FIN 341 Final REVIEW

Objective riskMeasurable variation in uncertain outcomes based of facts and dataFrequencyNumber of times a particular loss occurs in a period (how often) can not be negative100 year floodA 1 and 100 chance of occurringSeverityConditions on the event that happens, how much money the loss costs (how bad), must be positivePerilThe cause of lossHazardA condition that creates or increases the chance of lossPhysical hazardA physical condition that increases the chance of lossLegal hazardCharacteristics of the legal system or regulatory environment that increase the frequency or severity of lossMoral HazardDishonesty or character defects in an individual that increases the frequency or severity of a lossMorale HazardCareless concerning losses, no change of behavior due to some conditionsRisk ManagementA process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating such exposuresSteps in the risk management processs1. Identify loss exposures 2. Analyze loss exposures 3. Identify possible risk management options 4. Select from among various risk management options 5. Implement the chosen options 6. Periodically re-evaluate the chosen strategyRisk identificationIdentifying exposure to loss or loss exposureAnalyze loss exposureMeasurement and evaluation of the exposures or lossesIdentify possible risk management optionsEither risk control option to reduce frequency/severity or risk financing options (who pays for the loss)Select from among various risk management optionsDecision rule to chose among optionsImplement the chosen optionBeing the safety program, purchase insurances, set-up a self-insurance, wear the maskPeriodically re-evaluate the chosen strategiesIs the safety program working, does the loss exposure still exist in the same formThree part of insurance price1. Gross premium 2. Pure premium 3. Risk chargePure premiumUsed to cover unexpected lossesRisk chargeUsed to cover uncertainty (depends on the accuracy of estimation of PLoadingExpenses of running insurance business (advertising, commissions)Gross PremiumGross premium= pure premium + loading + risk chargeRisk avoidanceIf avoidance is properly implemented, loss exposure is avoided completelyHaving classes online and closing campus during COVID 19 is an example ofRisk avoidanceI am afraid of a stove gas leak, so I choose to replace the gas stove with an electric stoveRisk avoidanceProactive risk avoidanceOrganization never undertakes the risk EX: I am afraid of high malpractice risks of ob-gyn doctors - therefore don't go to medical school or specialize in that fieldReactive risk avoidanceOrganization ceases the activity EX: being afraid of planes - stop traveling by planes completelyProblems with risk avoidance1. Avoidance cannot be used for all loss exposures (natural disaster, risk of death) 2. Avoidance usually has an opportunity cost 3. Avoiding one loss exposure may create another loss exposer that did not previously exist Avoidance may have a legacy cost associated with itRisk PreventionInvolves reducing the frequency or a particular loss Does not completely eliminate it may or may not affect severityWearing a mask on campus during COVID 19Risk preventionI am afraid of a stove gas leak, so I choose to turn off the stove and double check the stove every time I leave the houseRisk preventionRisk ReductionActivities done wither before the loss or after the loss to minimize or reduce the severity of the loss in case the loss happens Pre loss activities: sprinklers, fire alarms, emergency exit signs Post loss activities: call fire department, legal defenses, crisis management, product recallSeparation of exposure unitesExposure unities: items, activities, assets, responsibilities, aim to reduce the severity of loss Break the exposure units down to smaller parts and separate themDuplication of exposure lossExposure units are replicated or duplicated and they are held in reserve not used on a day-to-day basis Aim to reduce severity of a lossRisk transferThird party pays for the lossExternal risk financing transferSeek funds from unrelated third parties to pay for losses and transfer the financial responsibility for payment of a loss to a third partyExternal risk financing insurance transferThe financial responsibility of a loss to the insurerExternal risk financing non-insurance transferLease tenant is financially responsible for all property losses while occupyingRisk retentionPay out of pocketInternal risk financing retentionA company or individual engaging in retention assumes the financial responsibility Retails the financial exposure to the loss, not buying insurance, underinsured insurance with a deductible in the contractActive internal risk financing retentionDeliberate decision to practice retention (aware)Passive internal risk financing retentionRetaining the exposure to loss, but you may be unaware or underestimating the loss (usually results from failure to identify)Funded retentionFirm sets aside funds every period to pay for losses Better for losses that are higher in severity and more predictableUnderfunded retentionNo separate fund to pay for losses When losses do occur, they are paid from current revenue or from borrowed funds Better for losses that are lower in severitySelf insuranceActive, funded retention Retention program for firms with many loss exposures and potentially large losses (health insurance, workers compensation, malpracticeSelf-insurance advantagesCost savings Flexibility The money paid for insurance can be invested at a higher return rate Retain full benefits of successful loss prevention/reduction programDisadvantages of self-insurancePossibility of catastrophic loss Firm has to perform many of the adminstrative activities previously performed by issuers Can't "pass the blame" to the isurer when denying claimsCaptive insuranceA firm starts an insurance company; an insurance company that is wholly owned subsidiary of a companyCaptive insurance advantagesBig advantage = acquire reinsurance Regulatory and income tax advantages Premium paid to captive can be deducted before taxIncurable risk characteristics1. Pure risk 2. Fortuitous losses (unexpected loss, accident) 3. Not catastrophic to insurers 4. Significant to insureds (not isuerer) 5. Definite and measurable 6. Large number of similar exposure units 7. AffordableLiability coverageIt will pay if you unintentionally cause an injury to another person or cause damage to another persons property (you must be liable)Medical payment coverageMedical payments coverage covers people who are injured in an accident in you home, regardless of whether you were at fault, this coverage does not apply to you or a member of your householdAdditional living expense coverageThis coverage will pay for the additional expenses you incur when you cannot live in your home because of damage or loss that is covered by your policyWhat does proposition 22 in California determine?Uber drivers are independent contractors, not employeesEmployee benefitsThe total cost to the employer is the same for paying salary or providing benefitsWhat are the advantages of group insuranceLess expensive Expected losses are easy to predict Commissions tend to be low ER helps with many of administration tasks Low search cost for EEWhat are disadvantages of group insuranceEE might leave the group and the benefit might not be portable One size does not fit allTraditional indemnity plansUse medical service first and then ask for reimbursementStructure of a typical HMO1. Select a primary care physician in the network (visiting doctors outside of the network will not be covered) 2. Must receive a referral to go to a specialist 3. HMO pays PCP by capitationStructure of a typical PPO (more flexible)1. No referral needed, no primary physician needed 2. Select any physicians in or out of the network, you could visit a doctor out of the network, but at a higher cost 3. PPO uses Fee-for-service reimbursement (FFS)Comsumer driven health plans (CDPHs)High-deductible plan with higher annual deductibles and out-of-pocket maximums than traditional health plans. Monthly premium is low CDHP uses Fee-for-service reimbursementAffordable care act has three major parts1. Insurance mandate 2. Insurance marketplace 3. Medicaid expansionDefined contribution (DC)The yearly contribution from the ER is defined the day of retirement you receive the lump sum for the ERDefined benefit plan (DB)The yearly contribution is not defined The day you retire you will start to receive retirement defined benefit until death The ER has to ensure the initial contribution is enough to cover this defined benefitSection 401(K)You contribute some and the employer will match; maximum contribution exists You do not pay now- you pay tax when you retireIf a firm is bankrupt and cannot support the DB plan anymore?Pension benefit gaurentee program provides plan termination insurance for DB plan (but not DC)Vested benefitGoes with the employee even though the EE changes the jobSocial insurance1. Social security 2. Workers compensation 3. Unemployment insuranceCharacteristic of social insuranceCompulsory participation (purchase) of insurance by law Social security employee and employer share the cost Workers compensation and unemployment the employer pays the full cost