Liability Risks and Insurance

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Questions and Answers

What is a key characteristic of liability risks?

They are only relevant to individuals, not businesses

They can only result in small nuisance claims

They have a maximum upper limit with respect to the amount of loss

There is no maximum upper limit with respect to the amount of loss (correct)

What is a potential consequence of a legal judgment against an individual?

A lien can be placed on the individual's income and financial assets (correct)

The individual is automatically declared bankrupt

The individual's income and financial assets are completely protected

The individual is exempt from paying legal defense costs

What type of risk can result in the financial crippling or bankruptcy of a business firm?

Operational risk

Speculative risk

Pure risk (correct)

Investment risk

What is an example of business property that can be damaged or destroyed?

All of the above Signup and view all the answers

Why are liability risks particularly important for individuals and businesses?

They can result in large financial losses Signup and view all the answers

What type of expense can be enormous for individuals and businesses without liability insurance?

Legal defense costs Signup and view all the answers

What is a potential consequence of a lawsuit against a business firm?

The firm may face financial crippling or bankruptcy Signup and view all the answers

What type of risk includes risks such as cyber attacks and identity theft?

Cybersecurity and identity theft risk Signup and view all the answers

What is the primary objective of loss prevention techniques?

To reduce the probability of loss Signup and view all the answers

Which of the following is an example of loss prevention?

Taking a safe-driving course Signup and view all the answers

What is the primary goal of loss reduction?

To reduce the severity of a loss after it occurs Signup and view all the answers

Which technique reduces the chance of loss by spreading the loss exposure across different parties?

Diversification Signup and view all the answers

What is the purpose of having back-ups or copies of important documents or property?

To make duplicates available in case a loss occurs Signup and view all the answers

Which of the following is an example of separation?

Storing finished goods in two warehouses Signup and view all the answers

What is the primary objective of loss control?

To reduce the frequency of losses and the severity of a loss after it occurs Signup and view all the answers

Which technique is used to avoid risk altogether?

Avoidance Signup and view all the answers

What is self-insurance also known as?

Self-funding Signup and view all the answers

What is the purpose of a hold harmless clause in a contract?

To transfer risk to the contractor Signup and view all the answers

What is the primary benefit of incorporation for a business firm?

To protect personal assets from creditors Signup and view all the answers

What is hedging price risks an example of?

Risk transfer Signup and view all the answers

What is a potential consequence of passive retention if the risk retained has the potential for financial ruin?

Financial ruin Signup and view all the answers

What is an example of a noninsurance transfer?

Purchasing a service contract Signup and view all the answers

What is the primary purpose of a service contract?

To transfer risk to the retailer Signup and view all the answers

What is a guaranteed price in a contract an example of?

Transfer of risk by contract Signup and view all the answers

What does loss prevention refer to?

Measures that reduce the frequency of a particular loss Signup and view all the answers

What is the main goal of diversification?

To reduce the chance of loss by spreading the loss exposure across different parties Signup and view all the answers

What is active risk retention?

The firm is aware of the loss exposure and consciously decides to retain part or all of it Signup and view all the answers

Under what condition can retention be effectively used in a risk management program?

When the worst possible loss is not serious Signup and view all the answers

What is a funded reserve?

A method for paying losses Signup and view all the answers

What is the primary purpose of retaining capital in a company?

To fulfill cash needs and safeguard against unexpected losses Signup and view all the answers

What is the purpose of a captive insurer?

To insure the parent firm's loss exposures Signup and view all the answers

What is separation in risk management?

Dividing the assets exposed to loss to minimize the harm from a single event Signup and view all the answers

According to Risk Process 1, what is the first step in managing risks effectively?

Prioritizing risk awareness Signup and view all the answers

What is the risk manager's responsibility in determining retention levels?

To determine the firm's retention level Signup and view all the answers

What is an important aspect of Measuring Risk, according to Risk Process 2?

Communicating well within the company Signup and view all the answers

What is one of the options a company has when identifying and understanding a risk, according to Risk Process 3?

Asking someone else to handle the risky task Signup and view all the answers

Why is it necessary for the CEO to endorse the risk management process, according to Risk Awareness 1?

To set the tone from the top Signup and view all the answers

What is the relationship between risk awareness and mistakes, according to Risk Process 1?

Risk awareness helps prevent mistakes Signup and view all the answers

What is one of the purposes of retaining capital, related to risk exposures?

To safeguard against unexpected losses Signup and view all the answers

What is a key aspect of Risk Process 2, in terms of risk management?

Recognizing when a risk becomes a big problem Signup and view all the answers

Study Notes

Liability Risks

Liability risks have no maximum upper limit, and a lien can be placed on income and financial assets to satisfy a legal judgment.
Legal defense costs can be enormous, and the cost of hiring an attorney to defend can be staggering.

Commercial Risks

Business firms face various pure risks, including property risks, liability risks, loss of business income, cybersecurity and identity theft, and other risks.
Property risks include damage or destruction of business property, such as plants, buildings, furniture, equipment, and inventories, due to perils like fires, windstorms, and earthquakes.

Loss Prevention and Control

Loss prevention reduces the probability of loss, reducing the frequency of losses.
Examples of loss prevention include taking a safe-driving course to reduce auto accidents, controlling weight and eating healthy to reduce heart attacks, and avoiding production of defective products.
Loss reduction reduces the severity of a loss after it occurs.
Techniques for reducing losses include:
- Duplication: having back-ups or copies of important documents or property available in case of a loss.
- Separation: dividing assets exposed to loss to minimize the financial loss from a single event.
- Diversification: spreading the loss exposure across different parties, securities, or transactions.

Risk Management Techniques

Self-insurance: retaining part or all of a given loss exposure, also known as self-funding.
Noninsurance transfers: transferring risk to a party other than an insurance company.
Transfer of risk by contracts: transferring undesirable risks through contracts, such as purchasing a service contract or having a guaranteed price in a contract.
Hedging price risks: transferring the risk of unfavorable price fluctuation to a speculator by purchasing and selling futures contracts.
Incorporation: transferring risk by incorporating a business firm, which limits the liability of personal assets.

Risk Financing

Risk financing refers to techniques that provide for the payment of losses after they occur.
Retention: retaining part or all of the losses that can result from a given loss exposure.
Active risk retention: consciously deciding to retain part or all of the loss exposure.
Passive risk retention: unplanned acceptance of losses due to failure to identify risk, failure to act, or forgetting to act.
Determining retention levels: determining the monetary amount of losses that the firm will retain.
Paying losses: using methods such as funded reserve, credit line, or captive insurer to pay losses.

Risk Processes

Promote risk awareness: harnessing the combined knowledge of management and staff to assess risks linked to present and planned activities.
Measure risk: recognizing when a risk becomes a big problem and understanding its severity.
Control: deciding what to do about a risk, including ignoring it, making it smaller, or taking action to lessen it.

Risk Awareness

Set the tone from the top: the CEO must wholeheartedly endorse the risk management process.

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Description

Understand the importance of liability risks and how they can impact your finances. Learn about the potential consequences of being sued and the benefits of having liability insurance.