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BU353 Midterm Review.docx

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Wilfrid Laurier University
Heather Graham

Steps in the Risk Management Process 5 Major Steps in Risk Management Decision -Cyclical process that is occurring all the time 1. Identify potential losses -Employee records -Checklists – with every risk you will have one -Trends – weather, industry, economic -Discussions with managers -Insurance professionals -Risk management consultants -Financial statements – what assets are at risk? -Employee surveys 2. Evaluate the potential frequency and severity of such losses -Frequency -Severity -Probability -Consider the range of possible outcomes and how they could occur -Enables decisions to be made about the extent and nature of risk treatments 3. Develop and select methods for managing risk (risk control or risk financing) -Control and/or finance -Loss prevention -Loss reduction – done before and after an event 4. Implement the risk management methods chosen 5. Monitor, monitor, monitor! -Determine: -Most common occurrences -Cost of losses -Efficacy of treatments “IS my driver training program providing better drivers?” -Occurrence of unforeseen events – stuff you didn’t anticipate to happen – Ex. Flood in Calgary in the Summer  In the future, this will be added to policies Risk Treatment -Taking or increasing risk -Removing the risk source -Change the likelihood -Change the consequences -Share the risk -Retain the risk -If risk is tolerable, ask yourself these questions Risk Control -Reduce the level of risky activity by transferring risk control to another party -Increase precautions: -Loss prevention – focuses on reducing the FREQUENCY of loss -Loss reduction – focuses on reducing the SEVERITY of loss (can be pre and post loss) Loss (Risk Financing) -Reserves – Predict losses and then set aside money -Unfunded – Don’t put money into an account -Funded -Borrowing [You can borrow money to finance losses]: -Issue new equity -Issue debt, or get a bank loan -Captive insurer – Insurance company set up by corporation to provide insurance for its risk -Commercial insurance -Contractual transfer for loss financing -Ex. Adding someone to an insurance policy ‘additional insured’  City of Orillia contracts -Market contracts OFSI & FSCO Regulation -Insurance companies are highly regulated -Required to be licensed either federally or provincially -OFSI – Federal Overseer -FSCO – Ontario Overseer Office of Superintendent of Financial Institutions (OFSI) -Federal overseer -Regulates and monitors Federally chartered and foreign insurance companies -Concerned only with supervision of a company’s funds -To ensure financial integrity of companies -To protect the public -Minimize threat of insolvency by regulating: -Minimum capital and surplus levels -Restrictions on dividend payments and amount of insurance that can be ceded -Oversight of “prudent person” investment strategies -Annual return -Duty of actuaries -Audits of insurer records -Solvency is threatened when: -Insurers do not invest prudently -Do not have additional capital resources to cover adverse experience -Do not have sufficient loss reserves -Did not correctly price insurance -Make sure the money is there to pay claims -Federally licensed insurers must report to OFSI Financial Services Commission of Ontario (FSCO) -Provincial overseer -Must file auto rates and underwriting rules for approval -Insurance companies cannot make changes without FSCO’s approval -Regulation and supervision of: -Provincially licensed insurers -Operation of brokers and agents -Operation of adjusters (except salaried adjusters) -Contracts (auto policy wordings, statutory conditions, fire policies) -Provincially licensed insurers report to provincial regulators -Determines fault using fault determination rules in property damage cases -In regards to automobile insurance, FSCO must approve: -Policy wordings -Application forms -Claims forms -Provincial regulatory bodies are responsible for: -Price of auto insurance -Business practices -Licensing of intermediaries -Solvency of provincially regulated insurers ASSURIS & PACCIC Consumer Protection against Insolvency -Consumers generally desire more from solvency regulation than an efficient reduction of insolvency risk through monitoring and controls; they want to be protected against loss if insurers fail – a small risk ASSURIS -Protects Canadian policyholders against loss of policy benefits in the event a life or health insurance company becomes insolvent -Policyholders will retain at least 85% of their promised benefits under a variety of products issued by member companies in Canada -Accumulated value benefits are transferred to a solvent company with ASSURIS guaranteeing 100% of the accumulated value up to $100,000 -Guarantees are funded by assessments on members of ASSURIS and are determined by pro- rating the amount of income from insured policies in force Property and Casualty Insurance Compensation Corporation (PACICC) -Protects owners of auto, homeowners, and other property-casualty insurance policies -Will pay up to a maximum of $250,000 for claims arising out of a single occurrence -Will refund 70% of the unexpired portion of a policyholder’s premium, up to a maximum payout of $700 per policy -Guarantees most Property and Casualty insurance policies up to certain limits Coinsurance Coinsurance -Coinsurance – requires an insured to pay a specified proportion of the loss -The effect of coinsurance is to provide less than full coverage, in line with what risk-averse consumers prefer when policies have a positive loading -Reduces moral hazard -Since the insured pays part of any loss with a coinsurance provision, the insured has a greater incentive to reduce losses with the coinsurance provision Insurance-to-Value (Coinsurance) in Property Insurance -Insurance-to-value clause – specifies the percentage of the property’s value that the insurer requires the insured to purchase to receive full reimbursement following a loss -A typical coinsurance percentage is 80% -Regardless of whether the insured purchased the required amount of coverage, the insurer will neither pay more than the amount of insurance purchased nor more than the actual loss -The amount paid by the insurer is the minimum of: -The maximum proportion of loss paid by the insurer times the actual loss -The amount of insurance coverage purchased -The actual loss Example -Charlotte owns a warehouse that is insured for $200,000. The policy contains an 80% coinsurance clause. The value of the warehouse at the time of loss is $500,000. a. If the amount of loss is $10,000, how much will she collect? -Assume Charlotte carried $400,000 of insurance at the time of loss. b. If the amount of loss is $10,000, how much will she collect? c. What if the loss was $450,000? a. Did__ x loss Should = 200,000__ x 10,000 0.8*500,000 = $5,000 b. Did__ x loss Should =400,000 x 10,000 400,000 =$10,000 She’s met the coinsurance requirement now c. She will get only $400,000 because that’s all she is insured for, which is why you should insure assets to full value Automobile Rating Criteria Driver Classes -Age/number of years licensed – Rates generally start out high for young drivers, decline with age until approximately age 30, and then level off -Gender – Young males have higher average claim costs than young females -Marital status – Up to age 25-30, married males and females generally have lower average claim cost (per vehicle) -Use of automobile – A typical rating plan will have higher rate for autos driven to work (used to commute) than for those that are not -Number of automobiles and accompanying homeowners insurance – Many insurers provide a multiple car discount to reflect possibly lower expected claim costs per auto in multiple car households and, savings in admin costs -Miscellaneous factors – Many companies include discounts for young drivers who have competed an approved driver education program and for good students -Drivers education classes – allows you to go from 0 to 3 years of experience *Age, gender, and marital status are restricted in most jurisdictions now in Canada Driving Record -In principle, rate increases for past accidents and traffic violations will reflect the predicted effect on expected costs during the next policy period -Many insurers will not increase rates if an insured’s car is damaged while parked -A growing number of companies use bonus malus (no claims discount) systems that provide increasing percentage discounts based on the number of years without a claim, up to some maximum discount Territorial Rating -Large cities have the highest average claim costs, followed by suburban areas, smaller cities, and small towns or rural areas -Insurers develop rating territories to reflect these differences -Buyers pay a rate based on where they live -An exception is made for students who take a car to school while temporarily residing at a different location – in this case, the car usually is rated based on the student’s permanent residence Type and Make of Car -Probability that the vehicle is stolen -Cost to repair the vehicle -Rate of injury *Get an accident forgiveness for your first accident Absolute Liability Law Liability that is determined to be against the public good or negligent on behalf of a company or parties action. Any party that is assigned absolute liability may have to pay damages to effected parties. -The insurance contract between the insurer and insured is subject to a number of terms and conditions – Ex. The insured is prohibited from using their vehicle in any race or speed test -Absolute Liability Law – gives third parties a direct right of action against the insurer to have the insurance money under the policy paid directly to them -The insured shall not be prejudiced by: a. Any assignment, waiver, surrender, cancellation or discharge of the policy b. Any act or default of the insured before or after the event in violation of the Act or policy c. Any violation of the Criminal Code or statute of any province by the owner or driver of the car -Simply must show that his conduct caused the damage -Ex. Dynamite explosion Risk Control & Risk Financing Risk Treatment -If the risk types or levels are unacceptable, then a decision must be made regarding avoiding the risk completely or modifying the risk in some way in order to bring it with an acceptable level -Major methods of treating risk: 1. Risk control 2. Risk financing -Risk control commonly involves decisions to invest resources to reduce expected losses -Risk financing decisions refer to decisions about how to pay for losses if they occur -Combinations are almost always possible and often the best treatment method Risk Control -Loss control – actions that reduce the expected cost of losses by reducing the frequency of losses and/or the severity of losses that occur -Actions that primarily affect the frequency of losses are loss prevention methods -Actions that primarily influence the severity of losses are called loss reduction methods -Many types of loss control influence both the frequency and severity of losses and cannot be readily classified as either loss prevention or loss reduction -Two general approaches to loss control: 1. Reducing the level of risky activity “risk avoidance” 2. Increasing precautions against loss for activities that are undertaken – make the activity safer Risk Financing -Loss financing- methods used to obtain funds to pay for or offset losses that occur -Four broad methods of financing losses: 1. Retention 2. Insurance 3. Hedging 4. Other contractual risk transfers -With retention, a business or individual retains the obligation to pay for part or all of the losses -Firms can pay retained losses using either internal or external funds -Insurance contracts reduce risk for the buyer by transferring some of the risk of loss to the insurer -Hedging involves financial derivatives such as forwards, futures, options, and swaps to manage various types of risk -Other contractual risk transfers allow businesses to transfer risk to another party Risk Retention and Firm Characteristics -Ownership structure: -Private firms retain less losses than public firms -In a
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