CAIB 3 Chapter 6 Instructor Slides PDF

 Important Terms So Far Students take two minutes to write down one important term that has been discussed so far in the course, in the chat window. Remember the Forgetting Curve! What are the 8 characteristics of a Surety Bond? (/8)  Characteristics of Surety Bonds 1)...

 Important Terms So Far Students take two minutes to write down one important term that has been discussed so far in the course, in the chat window. Remember the Forgetting Curve! What are the 8 characteristics of a Surety Bond? (/8)  Characteristics of Surety Bonds 1) Three Party Contract ○ A) Principle Definition: “The person primarily liable.” Example: Contractor who is building a residence for someone. ○ B) Obligee Definition: “The party to whom someone else is obligated under a contract.” They are the party to whom a bond is given. ○ C) Surety One who undertakes to pay money or do another act in the event that the principle fails to complete.  Characteristics of Surety Bonds 2) Principle is liable to surety Is a promise made to, the obligee and not to the principle. A bond is to protect the obligee ○ It a secondary obligation arising only on the default of the principle. The surety will only respond if the principle cannot fulfill obligation to obligee. ○ Surety’s duty to pay arises immediately upon default of the principle If the principle fails then the surety needs to pay. 2 ways a surety can collect from the principle: 1) Assignment to surety of obligee’s rights. 2) Right of subrogation  Characteristics of Surety Bonds 3) No losses expected. ○ Surety is based on the extension of credit without risk; therefore, they do not plan to pay out on a loss. 4) Of indeterminate length and non-cancellable. ○ The actual bond will end once the principle has fulfilled all obligations to the obligee. 5) Statutory or non-statutory in form ○ Definition: Statutory Bond “One that is required by a municipal ordinance, or federal or provincial regulation or statute.” ○ Definition: Non-Statutory Bond “One that is not required by law though required by contracts.”  Characteristics of Surety Bonds 6) Bond Limit (Penalty) ○ Definition: Bond Limit “the amount of credit given to the principle by the surety.” ○ The amount does not change within the period of the contract. 7) Bond Premium ○ The cost of a bond. 8) Written contract ○ The surety must provide in writing the contract under seal of the surety.  Chapter 6 Risk Management Section 1 Helping to Achieve Organizational Goals  Learning Topics Developing a Risk Management Program Step One: Identify and Analyze Loss Exposures Step Two: Examine Alternative Risk Management Techniques Step Three: Select Risk Management Technique(s) Step Four: Implement Technique(s) Step Five: Monitor Results  Risk Management - Means of Minimizing Loss Risk management Involves the application of a rational process to risk. Is it the process of carrying out decisions that will minimize loss. Risk Management is not about insurance. Risk management consists of two dimensions 1) A decision process Involves a 5 step decision making process in dealing with loss exposures. 2) A management or administration process Once risk management decision is made, implement and manage. Process relies on organizations ability to plan, organize, lead and control.  Chapter 6: Risk Management Section 1 - Helping to Achieve Organizational Goals  Risk Management - Means of Minimizing Loss Management Decision Plan Organize Lead Control Identify and Analyze Loss Exposures Examine Alternative Risk Management Techniques Select Technique(s) Implement Technique(s) Monitor Results  Broker as “Risk Manager” In most instances the risk manager is the owner of the organization. ○ They may often lack the experience or incentive to plan an effective risk management program. Brokers using a risk management approach to achieve the following results: ○ 1) A more informed clientele. ○ 2) Increased retention. ○ 3) Increased customer referrals. ○ 4) Increased claims satisfaction. ○ 5) Reeducation in errors and omissions potential.  Step 1 - Identify & Analyze Loss Exposure This is considered the most important step out of the five. Identification: Involves recognizing losses which might possible occur. Analysis: Involves estimating the likely significance of those possible losses. Classifying Exposures to Loss Definition – Loss Exposure: “It is the chance of financial loss to an organization as the result of a particular peril striking a thing of value.” Loss exposures can be classified according to: 1) The type of value exposed to loss. 2) The peril causing the loss. 3) The financial consequence of the loss.  Step 1 - Identify & Analyze Loss Exposure 1) The Type of Value Exposed to Loss The above is the most commonly used means to classify loss exposures. Four categories for all possible values subject to loss ○ Property Values ○ Net Income Values ○ Liability Loss ○ Personnel Loss  Step 1 - Identify & Analyze Loss Exposure A) Property Values Restoring property after a loss is a high-risk management and organizational priority. Property can be tangible or intangible. ○ 1) Tangible Property: It is real, can be touched, and has form and substance. Real Property Consists of land, and anything affixed to the land (example: lights, fencing) Personal Property This includes all tangible property other than real-estate. (example: clothing, furniture)  Step 1 - Identify & Analyze Loss Exposure A) Property Values 1) Tangible Property: It is real, can be touched, and has form and substance. ○ Debris Removal Removing debris after a loss will be necessary prior to repairs or replacement of damaged item. ○ Demolition Expense These costs represent the amount needed to demo a building after a loss. ○ Undamaged Property After a loss property that is undamaged may decline in value.  Step 1 - Identify & Analyze Loss Exposure A) Property Values 1) Tangible Property: It is real, can be touched, and has form and substance. ○ Increased Cost of Construction A building code may cause the costs of construction to increase. ○ Pair or Set Value When there is loss to one item of property in a pair or set, there is still value for the undamaged one. ○ Going Concern Value The is the difference in value of property which, must get sold after a loss and its value had the company continued operations.  Step 1 - Identify & Analyze Loss Exposure A) Property Values 1) Intangible Property: It has no physical substance and consists of legal rights rather than things. ○ Intangible Property can include: Securities such as stocks and bonds. Trademarks and trade names. Right to collect accounts. Copyrights and patents. Licences Leasehold Interests  Step 1 - Identify & Analyze Loss Exposure 1) The Type of Value Exposed to Loss B) Net Income Values ○ Net income is determined by subtracting expenses from revenues. ○ An accident can affect the net income causing Decreases in revenues Increased in expenses  Step 1 - Identify & Analyze Loss Exposure 1) Decreases in Revenues ○ After a loss decreases in revenues is expected. ○ They can be quantified according to the following categories 1) Business Interruption 1. If after a loss from an insured peril a company cannot operate or operates on a limited basis its income is interrupted. 2. The above coverage will indemnify a business and assist in paying back such loss. 2) Contingent Business Interruption 1. These losses occur away from the premises of the organization. 2. If a major supplier or manufacturer suffers a loss due to your business being down it is deemed contingent.  Step 1 - Identify & Analyze Loss Exposure 1) Decreases in Revenues 3) Loss of profits on finished goods. The above considers the profit that might have been realized had the accident not occurred. 4) Reduced rental income. Most rental agreement will state in the event of a loss the tenant will not need to pay the landlord the monthly rent for the space. 5) Decreased collections of accounts receivables. If accounting documents are destroyed collecting accounts will be difficult and company may suffer a net income loss.  Step 1 - Identify & Analyze Loss Exposure 2) Increases in Expenses ○ Those loss exposures which can an increase in expenses include 1) Increased operating expenses Additional costs needed to move the company or keep operations open. 2) Increased rental expenses If the property is damaged the company may need to pay additional costs to rent other locations needed to keep the company operational.  Step 1 - Identify & Analyze Loss Exposure 2) Increases in Expenses ○ Those loss exposures which can an increase in expenses include 3) Expediting costs These are the extra costs incurred in hastening the recovery of a business after a loss. Example of the above include: Advertising costs Overtime salaries Costs of speeding up repairs.  Step 1 - Identify & Analyze Loss Exposure C) Liability Loss ○ An organization has a liability loss exposure whenever there is a possibility that legal action could be taken against them. ○ They can be categorized according to: 1) Entity to whom duty is owed 2) Source of legal duty A legal action places the following costs on the organization ○ Costs to investigate and defend. ○ Payment of award for damages, or costs or corrective action.  Step 1 - Identify & Analyze Loss Exposure D) Personnel Loss ○ A significant to loss arising out of disability, resignation, retirement or deal of the organization's personnel. ○ The above is measured by the following: The value of an employees service. The costs of providing employee benefits.  Step 1 - Identify & Analyze Loss Exposure 2) The Peril Causing Loss Loss exposures are classified according to the perils likely to cause financial loss. Perils are grouped into a) natural, b) human or c) economic. A) Natural Perils ○ These are losses that are beyond any human control. Cave-In Collapse Drought Earthquake Hail Ice Rot Rust Tides Vermin Water Weeds Wind Lightning Flood  Step 1 - Identify & Analyze Loss Exposure 2) The Peril Causing Loss B) Human Perils ○ These are perils that find their origin in the individual or group and which can cause a loss to occur. Arson Discoloration Dust Explosion Human Loss Riot Terrorism Vibration Power Outage Embezzlement Contamination Leaks  Step 1 - Identify & Analyze Loss Exposure 2) The Peril Causing Loss C) Economic Perils ○ These stem from the actions of large numbers of persons or of governments. Recession Depression Strikes War Obsolescence Exploration Currency Consumers Confiscation Stocks  Step 1 - Identify & Analyze Loss Exposure 3) The Financial Consequences of the Loss Financial consequences for each loss need to get quantified. Need to review each loss exposure to obtain the following information. ○ The likelihood of a loss occurring (Loss Frequency) ○ The seriousness of losses that could occur (Loss Severity) ○ The potential dollar losses in any given period of time (Frequency Times Severity) ○ The reliability of the predictions of frequency and severity. Extent of Financial Loss Not Necessarily Related to Amount of Physical Damage Physical cause of loss not always related to extent of the physical damage caused. Example: Total loss fire will cause financial loss to owners of the location.  Step 1 - Identify & Analyze Loss Exposure Financial Consequences of Losses Directly Related to Loss Frequency and Severity. Overall financial consequences of a loss exposure during a given time are a joint product of both the frequency and the severity of those losses during a given period. Calculation: Frequency X Severity = Total Costs  Step 1 - Identify & Analyze Loss Exposure Financial Consequences of Losses Directly Related to Loss Frequency and Severity. A) Loss Frequency ○ When a peril occurs frequently over a period of time the cost to repair increases. ○ Loss frequency can be categorized as: Almost Nil – Extremely unlikely to happen, virtually no possibility. Slight – It could occur, but has not. Moderate – It happens once in a while. Definite – It happens regularly.  Step 1 - Identify & Analyze Loss Exposure Financial Consequences of Losses Directly Related to Loss Frequency and Severity. B) Loss Severity ○ The greater amount of each individual loss, the greater the financial consequences to a company. ○ Categories used to assess loss severity includes: Slight – The company can readily retain each loss. Significant – The company cannot retain each loss, some part needs to get transferred. Severe – The company must transfer virtually all of the loss, or endanger its survival.  Step 1 - Identify & Analyze Loss Exposure The Prouty Approach to Analyzing the Significance of Loss Exposures. Frequency/Severity Slight Significant Severe Almost Nil Slight Moderate Definite  Step 1 - Identify & Analyze Loss Exposure Methods of Identifying and Analyzing Loss Exposures. The exposure identification and analysis function is what starts the risk management process. A loss that is not identified cannot be effectively managed. The above step in risk management uses one or more of the following six steps to provide a proper basis of exposure identification and analysis. ○ 1) Standardized Surveys / Questionnaires. Advantage: It can normally be answered by people who have little risk management experience. Disadvantage: Does not lead responder to provide relevant information beyond scope of question  Step 1 - Identify & Analyze Loss Exposure Methods of Identifying and Analyzing Loss Exposures. ○ 2) Financial Statements & Underlying Records A) Balance Sheet Listing a businesses assets and liabilities for the end of each accounting period is located on a balance sheet. Balance sheet listing only existing liabilities which is little use to determine future liabilities.  Step 1 - Identify & Analyze Loss Exposure Methods of Identifying and Analyzing Loss Exposures. ○ 2) Financial Statements & Underlying Records B) The Operating (Profit and Loss) Statement The above is used to provide information about the sources of a company's income and expenses. C) The Statement of Changes in Financial Position The above allows risk manager to analyze changes in a businesses net working capital.  Step 1 - Identify & Analyze Loss Exposure ○ 2) Financial Statements & Underlying Records D) The Opinion Letter Provided by the accountant and identifies the basis on which the business’s annual financial statement was prepared. Letter is required to identify material change made on financial statement. ○ E) Notes Provides explanation of the various entries in the balance sheet, the operating statement, or the statement of changes in financial position. Summary of significant accounting policies. Explanation of how assets have been valued and amortized. Explanation of unusual details underlying these statements.  Step 1 - Identify & Analyze Loss Exposure 3) Other Records and Documents ○ Every record or document created by the organization may contain valuable information on the company. ○ Only records and document which are most likely to reveal changes in loss exposure should be reviewed. These include: Minutes of meetings of the board of directors, executives, or other senior management groups. Memoranda exchanged between senior executives or officials. All sales or purchase contracts over a predetermined amount. Plan or drawings for architectural or engineering, changes in the organizations building, machinery, workflow and office layout.  Step 1 - Identify & Analyze Loss Exposure ○ 4) Flow Charts Flow charts are graphic designs of the organization's activities in its basic form. They are often used in manufacturing or processing risks. The process shown in a single flowchart may encompass: A particular activity within a business. All of a business’s internal activities. The complete chain of economic activities of which a business is part. History of related activity/transactions ○ Limitations of flowcharts include: The are intended to focus only on the process of a company and do not provide a complete method for identifying all of its loss exposures.  Step 1 - Identify & Analyze Loss Exposure 5) Personal Inspections. ○ A personal inspection on the building owed by a company will allow one to point out loss exposures and work with insured on ways to prevent or reduce them if a loss occurs. 6) Consultation with Experts Within and Outside a Business. ○ A) Internal Sources Business personnel and the documents the company produces is a great source of information. Speaking to staff and management will allow one to see how effective systems and procedures are.  Step 1 - Identify & Analyze Loss Exposure 6) Consultation with Experts Within and Outside a Business. ○ B) External Sources Trade or government agencies provide valuable information on a business. Fire departments or local law enforcement can also provide information on the risk of a business and their exposure to loss.  Three Big Things Students have three minutes to write down three of the biggest or most important concepts we have gone over so far in class, in the chat window. Remember the Forgetting Curve!  Step 2 - Examine Alternative Techniques This step is concerned with formulating a combination of techniques for dealing with each exposure identified and analyzed. Techniques in above include risk control and risk financing. 1) Risk Control Techniques Objective is to reduce the frequency and severity of losses. Techniques considered include:  Step 2 - Examine Alternative Techniques 1) Risk Control Techniques A) Exposure Avoidance ○ The above eliminates any possibility of loss. ○ Most complete form of risk control. ○ Includes: Completely avoiding the exposure; and, Eliminating the exposure. ○ An exposure that has been completely eliminated cannot produce a loss.  Step 2 - Examine Alternative Techniques 1) Risk Control Techniques B) Loss Prevention ○ Any measure taken to reduce frequency of a particular loss is called loss prevention. ○ Loss prevention measures focus on how particular losses are caused. ○ Once identified measures can be taken to prevent them from occurring. ○ Loss prevention techniques are not effective in eliminating the loss. ○ Examples: Installing alarm systems.  Step 2 - Examine Alternative Techniques 1) Risk Control Techniques C) Loss Reduction ○ The above reduce the severity of those losses that do occur. ○ 1) Pre Loss Measures The above are intended to reduce the amount of property, number of people or other things of value that may suffer loss from a single event. Following pre-loss measures can be instituted.  Step 2 - Examine Alternative Techniques 1) Risk Control Techniques ○ D) Segregation of Exposure Units This involves arranging an organization's activities and resources so that no single event can cause simultaneous losses to all of them. Achieved in either of 2 ways: ○ 1) Separation This involves dividing assets or operations into two or more separate units. Example: Accounting and Claims. ○ 2) Duplication This involves complete reproduction of the organization's information.  Step 2 - Examine Alternative Techniques 1) Risk Control Techniques ○ E) Contractual Transfer A company may shift its legal and financial responsibility for loss by way of a transfer. (Example: Insurance Policy)  Step 2 - Examine Alternative Techniques 2) Risk Financing Techniques ○ Risk financing is concerned with playing those losses that inevitably occur. ○ They can be divided into 2 groups: 1) Retention Includes all means of generating funds from within a business to pay for losses. If the risk is retained that means the company can afford to pay the loss. Retention techniques include: ○ A) Current expensing of a loss The above technique involves pay losses as they occur under their current expenses. There are many uncertainties with the above as total cost of the loss can fluctuate.  Step 2 - Examine Alternative Techniques 1) Retention ○ B) Unfunded Reserves An unfunded reserve recognizes in advance that a business will suffer a loss. An account is open on the company's books which establishes the reserve amount. Advantage The account documents the financial impact that actual or anticipated losses will have on the company. Disadvantage Losses are paid as current expenses.  Step 2 - Examine Alternative Techniques 1) Retention ○ C) Funded Reserves Funded reserves are supported by cash, securities, or other liquid assets which have been set aside to pay expected losses. They are relatively rare and most companies will not use these reserves. Due to fluctuations in loss amounts its difficult to determine an amount to place into the fund.  Step 2 - Examine Alternative Techniques 1) Retention ○ D) Borrowed Funds Borrowing funds to pay of losses is not widely used. A concern is the more you borrow the more you will need to pay in interest. ○ E) Affiliated Captive Insurer Amount of the loss is paid for by the companies captive insurer.  Step 2 - Examine Alternative Techniques Appropriate Uses of Retention as a Risk Financing Technique: Retention as a risk financing technique may be forced upon a business or chosen as an effective option in which to finance its losses: 1) Forced Retention ○ Occurs when there are no transfer options available. ○ Forced retention includes: Losses resulting from certain uninsured perils. Amounts required as deductibles. The amount of any losses exceeding the limits of coverage provided by a business’s insurance policy.  Step 2 - Examine Alternative Techniques Appropriate Uses of Retention as a Risk Financing Technique: 2) Optional Retention ○ Assumes that some form of retention is more cost effective than any type of transfer. ○ Losses that one may retain include: Loss exposures that are within the companies retention capacity. Loss exposures unlikely to cause a large number of losses within an short period. Losses which are sufficiently frequent so as to be routinely budgeted.  Step 2 - Examine Alternative Techniques Appropriate Uses of Retention as a Risk Financing Technique: B) Contractual Transfer ○ Transfer includes all means of generating funds from outside of a business to pay for losses. ○ Above can be transferred in 2 ways ○ 1) Non-Insurance Transfer Indemnity Contracts When such contact is in place and a loss occurs, organization will be reimbursed by the transferee.  Step 2 - Examine Alternative Techniques B) Contractual Transfer ○ 1) Non-Insurance Transfer Indemnity Contracts When such contact is in place and a loss occurs, organization will be reimbursed by the transferee. Hold Harmless Agreements. Transferee agrees to pay for losses on behalf of the transferor. There are some uncertainties with non-insurance transfers. Party accepting risk may not have insurance or funds to pay. Transferred exposures are unclear. Enforceability of contract may be challenged in court.  Step 3 - Select Technique(s) Once the risk control and technique is applied to the loss, decision needed as to how to manage technique. 1) Forecasting This involves forecasting the effect that the available risk management options are likely to have on ability to fulfil objectives. 3 Forecasts are necessary to treating the loss: 1) Forecast of frequency and severity of losses that can be expected. 2) Forecast of the effects that various risk control and risk financing techniques are likely to have on the frequency, severity and predictability of those projected losses. 3) Forecast of the costs of these techniques.  Step 3 - Select Technique(s) B) Contractual Transfer ○ Above can be transferred in 2 ways ○ 2) Selection Criteria Once losses are forecasted, each alternative risk management technique is assessed in terms of: A) Effectiveness ○ This relates to how effective the chosen technique will assist the company. B) Economy ○ Refers to the selection of the least expensive of the possible effective ways to ensure business goals.  Step 4 - Implement Technique(s) Every technique selected needs to be successfully implemented. Proper implementation means making the following decisions: ○ 1) Technical Decisions These decisions relate to those matters which deal with the technical aspects of the risk management program. ○ 2) Management Decisions It is essential that the co-operation and support of all managers and employees be obtained prior to implementing the plan.  Step 5 - Monitor Results This is the last step in the risk management process. Once implemented, the risk management program needs to get: ○ 1) Monitored Ensures that the risk management program is achieving the results expected. ○ 2) Adjusted The risk management program has to be flexible enough to deal with changing loss exposures. Setting Standards to Measure A standards needs establishing for proper evaluation of the risk management program.  Recall and Write Students have three minutes to summarize this chapter in 1-3 sentences or write a question about it, in the chat window. Remember the Forgetting Curve!  Key Terms Risk Management Loss Exposure Tangible Property Going Concern Value Intangible Property Expediting Costs Risk Control Risk Financing Segregation Seperation Duplication Retention Contractual Transfer  Your Assignment Methods of Identifying/Analyzing Loss Exposures Please refer to your IGO assignment in your student portal and use information from the Chapter 6 slides to answer the question. You can submit your IGO activity to your facilitator or ask questions in class. For an explanation of the slide information and an answer to the activity, please check out the “IGO Answers” videos in your student portal. Please ask questions if you need to! Explain the final step of the Risk Management Process (/5)