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Chapter 4.pptx

  2. RM TOOLS (Techniques) • A.Risk Control  1. Avoidance  2. Reduction • B. Risk Financing  1. Retention  2. Transfer
  3. A. Risk Control • Broadly defined, risk control encompasses all techniques aimed at reducing the number of risks facing the organization or the amount of loss that can arise from these exposures. • Risk control includes risk avoidance and risk reduction.
  4. 1. Risk Avoidance  Risk avoidance simply means that an individual can evade certain risks merely by staying away from the risk that one chooses not to incur. Technically, avoidance takes place when decisions are made that prevent a risk from even coming into existence.  Risks are avoided when one refuses to accept the risk even for an instant.
  5. Risk Avoidance For example: • a firm that considers manufacturing some product but, because of the hazards involved, elects not to do so • An individual will not die in a plane crash if the individual chooses not to fly. • An individual will not be arrested for drunk driving, if the individual does not drink and drive
  6. Risk Avoidance  it is a negative rather than a positive approach. If avoidance is used extensively, the firm may not be able to achieve its primary objectives. Risk avoidance should be used in those instances in which the exposure has catastrophic potential and cannot be reduced or transferred.  Generally, these conditions will exist in the case of risks for which both the frequency and the severity are high.
  7. Risk Avoidance • Appropriate when there is potential for catastrophic loss Adv  Do not face loss at all Disadv  Not practical  Not all losses can be avoided
  8. 2. Risk Reduction • The term risk reduction is used to define a broad set of efforts aimed at minimizing risk. Other terms that were formerly used, and which have been displaced by the more generic term "risk reduction" include "loss prevention" and "loss control.” The term "risk reduction" is considered to include both loss prevention and loss control efforts. Common examples of risk reduction would include the installation of dead bolt locks, or the use of smoke detectors in a home.
  9. Risk Reduction • Broadly speaking, "loss prevention" efforts are aimed at preventing the occurrence of loss. In addition, "loss control" efforts can be directed toward reducing the severity of those losses that do occur. In other words, some risk control efforts aim at reducing frequency, others seek to reduce the severity of the losses that do occur.
  10. • Risk Prevention (Loss prevention) – Efforts to reduce the frequency of loss – Pre-Loss objective – Ex: Frequent inspection, training (safe procedures) • Risk Reduction (loss control) – Efforts to reduce the severity of loss – Post-loss objective – Ex: Fire drill, Sprinkler System, Smoke Detector, First-Aid kit
  11. B. Risk Financing • Risk financing consists of those techniques designed to guarantee the availability of funds to meet those losses that do occur.  Risk financing takes the form of retention or transfer.  All risks that cannot be avoided or reduced must, by definition, be transferred or retained.  Transfer and retention are used in combination for a particular risk, with a portion of the risk retained and a part transferred.
  12. 1. Risk Retention • Risk retention is the "residual" or "default" risk management technique, exposures that are not avoided, reduced, or transferred are retained. • The retention of risk means that an individual chooses to self-fund any losses that may be incurred • When nothing is done about a particular exposure, the risk is retained. • Applied when • Risk can’t be avoided • Low severity and frequency can be estimated
  13. Risk Retention • For example, an individual may chose a deductible of $1,000 on their automobile insurance coverage. This indicates that the individual is prepared to personally pay the first $1,000 of damage incurred in an auto accident. • Risk Retention Techniques Classified - Active retention - Passive retention
  14. Retention • Advantages  Save on premium loading  Investment income  Encourage risk control  Flexibility • Disadvantages  Possibility of higher losses  Risk management expenses
  15. 2. Risk Transfer • The transfer of risk simply means that individuals who are unable, or unwilling, to bear a particular loss may transfer this uncertainty to a third party, who is prepared to accept the risk • Risk transfer is accomplished in a variety of ways 1. Insurance transfer Purchase of insurance is a primary means of risk transfer. 2. Non – Insurance transfer
  16. Non-Insurance Risk Transfer • Methods other than insurance by which a pure risk and its potential financial consequences are transferred to another party  Hedging  Hold harmless agreements  Contract  Subcontracting certain activities  Leases
  17. Risk Sharing • Risk sharing is sometimes cited as an additional way of dealing with risk. Risk sharing may be viewed as a special case of risk transfer and risk retention. The risk of the individual is transferred to the group. The risks of a number of individuals are retained collectively.
  18. Insurance • Definition 1 Insurance may be defined as a contract in which one person pays money, which is called a premium, to a second party, known as the insurer, who promises to reimburse the individual for specified losses, should these losses occur. Insurance is a way to distribute losses and eliminate uncertainty. Insurance can be thought of as the reverse of gambling.
  19. Definition 2 The pooling of fortuitous losses by transfer of such risks to insurers in exchange of a premium. The insurer agrees to indemnify insured for covered losses, to provide other pecuniary benefits on their occurrence, or to render services connected with the risk.
  20. Insurance • The concept of insurance is relatively simple. People who face potential losses band together to establish a fund with which to compensate those who actually experience disaster. The principle of risk sharing is applied when large numbers of people pay a regular fee, which is known and therefore certain, in exchange for protection against a hazard that is uncertain.
  21. Insurance • The premium paid by individuals is composed of the pure cost of insurance plus a loading charge, with the loading charge representing the insurer's costs including a profit. • The pure cost of insurance is dependent upon three factors:  the probability of the event occurring,  the cost of the compensation, and  the number of individuals sharing the risk.
  22. Insurance • Advantages – Reduce uncertainty – Compensation is confirmed – Risk management services – Premium is tax deductible • Disadvantages – Premium is high – Not all risk is insurable – Less incentive for loss control – Difficult to get coverage
  23. Noninsurance Risk Transfer • Adv – Risk is transferred – Low cost • Disadv – Ambiguous contract – Inability to pay
  24. Other techniques – Duplication – Separation – Diversification
  25. Non Traditional Risk Financing • Also known as Alternative Risk Transfer (ART) • Characteristics: - Involves a high level of retention - covers multiple years - provides coverage for multiple sources of risk - provides sources of risk that are not offered by traditional insurance
  26. ART Methods • Loss sensitive contract • Finite risk contract • Captive insurer
  27. Loss Sensitive Contract • Insurer assumes less risks but policyholder assumes large portion of risk • An experience rated policy vs retro policy
  28. Finite Risk Contract • Multiple year loss sensitive contract • A finite risk contract spreads risks across time Adv • Protection against the timing of loss exposure. • Systematic cash accumulation to finance loss. • Premium payment is tax deductible item. • Cash flow stabilisation
  29. Captive Insurer A captive insurer is a wholly owned insurance company subsidiary formed by a parent company for the main purpose of providing insurance protection to finance the losses retained by the parent company in a formal structure.
  30. Types of Captive Insurer • Pure captive insurer vs group captive insurer • Onshore vs offshore
  31. Motivations of establishing a captive • Tax advantage of insurance • Parent company can purchase excess policy directly from its captive • Retain a large portion of its risk • Reduce the risk exposure • Profit center • Provide coverage that is not available in the market.