Bonus C – Managing Risk
C-1
bonus chapter
.
Managing Risk
what’s new in this edition C.2
brief chapter outline and learning objectives C.3
lecture outline and lecture notes C.5
PowerPoint slide notes C.27
lecture enhancers C.36
lecture enhancer C-1: THE FOUR FACETS OF RISK C.36
lecture enhancer C-2: RISK PERCEPTION: ANALYTICAL VERSUS INTUITIVE C.37
lecture enhancer C-3: THE ECONOMIC IMPACT OF A CATASTROPHE C.37
lecture enhancer C-4: RECONSIDERING FLOOD INSURANCE C.38
C
Bonus C – Managing Risk
C-2
what’s new in
this edition
additions to the 11th edition:
• Getting to Know Dan Cox of Aflac
• New subsection: Protection From Cyber Attacks
revisions to the 11th edition:
• Text was revised to eliminate redundancy and tighten discussions.
• Statistical data and examples throughout the chapter were updated to reflect current information.
• Discussion of recent health care issues in subsection Health Insurance
deletions from the 10th edition:
• Getting to Know Joaachim Oechslin of Munich Re
• Deletion of subsection: Health Maintenance Organizations (HMOs)
• Deletion of subsection: Preferred Provider Organizations (PPOs)
Bonus C – Managing Risk
C-3
brief chapter outline
and learning objectives
CHAPTER C
MANAGING RISK
Getting to Know DAN AMOS, of AFLAC
learning objective 1
Identify the environmental changes that have made risk management im-
portant.
I. UNDERSTANDING BUSINESS RISKS
A. How Rapid Change Affects Risk Management
learning objective 2
Explain the four ways of managing risk, and distinguish between insurable
and uninsurable risk.
II. MANAGING RISK
A. Reducing Risk
B. Avoiding Risk
C. Self-Insurance
D. Buying Insurance to Cover Risk
E. What Risks are Uninsurable
F. What Risks are Insurable
learning objective 3
Define insurance policies and explain the law of large numbers
and the rule of indemnity.
III. UNDERSTANDING INSURANCE POLICIES
A. Rule of Indemnity
B. Types of Insurance Companies
learning objective 4
Discuss the various types of insurance businesses can buy to
manage risk.
Bonus C – Managing Risk
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IV. INSURANCE COVERAGE FOR VARIOUS KINDS OF RISK
A. Health Insurance
B. Health Savings Accounts
C. Disability Insurance
D. Workers’ Compensation
E. Liability Insurance
F. Life Insurance for Businesses
G. Insurance Coverage for Home-Based Businesses
H. The Risk of Damaging the Environment
I. Protection from Cyber Attacks
V. SUMMARY
Bonus C – Managing Risk
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Getting to Know DAN AMOS, of AFLAC
Aflac was created 60 years ago by now-CEO, Dan Amos’ father and two uncles. It
is now the largest provider of supplemental insurance in the United States.
learning objective 1
Identify the environmental changes that have made risk management more im-
portant.
I. UNDERSTANDING BUSINESS RISKS
A. RISK MANAGEMENT is a major issue for business-
es.
1. Given natural disasters, hackers, identity theft,
and other catastrophes, risk management is get-
ting more attention.
2. In some states, insurance is not available or too
expensive for some businesses.
3. Some states have passed legislation to let com-
panies obtain insurance coverage again at a rea-
sonable price.
4. When events involve loss, businesses must pay
to restore the property and compensate those
who are injured.
5. More than 80% of organizations are building EN-
TERPRISE RISK MANAGEMENT (ERM) pro-
grams.
This insurance company is a nonprofit organization owned by its policyholders.
Any excess funds (over losses, expenses, and growth costs) go to the policyholders
in the form of dividends or premium reductions. Who are we?
(Students should read the chapter before guessing the company’s name: A mutual in-
surance company.)
Bonus C – Managing Risk
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PPT C-1
Bonus Chapter Title
Copyright © 2015 by the McGraw-Hill Companies, Inc. All rights reserved.
McGraw-Hill/Irwin
Managing Risk
BONUS CHAPTER C
PPT C-2
Learning Objectives
LEARNING OBJECTIVES
C-2
1. Identify the environmental changes that have
made risk management important.
2. Explain the four ways of managing risk, and
distinguish between insurable and uninsurable
risk.
3. Define insurance policies, and explain the law of
large numbers and the rule of indemnity.
4. Discuss the various types of insurance
businesses can buy to manage risk.
(See complete PowerPoint slide notes on page C.27.)
PPT C-3
Dan Amos
DAN AMOS
Aflac
C-3
• Amos has been CEO of Aflac
for over 25 years.
• The company has decided to
only operate in the U.S. and
Japan covering expenses that
normal health insurance does
not.
• Aflac is one of the 100 best
U.S. companies to work for
and Amos claims much of the
credit goes to the duck!
PPT C-4
Name That Company
NAME that COMPANY
C-4
This type of insurance company is a nonprofit
organization owned by its policyholders. Any
excess funds (over losses, expenses, and
growth costs) go to the policy-holders in the
form of dividends or premium reductions.
Name that company!
PPT C-5
What’s Enterprise Risk
Management?
WHAT’S ENTERPRISE RISK
MANAGEMENT?
C-5
LO C-1
• Goals of enterprise risk management (ERM):
1) Defining which risks the program will manage.
2) What risk management processes, technologies, and
investments will be required.
3) How risk management efforts will be coordinated across
the firm.
Bonus C – Managing Risk
C-7
6. An ERM program should have well-defined
goals, such as defining:
a. Which risks the program will manage
b. What risk management process, technolo-
gies, and investments will be required
c. How these efforts will be coordinated
B. HOW RAPID CHANGE AFFECTS RISK MAN-
AGEMENT
1. Changes are occurring so fast that it is difficult to
keep up with the new risks involved.
2. Recent changes include Internet selling, curren-
cy fluctuations, global warming, threat of new
terrorist attack, a possible flu epidemic, and fi-
nancial collapse.
learning objective 2
Explain the four ways of managing risk, and distinguish between insurable and
uninsurable risk.
II. MANAGING RISK
A. RISK refers to the chance of loss, the degree of
probability of loss, and the amount of possible loss.
1. There are two different kinds of risk.
a. SPECULATIVE RISK involves a chance of
either profit or loss.
i. Buying new machinery may bring extra
revenue, but it also involves risk.
ii. An entrepreneur takes speculative risk
on the chance of making a profit.
Bonus C – Managing Risk
C-8
PPT C-6
What’s Risk?
WHAT’S RISK?
C-6
LO C-1
• Risk — The chance of loss,
the degree of probability of
loss, and the amount of
possible loss.
• Speculative Risk — A
chance of either profit or loss.
• Pure Risk — The threat of
loss with no chance for profit.
lecture enhancer C–1
THE FOUR FACETS OF RISK
Bonus C – Managing Risk
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b. PURE RISK is the threat of loss with no
chance for profits.
i. Pure risk involves the threat of fire, acci-
dent, or loss.
ii. If such events occur, a company loses
money; but if the events do not occur,
the company gains nothing.
2. PURE RISK threatens the very existence of
firms.
3. Once such risks are identified, firms can:
a. REDUCE THE RISK
b. AVOID THE RISK
c. SELF-INSURE against the risk
d. BUY INSURANCE against the risk
B. REDUCING RISK
1. A firm can reduce risk by establishing LOSS-
PREVENTION PROGRAMS.
2. Examples:
a. Fire drills, health education, safety inspec-
tions, equipment maintenance, accident pre-
vention programs can reduce risk.
b. Retail stores use mirrors and cameras to re-
duce shoplifting.
c. Industries have safety devices to protect
workers against accidents and injury.
3. COMPANIES can also reduce risk.
a. Tyson killed and buried 15,000 hens be-
Bonus C – Managing Risk
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lecture enhancer C–2
RISK PERCEPTION: ANALYTICAL
VERSUS INTUITIVE
PPT C-7
How to Deal with Pure Risk
HOW to DEAL with PURE RISK
C-7
LO C-2
1) Reduce the risk
2) Avoid the risk
3) Self-insure against the risk
4) Buy insurance against the
risk
Bonus C – Managing Risk
C-11
cause the government suspected they had
been exposed to bird flu.
b. Firestone and Ford recalled thousands of
tires when 400 deaths were linked to faulty
tires.
4. Employees can reduce risk by wearing protec-
tive gear.
5. An EFFECTIVE RISK MANAGEMENT STRAT-
EGY starts with a good loss-prevention program.
6. High insurance rates have forced some people
to avoid risks, and in extreme cases go out of
business.
C. AVOIDING RISK
1. Many risks cannot be avoided.
2. Some companies avoid risk by NOT ACCEPT-
ING HAZARDOUS JOBS and by outsourcing
certain functions.
3. Due to lack of liability insurance, some compa-
nies are losing outside members of boards of di-
rectors.
D. SELF-INSURANCE
1. SELF-INSURANCE is the practice of setting
aside money to cover routine claims and buying
only “catastrophe” policies to cover big losses.
2. Self-insurance is most appropriate when a firm
has several widely distributed facilities, where
one catastrophe will not destroy the whole oper-
ation.
Bonus C – Managing Risk
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PPT C-8
Most Costly Disasters
MOST COSTLY DISASTERS
DisasterYear Losses
Hurricane Katrina 2005 $122 Billion
Central U.S. Drought 1988 $76.4 Billion
Superstorm Sandy 2012 $65.7 Billion
Northridge California Earthquake 1994 $40 Billion
Hurricane Ike 2008 $35 Billion
Hurricane Andrew1991 $28 Billion
9-11 Terro rist Attacks 2001 $21.37 Billion
Source: NOAA, www.noaa.gov, accessed November 2014.
C-8
LO C-2
lecture enhancer C-3
THE ECONOMIC IMPACT OF A CA-
TASTROPHE
PPT C-9
What’s Self Insurance?
• Self-Insurance — The practice of setting aside
money to cover routine claims and buying only
“
catastrophe
”
insurance policies to cover big losses.
WHAT’S SELF INSURANCE?
C-9
LO C-2
• Companies that self-
insure can “go bare”
and pay claims from
their operating budgets
or set up special funds
to pay for claims.
Bonus C – Managing Risk
C-13
3. Some companies are using a risky strategy for
self-insurance called “GOING BARE,” paying
claims straight out of the budget.
4. A less risky alternative is the forming of RISK
RETENTION GROUP-INSURANCE POOLS
that share similar risks.
E. BUYING INSURANCE TO COVER RISK
1. Well-designed, consistently enforced risk–
prevention programs REDUCE THE PROBA-
BILITY OF CLAIMS, but accidents do happen.
a. Spending by business and nonprofits on in-
surance makes up 10% of the GDP.
b. The federal government provides some in-
surance protection.
c. Most risks must be covered by individuals
and businesses on their own.
2. WHAT RISKS ARE UNINSURABLE?
a. An UNINSURABLE RISK is a risk that no
insurance company will cover.
b. You cannot insure market risks, political
risks, some personal risks, and some opera-
tional risks.
3. WHAT RISKS ARE INSURABLE?
a. An INSURABLE RISK is a risk that the typi-
cal insurance company will cover.
b. Insurance companies use these guidelines:
i. The policyholder must have an INSUR-
Bonus C – Managing Risk
C-14
TEXT FIGURE C.1
Public Insurance
PPT C-10
What Risks Are Uninsurable?
WHAT RISKS are
UNINSURABLE?
C-10
LO C-2
• Uninsurable Risk — A risk that no insurance
company will cover. Risks can include:
– Market risks
– Political risks
– Personal risks
– Operational risks
Bonus C – Managing Risk
C-15
ABLE INTEREST, the possibility of the
policyholder to suffer a loss.
ii. The loss should be MEASURABLE.
iii. The CHANCE OF LOSS should be
measurable.
iv. The LOSS must be ACCIDENTAL.
v. The risk should be DISPERSED, spread
among different geographic areas.
vi. The insurance company can SET
STANDARDS FOR ACCEPTING RISK.
learning objective 3
Define insurance policies, and explain the law of large numbers and the rule of
indemnity.
III. UNDERSTANDING INSURANCE POLICIES
A. An INSURANCE POLICY is a written contract be-
tween the insured and an insurance company that
promises to pay for all or part of a loss.
1. A PREMIUM is the fee charged by the insurance
company for an insurance policy.
2. A CLAIM is statement of loss that the insured
sends to the insurance company to request
payment.
3. The object of an insurance company is to make
a profit.
4. The LAW OF LARGE NUMBERS makes the
acceptance of risk possible.
5. The LAW OF LARGE NUMBERS is the princi-
ple that if a large number of people are exposed