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RSM100Y1 (431)

RSM100Y1 Appendix D.docx

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Rotman Commerce
Course Code
Michael Khan

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RSM100Y1 Textbook Notes Appendix D  Risk: uncertainty about loss or injury.  Risks can be divided into: o Speculative Risk  Gives the firm or individual the chance of profit or a loss (i.e. business expanding to new market can succeed or fail). o Pure Risk  Involves only the chance of loss (i.e. motorists always face the risk of an accident and an accident can result in financial and physical losses but no accident does not provide profit).  Risk management: calculations and actions a firm takes to recognize and deal with real or potential risks to its survival.  Executives must consider many factors when evaluating risks, such as: o A nation’s economic stability o Social and cultural factors (i.e. language) o Available technologies o Distribution systems o Government regulations  Businesses have four alternatives in handling risk: o Avoid It  I.e. a manufacturer can locate a new production facility away from an area that is at risk of hurricanes or tornadoes. o Minimize It  Managers can minimize risk by removing hazards or by taking preventive measures.  Many companies develop safety programs to educate employees about potential hazards and the proper methods of performing dangerous tasks.  Accidents cost companies time and money.  Most major insurers offer the services of loss-prevention experts who evaluate customers’ work environments and recommend procedures and equipment to help firms minimize worker injuries and property losses. o Assume It  Some companies accumulate special funds that are created by periodically setting aside cash reserves that the firm can draw on in the event of a financial loss resulting from a pure risk. o Transfer It  Insurance: a contract in which the insurer, for a fee, agrees to reimburse an insured firm or individual a sum of money if a loss occurs.  Premium: the insured party’s fee to the insurance company for coverage against losses.  Insurance substitutes a small, known loss for a larger, unknown loss.  Insurer must understand the customer’s business, risk exposure, and insurance needs.  Multinational firms do business with insurance companies that maintain global networks of offices. Premiums Insurance Return on Investments Company Claims Operating Reserves Expenses  Steps in the operation of an insurance company: o Insurance company collects premiums from policyholders in exchange for insurance coverage. o Some of these funds are used to pay current claims and operating expenses. o The remaining funds are held in the form of reserves, which are invested. o Returns from the reserves may allow the insurer to reduce premiums, generate profits, or both.  By investing in reserves, the insurance industry represents a major source of long-term financing for other businesses.  The basic principles that underlie insurance are: o The concept of insurable interest  To purchase insurance, the policyholder must stand to suffer a loss, financial or otherwise, due to fire, storm damage, accident, theft, illness, death, or lawsuit (insurance interest).  Firm’s can purchase property and liability insurance on physical assets to cover losses due to fire and theft because the company has an obvious insurance interest.  A business often purchases key-person life insurance, which compensates the business should an important individual die. o The concept of insurable risk  Insurable risk: the requirements that a risk must meet for the insurer to provide protection.  Only some pure risks are insurable; no speculative risks are.  A pure risk must meet four requirements to be considered an insurable risk:  The likelihood of loss should be reasonably predictable. If an insurance company cannot reasonably predict losses, it has no basis for setting affordable premiums.  The loss should be financially meas
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