CAIB 3 - Chapter 6

Identification and Analysis of Loss Exposure

• Loss exposure is categorized into four types: Property values, Net income values, Liability loss, and Personnel loss.

Property Values

• Property values can be tangible (physical items) or intangible (legal rights).

Tangible Property

• Real Property: Includes land and fixtures (e.g., lighting, fencing).
• Personal Property: All tangible items excluding real estate (e.g., clothing, furniture).
• Debris Removal: Necessary after a loss for repair or replacement.
• Demolition Expense: Costs incurred for demolishing a building post-loss.
• Undamaged Property: May lose value after a loss, even if not directly affected.
• Increased Cost of Construction: Building codes may raise construction costs after a loss.
• Pair or Set Value: Loss of one item in a set affects the total value, but the undamaged item retains some value.
• Going Concern Value: The difference in property value if the company operates vs. if it gets sold after a loss.

Intangible Property

• Includes assets like securities, trademarks, copyrights, licenses, and leasehold interests.

Net Income Values

• Net Income: Calculated by subtracting expenses from revenues; loss can impact both.

Decreases in Revenues

• Business Interruption: Income loss when operations cease or are limited due to a loss.
• Contingent Business Interruption: Losses impacting suppliers or manufacturer operations away from the premises.
• Loss of Profits on Finished Goods: Potential profits not realized due to the incident.
• Reduced Rental Income: Tenants typically cease rent payments after a property loss.
• Decreased Collections: Loss of accounting documents can hinder the collection of receivables.

Increases in Expenses

• Increased Operating Expenses: Extra costs to keep business operations afloat.
• Increased Rental Expenses: Costs arising from renting alternate locations post-loss.
• Expediting Costs: Additional expenses to hasten recovery (advertising, overtime, rapid repairs).

Liability Loss

• Liability exposure arises from the potential for legal claims against the organization.

Methods for Identifying and Analyzing Loss Exposures

• Financial Statements:

  • Balance Sheet: Lists assets and liabilities at each accounting period’s end.
  • Operating Statement: Shows sources of income and expenses.
  • Statement of Changes: Analyzes changes in net working capital.
  • Opinion Letter: Details the basis of the financial statements prepared.
  • Notes: Explains accounting policies and unusual transactions.

• Other Records: Important documents (meeting minutes, contracts, architectural plans) help reveal loss exposure changes.

• Flow Charts: Visualize activities but may not cover all loss exposures comprehensively.

• Personal Inspections: Direct assessments of company property can pinpoint loss exposures.

• Consultations with Experts: Engaging both internal personnel and external agencies (e.g., fire departments) can uncover valuable loss exposure information.

Risk Control Techniques

• Aim to minimize both frequency and severity of losses.

Techniques Include:

• Exposure Avoidance: Completely eliminates a risk.
• Loss Prevention: Implements measures that reduce the frequency of specific losses.
• Loss Reduction: Aims to lessen the severity of losses when they occur.
• Segregation of Exposure Units: Structures operations to avoid simultaneous losses; achieved through separation and duplication.
• Contractual Transfer: Shifts legal and financial responsibilities (e.g., through insurance).

Risk Financing Techniques

• Focus on managing inevitable losses, divided into two groups.

Retention Techniques

• Methods to fund losses internally, including:
• Current Expensing: Paying losses as they arise under current expenses, often uncertain in total costs.
• Unfunded Reserves: Advanced acknowledgment of potential business losses.