Chapter 3 Review Questions

Identify the sources of information that a risk manager can use to identify loss exposures.

--Current net income --unfunded reserve --funded reserve --credit line

What conditions should be fulfilled before retention is used in a risk management program?

--No other method of treatment is available --The worst possible loss is not serious --Losses are fairly predictable.

Explain the advantages of a captive insurer in a risk management program.

-Favorable regulatory environment -lower costs -easier access to a reinsurer.

Explain the advantages of using insurance in a risk management program,

-The firm will be indemnified after a loss occurs -Uncertainty is reduced -can provide valuable risk management services, such as risk-control services, loss exposure analysis, and claims adjusting

Explain the disadvantages of using insurance in a risk management program.

-The payment of premiums is a major cost -Considerable time and effort must be spent in negotiating the insurance coverages -Risk manager may have less incentive to implement loss control measures because the insurer will pay the claim if a loss occurs.

Explain the following risk-control techniques. 1. Avoidance 2. Loss prevention 3. Loss reduction

1) Avoidance: --means a certain loss exposure is never acquired, or an existing loss exposure is abandoned --the chance of loss is decreased to zero --it is not always possible, or practical, to avoid all losses 2) Loss Prevention: refers to the measure that REDUCES the FREQUENCY of a particular loss Ex: installing safety features on hazardous products 3)

Explain the following risk-financing techniques. 1. Retention 2. Noninsurance transfers 3. Insurance

1) Retention Risk management technique in which an individual or a firm retains part or all of the losses resulting from a given loss exposure. Used when no other method is available, the worst possible loss is not serious, and losses are highly predictable. 2) Noninsurance Transfers Various methods other than insurance by which a pure risk and its potential financial consequences can be transferred to another party, for example, contracts, leases, and hold-harmless agreements. 3) Insurance is appropriate for loss exposures that have a LOW PROBABILITY of loss but for which the SEVERITY of loss is HIGH

Explain what is meant by "captive insurer" and describe the types of captive insurers.

Captive Insurer: Insurance company established and owned by a parent firm in order to insure its loss exposures while reducing premium costs, providing easier access to a reinsurer, and perhaps easing tax burdens. --Pure Captive: Single-Parent Captive: an insurer owned by only one parent. Ex: Corportation --Association or Group Captive: insurer owned by several parents. Ex: Corporation that belongs to a trade association

Describe and explain the difference between "maximum possible loss" and "probable maximum loss."

Maximum Possible Loss: is the worst loss that could happen to the firm during its lifetime Probable Maximum Loss: is the worst loss that is likely to happen

Explain the objectives of risk management both before (pre-loss) and after a loss occurs (post-loss).

Pre- Loss First Objective: the firm should prepare for potential losses in the most economical way Second Objective: reduction of anxiety Final Objective: meet any legal obligations. Post Loss First Objective: survival of the firm Second Objective: continue operating Third Objective: stability of earnings Fourth Objective: is continued growth of the firm Objective of social responsibility: minimize the effects that a loss will have on other persons and on society.

What is self-insurance?

Retention program in which the employer self-funds or pays part or all of the losses.

Explain the meaning of risk control.

Risk management techniques that reduce the frequency or severity of losses, such as avoidance, loss prevention, and loss reduction

Describe the steps in the risk management process.

Step 1: Identify Loss Exposers Step 2: Measure and analyze the loss exposures Step 3 Select and Appropriate combination of techniques for treating the loss exposures Step 4: Implement and monitor the risk management program.

What is a risk retention group?

is a group captive that can write any type of liability coverage except employers' liability, workers compensation, and personal lines

Explain the meaning of risk financing.

risk management techniques that provide for the funding of losses after they occur, such as retention, non insurance transfers, and commercial insurance.

Explain the meaning of risk management.

systematic process for the identification and evaluation of loss exposures faced by an organization or individual, and for the selection and implementation of the most appropriate techniques for treating such exposures