Ch.5
Breach of Warranty
Products Liability Loss Exposures
Arise out of injuries or damage that result from a defective
product. The liability loss exposures faced by product
manufacturers, distributors, and sellers arise from the
following three sources:
1. Breach of warranty
2. Negligence
3. Strict liability in tort
Challenging Part 9 – Ch.5
Legal Duty Owed
Breach of warranty - The failure to adhere to an express or
implied warranty regarding the title, quality, content, or
condition of the goods sold.
Implied warranty - An obligation that the courts impose on a
seller to warrant certain facts about a product even though not
expressly stated by the seller.
Implied warranty of merchantability - An implied warranty that
a product is fit for the ordinary purpose for which it is used.
Challenging Part 9 – Ch.5
Legal Duty Owed
Implied warranty of fitness for purpose - An implied warranty
that a product is fit for a particular purpose; applies if the seller
knows about the buyer’s purpose for the product.
Express warranty - A statement or representation about a
product’s quality or suitability for its intended use.
Challenging Part 10 – Ch.6
Persons and Employments Covered
Employers’ Liability Under Statutes
The following features in the U.S. workers’ compensation laws
affect the scope of workers’ compensation loss exposures:
• Choice of law
•·Persons and employments covered
• Injuries and diseases covered
• Benefits provided
• Procedures for obtaining benefits
Challenging Part 10 – Ch.6
Persons and Employments Covered
As a general rule, an employer’s legal obligations for
occupational injury or disease extend to employees only, not to
independent contractors.
Challenging Part 10 – Ch.6
Persons and Employments Covered
• An employee is one the employer fixes the hours of
employment, provides the tools to do the work, and supervises
the results of the work, as well as the methods and means of
doing the work.
• An independent contractor is one the employer does not
typically fix the hours of employment and may provide the
tools to do the work. The employer defines the results of the
work but does not supervise the methods and means of doing
the work.
Challenging Part 10 – Ch.6
Persons and Employments Covered
Exception to the general rule is a statutory employee which is
an independent contractor’s employee who, because the
independent contractor has not maintained workers’
compensation insurance, is considered to be an employee of
the principal employing the independent contractor.
Challenging Part 11 – Ch.6
Statute
Environmental Liability Causes of Loss
An organization can incur environmental liability under tort,
contract, or statute.
Challenging Part 11 – Ch.6
Statute
The majority of environmental statutes regulate materials that
are reactive, corrosive, toxic, or flammable. These statutes
contain provisions that can lead to injunctions, fines, and other
penalties for noncompliance, such as revocation of permits and
criminal prosecution of corporate officers.
Challenging Part 11 – Ch.6
Statute
Continued on next 2 slides
Challenging Part 11 – Ch.6
Statute
Continued on next slide
Challenging Part 11 – Ch.6
Statute
Challenging Part 12 – Ch.7
Duty of Care
Directors and officers have the duty of care (also called the
duty of diligence) in the performance of their corporate
functions. A definition of “duty of care” is that directors must
discharge their duties with the care that a person in a like
position would reasonably believe appropriate under similar
circumstances.
Challenging Part 12 – Ch.7
Duty of Care
Business judgment rule is a legal rule that provides that a
director will not be personally liable for a decision involving
business judgment, provided the director made an informed
decision and acted in good faith.
Challenging Part 13 – Ch.7
Duties and Liabilities of Employee Benefit Plan
Fiduciaries
Employee Retirement Income Security Act of 1974 (ERISA)
The federal law that governs retirement and other benefit
plans. It was enacted in response to abuses and underfunding
in many benefit plans.
Challenging Part 13 – Ch.7
Duties and Liabilities of Employee Benefit Plan
Fiduciaries
• Care. ERISA specifies that a fiduciary must act with the care,
diligence, and skill that would be exercised by a reasonably
prudent person in the same or similar circumstances.
• Loyalty. A fiduciary must act in the best interests of the plan
and all of its participants and beneficiaries.
• Diversification. A fiduciary must ensure that the plan’s
investments are sufficiently diversified to minimize the risk of
large losses.
• Obedience. A fiduciary must act according to the plan
documents and applicable law.
Challenging Part 14 – Ch.8
Value Maximization and Social Responsibility
Role of Corporate Governance
Shareholders of for-profit corporations generally want
managers to make risk management and other decisions that
maximize the value of their shares, which in turn generally
requires maximization of the corporation’s total economic
value.
Challenging Part 14 – Ch.8
Value Maximization and Social Responsibility
Role of Corporate Governance
In part because of corporate scandals, increased media and
regulatory attention has focused on whether the goal of
maximizing a corporation’s economic value (value
maximization) appropriately serves the overall interests of
society.
Challenging Part 15 – Ch.8
Corporate Financial Reporting
Key Issues in Corporate Governance
Five corporate governance issues that affect long-term
economic value creation:
1. Pressures from shareholder expectations and behavior
2. Executive incentives and compensation
3. Accountability of directors
4. Corporate financial reporting
5. Importance of integrity
Challenging Part 15 – Ch.8
Corporate Financial Reporting
Corporate Financial Reporting is concerned with the extent
external (independent?) auditors of corporate financial reports
accommodated deceptive reporting practices in recent
corporate scandals.
Also, is the U.S. rules-based accounting system preferable to
principles-based systems practiced in the United Kingdom?
Challenging Part 16 – Ch.9
Trends Affecting Personnel Loss Exposures
Forecasting personnel losses requires attention to demographic
trends that affect employee morbidity, mortality, retirement, or
employee separations. One of the most significant
demographic trends in the U.S. is the aging of the population,
particularly the baby boomers.
Challenging Part 16 – Ch.9
Trends Affecting Personnel Loss Exposures
Continued on next slide
Challenging Part 16 – Ch.9
Trends Affecting Personnel Loss Exposures
Challenging Part 17 – Ch.10
Financial Consequences of Business Interruption
To assess the financial consequences of a net income loss from
a business interruption, a risk management professional should
consider the following factors that affect the severity of a net
income loss:
1. Length of business interruption
2. Degree of business interruption
3. Changes in revenues
4. Changes in expenses
5. Restoration to normal income
Challenging Part 18 – Ch.10
Methods of Assessing Net Income Loss Exposures
The methods for assessing any loss exposure (see Slide 9) are
also useful in assessing an organization’s net income loss
exposures. The methods are as follows:
1. Risk assessment questionnaires
2. Loss histories
3. Financial statements and underlying accounting records
4. Other records and documents
5. Flowcharts and organizational charts
6. Personal inspections
7. Expertise within and beyond the organization
Challenging Part 19 – Ch.11
Trend Analysis
Trend Analysis identifies patterns in past losses and then
projects these patterns into the future. The two most common
types of trend analysis are time trends and regression analysis.
Challenging Part 20 – Ch.11
Regression Analysis
• Regression analysis definition: “A statistical technique used to
estimate relationships between variables”
• Why calculate it? To find the equation for the line that best fits
the data points and to project this line to forecast the number
of future losses.
• How to calculate it? y = a + bx
Challenging Part 20 – Ch.11
Regression Analysis
The equation for regression analysis is y = a + bx
y = the dependant variable, which is the variable being forecast
(losses).
x = the independent variable, which is the variable that
determines the value of the variable being forecast (years)
a = the y intercept
b = the slope
Challenging Part 20 – Ch.11
Regression Analysis
Continued on next slide
Challenging Part 20 – Ch.11
Regression Analysis
Challenging Part 20 – Ch.11
Regression Analysis
Challenging Part 21 – Ch.12
Alternative Probabilities
An alternative probability is the probability that any one of
two or more events will occur within a given period.
The formula for calculating alternative probabilities is
determined by whether the events involved are mutually
exclusive or non-mutually exclusive.
Challenging Part 22 – Ch.12
Mutually Exclusive Events
For mutually exclusive events, the probability that any one of
them will occur is the sum of their separate probabilities:
p(A or B) = p(A) + p(B).
For example, the probability of rolling either a three or a five
on one roll of one die is:
p(3 or 5) = 1/6 + 1/6 = 2/6 (or 1/3).
Challenging Part 23 – Ch.12
Non-Mutually Exclusive Events
When two events can occur at the same time, they are not
mutually exclusive. The probability that at least one, and
possibly both of them, will occur is the sum of their separate
probabilities minus the joint probability that they will both
occur, this can be expressed as:
p(A or B or both) = p(A) + p(B) – p(A and B).
Challenging Part 23 – Ch.12
Non-Mutually Exclusive Events
For example, the probability of drawing a five from a deck of
cards is 1/13, the probability of drawing a club is 1/4, and the
probability of drawing the five of clubs is 1/52. Therefore, the
probability of drawing a five or a club is calculated as:
p(five or club) = p(five) + p(club) – p(five and club)
= 1/13 + 1/4 – 1/52
= 4/52 + 13/52 – 1/52
= 16/52
= 4/13.
Challenging Part 24 – Ch.13
Net Present Value (NPV) Method
•
•
•
Net present value definition: “The present value of all
future net cash flows (including salvage value) discounted
at the cost of capital, minus the cost of the initial
investment, also discounted at the cost of capital.”
Or stated another way:
NPV = PV (sum of future net cash flows) – (initial
investment)
Why calculate it? Ranking capital investment proposals
How to calculate it? See remaining slides for this
challenging part.
Challenging Part 24 – Ch.13
Net Present Value (NPV) Method
Find the:
1. Amount of initial investment
2. Useful life of asset invested in
3. Differential annual after-tax cash flow
4. Minimum acceptable rate of return
5. Salvage value
Continued on next slide
Challenging Part 24 – Ch.13
Net Present Value (NPV) Method
6.
Present value of all differential cash in flows:
- if equal inflows each year use the PVF in Appendix B,
p.13.34
- if unequal inflows each year use a different PVF per year
in Appendix A, p. 13.32
7. Subtract the initial investment from the present value of all
differential inflows (is the result positive or negative?)
Challenging Part 24 – Ch.13
Net Present Value (NPV) Method
Continued on next slide
Challenging Part 24 – Ch.13
Net Present Value (NPV) Method
Challenging Part 25 – Ch.14
Considering Uncertainty in Cash Flow Analysis
• What happens if the risk management professional must
account for costs that cannot be measured with much precision
but are expected to reduce future cash flow? You have the cost
of uncertainty
• Why calculate it? To give management a more complete
estimate of a proposal's cost.
Challenging Part 25 – Ch.14
Considering Uncertainty in Cash Flow Analysis
• How to calculate it?
1. Assign a subjective estimate of the cost of uncertainty to
each risk management technique
2. Deduct the assigned cost of uncertainty from the after-tax
net cash flow
3. Calculate the NPV and the IRR using the net cash flow
adjusted for the assigned costs of uncertainty
Challenging Part 25 – Ch.14
Considering Uncertainty in Cash Flow Analysis
Continued on next 2 slides
Challenging Part 25 – Ch.14
Considering Uncertainty in Cash Flow Analysis
Continued on next slide
Challenging Part 25 – Ch.14
Considering Uncertainty in Cash Flow Analysis
Wrap Up
Questions?
• Ask me now before you leave or
• Call 610-644-2100 ext.7995 or
• Email Berthelsen@TheInstitutes.org
If you had fun tell your friends.