Study Notes 1 Introduction to Risk Management
RISK
Risk is a chance of loss. All businesses face risk in their day-to-day operations
Speculative Risk – the probability of either gain or loss. Is managed by the business owner or manager’s specific business experience.
Pure Risk – the chance of loss but no chance of profit. Businesses face pure risks in the possibility of loss or destruction of property or the possibility of incurring liability
RISK MANAGEMENT
Techniques that permit insurance and risk professionals to apply a systematic approach to eliminate loss exposures, or minimize the detrimental effects of loss exposures, at the least possible cost.
Considered scientific because it identifies, measures, and controls risk.
It is also an art, relying heavily on experience and common sense
Risk Management Process involves:
- identifying and analyzing risk exposures
- formulating options for dealing with each exposure
- selecting the best technique or combination of techniques for dealing with the exposure
- implementing the chosen technique or combination of techniques
- monitoring the results and modifying techniques used as necessary
Risks are identified by determining which perils could occur resulting in loss.
Risks are measured by determining the likelihood of each identified peril occurring – its frequency and severity of any resulting loss
Risks can be measured a number of ways:
- reduction of elimination of risk by preventive efforts
- assumption or retention of risk by self-insuring
- transfer of risk:
o insurance
o contracts with other parties
Risk management not only used as the provision of insurance and reduction of loss potential and transfer of risk.
Brokers use as a prospecting tool. A focus on risk management ensures your brokerage and insurers are only taking on those risks you are prepared to management and able to service
A professional approach to risk management is not only the arranging of insurance for your client but your willingness to work with them to manage their risks.
A Risk Manager can be the principal of the client’s business, working alone or together with the accountant, plant manager, vice president, human resources manager, lawyer, a professional risk manager within the firm or an independent professional risk manager.
Large organizations employ risk managers who are responsible for developing and co-coordinating risk management functions acting as advisors to the business.
Smaller companies have this role shared among line managers.
The broker’s role is to participate in and bring additional value to the risk management process.
Know your limits as well as your professional and legal boundaries. When referring clients to outside experts, determine the appropriate person/organization so they can obtain the information they need:
- municipal fire departments
- police
- accountants
- lawyers
- consultants
- specialized consultants
- property appraisers
The broker role in loss prevention can only extend as bar as the broker’s relationship with the client will permit.
IDENTIFYING AND ANALYSING RISK
Cataloguing Exposures
Must be clearly identified. Exposures are caused by specific hazards that threaten a business because of external or internal conditions.
Includes recognizing how significant each type of loss would be to the client and the financial consequences of that loss to the future of the business.
Recognize there are different levels of risk. Some more likely to occur than others (known as frequency) and some will have greater financial consequences (known as severity)
Frequency can be the number of losses in a given period or the likelihood of a loss occurring
Severity is how large the loss is in terms of the amount of damage suffered or the actual dollar amount of the loss
Resources to assist analysis
Survey forms – designed to elicit details of exposures – are useful tolls in identifying risk because they allow the broker to describe a risk, classify it and assess it. They’re like a checklist to ensure the broker gathers all relevant information and will initiate discussions about improving the risk exposures.
Analysis by exception – establishing an understanding of the client’s business. Permits you to determine what risk will likely affect the company the most. Familiarizing yourself with the industry the client works in then ask specifically tailored questions to determine how this client’s business is different from others in the industry.
Brokers who specialize in a particular type of business/industry allows them to obtain a more in-depth understanding as to what is “standard” in that industry.
Information resources – doing research before meeting with the client allows for better anticipation of clients requirements:
- researching the company/industry on the internet or library
- reading industry specific periodicals
- speaking with insurance company personal who may be familiar with industry exposures
- talking to insurance claims personnel to understand industry losses and potential exposures the client faces
Research the individual – obtain information about the specific account to be insured. When speaking with the prospect, discuss what other businesses in the same industry are doing and how your prospective client’s company compares with these competitors and any proposed future changes to the clients company.
Companies tend to differ regarding:
- specific risks faced – including risks assumed in contracts
- insurance requirements (optional and mandatory) for the jurisdiction(s) the business operates in
- risk appetite – what the client is willing to retain
- improvements that can prevent/reduce risk of loss
- market choices – which insurer will best suit the client now and in the future
Client’s records – can reveal valuable information about how the organization is run and specific losses it might be exposed to.
- financial statements
- accounting records
- contracts
- sales brochures
- websites
Loss history – can provide information about the types of loss that the client is prone to. Frequent losses could indicate the need to amend loss control procedures/ higher deductibles. Severity of losses could indicate loss control techniques combined with insurance solution
Comparing client’s loss history with similar companies allows you to determine whether the client’s loss exposures are above or below average and might point to otherwise undetected differences in their operations from what is “normal” for the industry.
Inspections – can reveal information pertinent to underwriting the risk.
DETERMINING HOW TO MANAGE RISK
Risk Management Plan – once risk exposures have been identified and analyzed, formulate options for dealing with each exposure by selecting the most appropriate risk management technique or combination of techniques to minimize the effects of exposures:
- avoiding risk – eliminate potential losses, if possible
- reducing risk – can be accomplished through a variety of loss control techniques
- transferring risk:
o non-insurance transfers – transfer to others through contractual agreements
o transfer risk to insurance companies
- retaining risk – exposures the client judges to be relatively minor, predictable and within tolerance for loss to be retained and exposures that cannot be managed any other way.
Loss Prevention – not only saves money but also can reduce the risk of injuries or death and can mean the difference between a business continuing or closing.
Even if a loss is covered by insurance, permanent loss to the business can happen:
- inconvenience of setting up temporary facilities and replacement equipment
- potential cost of replacing customers
- delay in taking products to the marketplace
- loss of employees
- interruption of business during a time of growth
Avoiding Risk – by eliminating loss exposures. However, in many cases eliminating a loss exposure is not an option, or not a good option. Sometimes when a company avoids one exposure, another is created.
Reducing Risk – Some losses are inevitable, but there are ways of managing risk that will reduce the frequency and severity of losses through implementing safety measures. These measures can be physical or administrative:
Physical Safety Measures
- repairing/maintaining property and equipment, or installing safety devises on machines
- removing ice from driveways and walkways in winter
- better lighting in parking areas
- keeping walkways and floors free to tripping hazards
- regular removal of flammable waste
- devices such as sprinkler systems
Administrative safety Measures
- duplicating valuable information and storing off premises
- monitoring driving records for all regular drivers
- regular audits of cash and inventory
- requiring credentials, references and proof of insurance from independent contractors
Retaining Risk – a term used to describe the process when a company absorbs all or part of a financial loss itself.
Can be voluntary or involuntary – an insured can elect to retain the risk or the insurer’s wording through deductible or exclusions can avoid the transfer of risk to the insurer.
A mandatory minimum deductible is effectively a retention of part of the risk by the insured.
An exclusion limiting or removing cover makes losses from that peril the insured’s responsibility.
Risk Transfer – the responsibility for paying for a loss can be transferred either to other entities by a business contract or to an insurer through an insurance policy.
Contractual Transfer - entails transferring the potential for loss from one party to another through a legal document. Generally accomplished through hold harmless agreements or disclaimers
Hold harmless agreement – sometimes knows as an indemnity provision. Is an agreement between two or more parties transferring liability from where it would normally lie to someone else. These clauses are commonly found in contracts such as a lease, equipment rental agreement or maintenance contract.
Disclaimer – is a refusal to accept liability for damages that might occur. It denies a plaintiff’s right to recovery. Often notices posted in parking garages warn customers that no responsibility will be accepted for theft from vehicles parked.
A contractual risk transfer process is most equitable and effective where there is an appropriate balance of knowledge and skills to protect the interests of each party:
- knowledge of the business to which the contract refers
- experienced lawyers knowledge of legal issues, statutes and contract construction techniques
- risk management professional’s or broker’s knowledge of risk management principles, insurance coverages, terminology and marketplace
Greeven v. Blackcombe Skiing Enterprises ltd (1994) C.C.L.T. (2nd) 265 (B.C.S.C.)
Drawbacks to contractual transfers – such as courts voiding the transfer, cost control, incompleteness of the risk transfer, lack of control of the risk.
Cost control – although the client can takes steps to control their own risk and insurance costs – they cannot control the insurance costs of the business accepting the risk transfer
Incompleteness of the Risk Transfer – no matter how well drafted a contractual transfer is the transferor is left holding certain residual risks:
- transferee’s insurance could be depleted by other claims
- transferee could become insolvent
- injured third party not party to the transfer agreement may still look to client for indemnity
- court could interpret the meaning of the contract differently than was intended
Lack of control – contractual risk transfers are implemented indirectly through other parties whereby the transferor has little or no control as to the insurer, coverages or any other special provisions
Insurance Transfer
Insurance policies are a way to transfer financial responsibility of loss onto another party (the insurer) for a fixed premium.
Using this method of transfer the client has control of what is insured, which insurer it is transferred to, the deductible and other terms accepted and has full knowledge of all costs involved.
DESIGNING A RISK MANAGEMENT PLAN
After the broker and client have reviewed the exposures the business faces and risk management methods available, the client will be able to begin making choices of which technique to apply, taking into account:
- effects that difference risk management methods have on frequency and severity of potential losses
- comparable costs and savings for using different risk management methods
As part of the risk management process you assist the client in deciding which exposures to retain, which to eliminate and which to transfer.
IMPLEMENTING THE RISK MANAGEMENT PLAN
Implementing the risk management plan requires knowledge of the managerial and financial decisions involved.
Risk Avoidance – have you and the client considered the ramifications of each decision? Will avoiding the risk create new exposures? Are they greater or lesser than the ones being avoided
Risk Reduction – to consider:
- what physical improvements will be made
- within what time frame will work be done
- what is required to accomplish the work
Your assistance relates to how any improvements will affect loss prevention and insurance
Budget restraints and other factors may make it necessary to prioritize risk management action strategies
Risk Retention and Transfer – clients will determine which exposures will be retained by the business and which can be transferred to others contractually and through insurance.
Evaluating prior loss history to identify frequency and severity of losses aid in determining which risks will be retained.
When arranging a non-insurance transfer of exposures the client should obtain legal assistance
When specific exposures to be insured are identified:
- tailor the coverage to fit the risk management program
- negotiate the terms of the insurance policy or policies
- arrange insurance in accordance with client instructions
Since coverage conditions and insurers underwriting requirements change from time to time, keeping your knowledge of the marketplace up-to-date will help you arrange an appropriate insurance program.
ARRANGING THE INSURANCE PROGRAM
Solicit the broadest possible coverage available in the marketplace through an insurer who is most qualified to write the risk and who is acceptable to the client.
Value of an insurance product is not based on its price. Value also comes from how a product performs in a loss situation and from hot it meets the clients expectations
The quality of your service lies in part in your knowledge of the insurance market and your expertise in dealing with underwriting considerations. Understanding both the client’s requirements and the insurer’s policies, practices and underwriting appetite with respect to the type and size of risks it is willing to accept
Review the coverage insurers provide to confirm that the insurance will adequately cover the client’s exposures with respect to both limits covered and perils insured.
If unable to arrange insurance through regular markets, consider if insurance is available elsewhere (wholesale broker; mga)
If still unable to obtain insurance, advise the client accordingly and confirm in writing. Beware of stating categorically that the insurance is unavailable anywhere
Markal Investments Ltd. v. Morley Shafrom Agencies Ltd., (1990-02-28) BCCA CA008555
As far as possible, review the coverage with reference to what the client expects and confirm both verbally and in writing so that they understand the extent of coverage.
MONITORING AND MODIFYING THE RISK MANAGEMENT PLAN
Maintain contact – your involvement with the client does not end with arranging insurance.
Client’s requirements can change at any time so maintain regular contact with client to keep yourself apprised of their situation.
Analyze any newly identified or changed exposures. If a company’s circumstances/operations change the dynamics of its loss exposures, revise the risk management plan to meet client’s new requirements
If aspects of the program are not effective evaluate ways to improve the plan. Examples to look for:
- changes in chemicals used in manufacturing may increase or reduce risk of fire
- fleet safety program does not reduce accident rate
- changes in legislation or court decisions can affect the kind of liability client faces
- cyberspace exposures can open the client to exposures of the still evolving Internet Law
To be effective, risk management programs require regular re-evaluation and updating as necessary.
Consider that new exposures can develop and existing exposures can increase, decrease or be eliminated.
Establishing standards and benchmarks will assist in measuring performance and evaluating programs.
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