Risk and
Insurance
Part 5 Managing Growth in the
Small Business
PowerPoint Presentation by Charlie Cook
The University of West Alabama
Copyright © 2006 Thomson Business & Professional Publishing.
All rights reserved.
Looking Ahead
After studying this chapter, you should be able to:
1.
Define risk and explain the nature of risk.
2.
Explain how risk management can be used in coping
with business risks.
3.
Describe the different types of business risk.
4.
Explain the basic principles used in evaluating an
insurance program.
5.
Identify the different types of business insurance
coverage.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 21–2
Risk
• Risk is a condition in which there is a possibility of an
adverse deviation from a desired outcome.
• Business risks can be classified into two broad
categories: market risk and pure risk.
• Market risk is the uncertainty associated with an
investment decision.
• Pure risk exists in a situation where only loss or no loss
can occur—there is no potential gain.
• In general, only pure risk is insurable.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 21–3
Risk Management
• Risk management is concerned with protection of the
assets and the earning power of a business against loss.
• Risk management involves identifying and evaluating
the severity of risks, selecting methods for managing
risk, implementing the decision, and evaluating and
reviewing prior decisions.
• The two ways to manage business risks are risk control
and risk financing. Risk control is designed to prevent,
avoid, or reduce risk, while risk financing involves
transferring the risk to someone else or retaining the risk
within the firm.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 21–4
Types of Risk
• Pure risks that face any business fall into three groups:
property risks, liability risks, and personnel risks.
– Property risks involve potential damage to or loss of real property
(e.g., land and buildings) and personal property (e.g.,
equipment).
• For insurance purposes, property may be valued based on its
replacement value or its actual cash value (ACV).
• A peril is defined as a cause of loss, either from naturally occurring
events or from the actions of people.
• Property losses are categorized as direct losses, arising from obvious
physical damage, or indirect losses, which result from inability to
carry on normal operations because of a direct loss to property.
– Liability risks arise from statutory liabilities, contractual liabilities,
or tort liabilities.
– Personnel risks, such as premature death, poor health, and
insufficient retirement income, directly affect individuals,
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 21–5
Evaluating an Insurance Program
• Basic principles of a sound insurance program include:
– (1) identifying the business risks to be insured
– (2) limiting coverage to major potential losses
– (3) relating the cost of premiums to the probability of loss
• A firm must first secure risk coverage required by law or
by contract.
• Property should be revalued periodically to be certain
that adequate insurance is being maintained.
• A company should determine the magnitude of loss it
can sustain without serious financial difficulty.
• The cost of insurance is proportional to the probability of
occurrence of the insured event.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 21–6
Types of Business Insurance Coverage
• A business owner’s policy (BOP) is a business version of
a homeowner’s policy, designed to meet the property
and liability insurance needs of small business owners.
• A BOP can cover both real property and personal
property; offers named-peril and all-risk options; values
property on a replacement-cost basis; and includes:
– business interruption coverage
– commercial general liability (CGL) coverage
– medical payments coverage
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 21–7
Types of Business Insurance Coverage (cont’d.)
• Insurers use two approaches to define the perils covered
by property insurance:
– with the named-peril approach, the specific perils covered are
identified
– with the all-risk approach, all direct damages to property are
covered except those caused by perils specifically excluded
• Most property insurance policies contain an insurance to
value provision that requires the insured to carry a
minimum policy limit relative to the actual value of the
property.
– The most common version of this feature is a coinsurance
provision that requires the property be insured for at least 80
percent of its value.
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 21–8
Types of Business Insurance Coverage (cont’d.)
• Two types of insurance provide coverage for key
individuals within a business:
– key-person insurance
– disability insurance
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 21–9
Key Terms
risk
market risk
pure risk
risk management
risk control
loss prevention
loss avoidance
loss reduction
risk financing
risk transfer
risk retention
self-insurance
real property
personal property
replacement value of property
actual cash value (ACV)
peril
direct loss
indirect loss
workers’ compensation legislation
torts
reasonable (prudent person) standard
compensatory damages
economic damages
noneconomic damages
punitive damages
proximate cause
personnel risks
business owner’s policy (BOP)
named-peril approach
all-risk approach
insurance to value
coinsurance provision
business interruption coverage
commercial general liability (CGL)
coverage
medical payments coverage
key-person insurance
disability insurance
Copyright © 2006 Thomson Business & Professional Publishing. All rights reserved.
Student 21–10