Ch. 2: Risk Management

What are some examples of perils?

- personal perils: illness, injury, death - property perils: fire, flood, earthquake, theft

What is auto determination of benefits?

Coverage is determined for all individuals in the group on an automatic basis to prevent unhealthy lives in a group from obtaining a large portion of a benefits

What is the difference between gambling and insurance?

- gambling creates risk, insurance handles pre-existing risk - gambling creates speculative risk, insurance addresses pure risk - gambling yields gains for one party at expense of other; insurance based on sharing of losses - gambling losses stand; $ loss by insured is fully/partially reimbursed

What are the characteristics of insurance in an EE ben plan?

- insured (ER/EE) pay money (premiums) into a fund (insurance co) - reimbursement is paid to person who suffers loss - risk of financial loss is reduced/eliminated for insured b/c all premium payers share $ loss - losses are more predicable b/c more exposure units

What are the three types of hazards?

- physical: e.g. faulty wiring - moral: deliberate dishonesty (vandals, thieves, etc.) - morale: carelessness or indifference b/c insurance will cover any loss (failure to lock up)

What are the possible outcomes for speculative risk?

1. no loss 2. loss 3. positive gain - gambling, purchase of stock, business acquisition

What are the advantages and disadvantages of using insurance in design of an EE benefit plan?

Advantages: - premium cost known in advance (ER can budget) - outside administration (ER stays neutral) - financial backing of outside institution - cost management (insurance co. knowledgeable re loss control) - economical (insurance co. more efficient) Disadvantages: - possible additional costs (admin expenses, premiums include "loading" for overhead) - employee satisfaction impacted (insurer may be slow, impersonal) * loading: includes home office costs, licensing costs, commissions, taxes, loss adjustment expenses (can be 2- 25% of premium)

What aspect of the EE benefit plan is easiest to meet insurance risk standards? What is most difficult?

Easiest: life insurance More difficult: disability income plans (lots of fraud)

What is group technique?

Many types of insurance (life, health) written as group coverage - viewed as group - no individual eligibility standards - must have low adverse selection

What type of risk is transferred to the insurer?

Pure risk

Definition of Risk

Uncertainty with respect to possibility of loss. - for EE ben plans: uncertainty re number & value of future claims

What is underwriting?

When insurers select & classify applicants - can help control adverse selection - policy provisions: pre-existing conditions (outlawed), suicide clauses, max coverage amounts/exclusions, OE period restrictions

What is self funding/self-insurance?

When organization retains risk instead of using insurance co. - characteristics of ideally insurable risk - company must be big enough for law of large numbers - some consider themselves self-funded but transfer risk to insurers

What is the law of large numbers?

the great the # of exposures, the closer actual results approach probable results expected from infinitive # of exposures

What is adverse selection?

when EEs w/high potentially insurable risks makeup large % of group than desired ("select against" insurer) - insurers wants spread of risks through range of EEs - could leave to high premiums

What are examples of group technique?

- only certain groups eligible (can't be formed solely to obtain insurance) - steady flow of lives through group - min # healthy (usually 10) to less impact of 1-2 people - min portion of group must participate (75% if contributory, 100% if not) - eligibility reqs (waiting periods, etc.) - max benefit limits (PPACA curtails) - auto determination of benefits (linked to salary, etc. ) - central + efficient admin agency (i.e. employer payroll) insurers have liberalized section standards from experience + competition

What are the methods of handling risk?

1. Avoidance: avoid certain actions to avoid risk - i.e. never fly to avoid plane crash 2. Control: attempt to prevent or reduce probability of risk - i.e. give up smoking to reduce risk of heart attack, install seatbelts, annual physicals - EE ben plan: wellness, smoke-free workplace 3. Retention: risk is assumed/paid by person who suffers loss - i.e. retain risk of loss from auto collisions up to amount of deductible - may be more efficient, less expensive than insurance - makes sense if losses have small financial impact (loss < premiums + deductible) - not suitable for highly unlikely events w/ruinous cost 4. Transfer: shift financial burden of risk to another party - non-insurance transfers not typically used 5. Insurance: pooling of fortuitous losses by transferring such pure risks to insurers who indemnity insured for losses or provide other services connected with the risk - form of transfer

Characteristics of an insurable risk

1. big # homogenous risk (exposure units) 2. loss should be verifiable + measurable 3. loss should NOT be catastrophic in nature (usually in a concentrated geographic area) 4. chance of loss subject to calculation (for premiums) 5. premiums reasonable + economically feasible (pure premium + loading) 6. loss should be accidental from standpoint of insured

What are the possible outcomes for pure risk?

1. risk event will NOT happen (no financial loss) 2. risk even WILL happen (financial loss) - outcome is neutral or negative - re illness, fire, accident, unemployment, disability, earthquake, etc. - many can be insured

Individual vs. group contracts

Individual eligibility reqs don't apply to EEs under group insurance - underwriters see group as unit, not individuals

What is the difference between peril and hazard?

Peril = cause of loss, destruction or damage Hazard = condition that either increases probability that a peril will occur or increase severity of loss from peril

From an EE benefit POV, what is most important type of pure risk?

Personal risk: losses that directly impact an individual's life or health

How is the possibility of catastrophic losses generally handled by EE Ben plans?

Policy limits, reinsurance, restrictions (not likely geographic location)

Do EE Benefit plans cover property and legal liability risks?

Sometimes: homeowners insurance, auto insurance, group legal, etc. - bigger emphasis on personal risk

How can risk-handling alternatives be combined?

all except avoidance can be combined - medical plan might use several: insurance (transfer), deductible (retention), accident prevention or wellness program (control)

What are the subcategories of pure risk?

personal risk: losses have direct impact on person's life or health - death, illness, disability, old age, etc. - can be measured w/accuracy - most significant type of risk to cover in EE ben plans property risk: decrease value of real/personal property - fire, flood, earthquake, wind, theft, etc. - possible (uncommon) EE benefits: homeowners' insurance, financial planning services legal liability risk: someone's negligence results in injury to another person who can sue - may stem from use of auto, home, job performance, defective product, etc. - potential loss is unlimited - possible (uncommon) EE benefits: group legal services, auto liability insurance

What is indemnification (related to insurance)?

returns insured to financial situation that existed prior to loss (makes victim "whole") - i.e. reimbursement for lost or damaged property