RISK MANAGEMENT
ASSIGNMENT 2
PARTI :MULTIPLE CHOICES QUESTIONS
1. A pharmaceutical firm recalls a popular drug after a study reveals that it causes deadly side
effects and later announces that it will no longer sell the drug. This decision is an example of
which of the following?
a. Avoidance
b. Self-insurance
c. Loss prevention
d. Contractual transfer
2. Installing airbags in automobiles is an example of which of the following?
a. Avoidance
b. Loss reduction
c. Loss prevention
d. Limited liability
3. ABC Mills agrees to assume the financial responsibility for losses caused by a local railroad
as part of an agreement to build a railroad sidetrack next to ABC’s silos. This exemplifies
which of the following?
a. Limited liability
b. An exculpatory clause
c. Hold-harmless agreement
d. Avoidance
4. Insurance is frequently used as a risk-handling technique for ____________ losses.
a. high frequency, high severity
b. high frequency, low severity
c. low frequency, high severity
d. low frequency, low severity
5. Which of the following statements regarding deductibles in insurance policies is correct?
I. Deductibles decrease moral hazard behavior by policyholders.
II. Increasing the deductible in an insurance policy can help decrease the policy premium.
a. I only
b. II only
c. Both I and II
d. Neither I nor II
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6. An insurance policy with a deductible is an example of which of the following?
a. Risk transfer
b. Risk assumption
c. Both a and b
d. Neither a nor b
7. Self-insurance is frequently used as a risk-handling technique for ____________ losses.
a. high-frequency, high-severity
b. high-frequency, low-severity
c. low-frequency, high-severity
d. low-frequency, low-severity
8. Cellar-Dwellers, Inc. is a construction firm that specializes in building residential basements.
The firm estimates that thieves steal 1,000 cement blocks from the firm’s work sites each
year, which it pays for out of its current cash accounts. This financing arrangement
exemplifies which of the following?
a. Loss reduction
b. Loss prevention
c. Risk retention
d. Self-insurance
9. Captive insurers
I. often are used to finance the self-insured losses of a large corporation.
II. often are located in locations like Bermuda or the Cayman Islands.
a. I only
b. II only
c. Both I and II
d. Neither I nor II
10. The federal law that promotes a safe working environment for workers is
a. Superfund.
b. Equal Opportunity Act.
c. OSHA.
d. CERCLA.
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Part II: Short Essay Questions
1. How is loss prevention different from loss reduction? Give some examples of each.
2. Describe the conditions in which avoidance is an appropriate risk-handling technique.
3. What is OSHA, and how does it relate to a firm’s risk-management program?
4. Describe how firms use contractual transfer methods to handle risk. Provide two examples.
5. Describe how firms can use limited liability as a means to protect themselves from risk.
6. Describe the advantages and disadvantages of using insurance as a loss-financing technique.
7. Describe the role of deductibles in insurance contracts.
8. How does self-insurance differ from risk assumption as an internal loss-financing technique?
9. What are the potential advantages (and disadvantages) of a self-insurance program?
10. Describe the benefits associated with using captive insurers as a loss-financing technique.
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Part III: Fire Case
In 2007, a fire hit several buildings in Bakaro, among the buildings damaged by the fire
tall building that a large telecommunication company had leased for administrative offices for its
60 employees. There was no loss of life, but property damage to the building was extensive
because the fire hit just after the end of workday. Because the company did not own the building,
the company had to arrange for access to the property after the loss through the building’s
owners. Moreover, the city’s building inspectors declared the building to be imminently
dangerous. After the building was labeled imminently dangerous, the company’s officers and
employees had no access to it for over a week. During this week and rain caused further damage
to the furniture, and equipment, and valuable papers.
The company’s risk manager had made prior arrangements with a disaster recovery
facility in a remote location that allowed the company to use the emergency facility’s computers,
phones, and fax machines after a disaster. This facility provided work-space about one-third of
the company’s important employees.
The company had planned to replace all the destroyed furniture, carpeting, and electronic
equipment as to repaint its entire premises before reoccupying the damaged property. While the
build unusable, the company had to find and rent alternate locations for many of its employees. It
also continues the expensive shuttle service to Bakaro and to provide many employees with an
allowance for their commuting expense. In addition, the company experienced much
inefficiency, such as the inability to hold needed conferences and meetings that normally would
have taken place in the damaged location. Perhaps the greatest complication arose when the
building owner declared that it was too expensive to repair the building and therefore it was
terminating all the leases. Leasing the same amount of space in a new location would likely cost
the company about twice what it had been paying at the damaged location.
Required:
1. Identify all the direct losses the company experienced.
2. Identify all the indirect losses the company experienced.
3. In a maximum probable loss event arising from a fire, identify the additional losses that
you would expect to see.
4. How could the company’s risk manager use each of the following risk management tools
in this case?
a. Risk assumption
b. Loss prevention
c. Loss reduction
d. Insurance
e. Risk transfer
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