RMIN chapter 4

Introduction to Risk Management

• Risk management is a process that identifies potential losses and chooses the suitable strategies to handle them.
• Risk management targets to reduce the likelihood or severity of losses for an organization.

Risk Management Objectives

• Pre-Loss:

  • Efficient cost of risk
  • Enhanced decision-making
  • Meeting legal obligations

• Post-Loss:

  • Firm survival
  • Business continuity
  • Earnings and growth
  • Societal impact

Risk Management Process Steps

• Step 1: Identify Loss Exposures
  • Determine the assets requiring protection.
  • Identify the perils threatening these assets.
• Step 2: Measure and Analyze Loss Exposures
  • Evaluate frequency (probability). How often does the loss occur?
  • Assess severity (outcome). How costly is a loss when it occurs?
  • Rank loss exposures based on their importance. Severity is often more crucial than frequency.
  • Calculate the Maximum Possible Loss (MPL) - worst-case loss scenario.
  • Establish the Probable Maximum Loss (PML) - likely worst-case scenario.
• Step 3: Consider and Select Appropriate Risk Management Techniques
  • Risk Control: Actions to reduce loss frequency or severity. Includes avoidance, loss prevention, loss reduction, duplication, separation, and diversification.
  • Risk Financing: Methods for funding losses. Includes retention (funded and unfunded), commercial insurance, and non-insurance transfer techniques.
• Step 4: Implement and Monitor Chosen Techniques
  • Establish a detailed Risk Management Policy Statement outlining firm objectives and loss treatment policies.
  • The plan should involve cooperation across multiple firm departments
  • The plan should be reviewed periodically to see whether it meets the objectives.
  • The risk manager should evaluate the costs and benefits of all risk management activities.

Important Exposures

• Property
• Liability
• Business Income
• Human Resources
• Crime
• Employee Benefits
• Foreign
• Intangible
• Regulatory

Sources for Identifying Loss Exposures

• Meetings with management (including the Risk Manager)
• Financial statements
• Loss history
• Other firms/competitors
• Risk management consultants
• Surveys/questionnaires
• Site inspections
• Review sales and purchase agreements
• Flowcharts

Risk Control Techniques

• Avoidance: Declining to engage in an activity that could expose the firm to loss.
• Loss Prevention: Methods to reduce the frequency of a loss.
• Loss Reduction: Steps to limit the severity of a loss.
• Duplication: Maintaining backups or copies of critical documents or assets.
• Separation: Dividing assets or activities to minimize the impact of a single event.
• Diversification: Spreading risk across diverse customers, suppliers or investments.

Risk Financing - Retention

• Fundamentals: A certain amount of loss is accepted.
• Funded vs. Unfunded:
  • Funded: Setting apart funds to cover potential losses.
  • Unfunded: Covering losses directly from available cash flow.
• Types of Retention:
  • Unfunded
  • Funded Reserves
  • Deductible
  • Captive Insurers
  • Self-Insurance Plans
  • Risk Retention Groups / Group Captives

Risk Financing - Retention - Captive Insurers

• Captive insurer: A form of retention where the firm creates and controls its insurers.
• Types: Single-parent, association/group
• Advantages: Potential for lower costs (reduced brokers' commissions), interest earned on premiums, easier access to reinsurance and possible tax advantages

Risk Financing - Other Forms of Retention

• Self-insurance: planned retention of part or all of loss exposures
• Risk Retention Group (RRG): a captive insurance entity that offers liability coverage to members.

Risk Financing - Non-Insurance Transfer

• Fundamentals: Transferring risk-related financial responsibilities to other parties.
• Examples: Contracts, leases, and hold-harmless agreements

Risk Financing - Commercial Insurance

• Fundamentals: Insurance obtained to fund large potential losses, common for low-frequency, high-severity events.
• Key Steps:
  • Selection of insurance coverage
  • Choosing an appropriate insurer
  • Negotiation of policies' terms and services (risk control, claims)
  • Communicating about insurance coverage for others in the firm.
  • Regular program reviews.
• Terms:
  • Deductible
  • Excess insurance
  • Manuscript policy

Advantages/Disadvantages of Commercial Insurance and Retention

• Retention advantages and disadvantages, and insurance advantages and disadvantages.

Underwriting Cycles

• Hard Market: insurers are less profitable, demanding higher premiums, stringent underwriting standards.
• Soft Market: insurers are more profitable, offering lower premiums and more lenient underwriting.

Conclusion

• Risk Management is essential for firms to achieve their objectives.
• The risk management process covers all steps of risk management, from identification and analysis through selection and implementation to follow up and review.