• Managerial function of business

• That uses scientific approach

• To deal with risks by
anticipating possible loss
• And designing and
implementing procedures to
minimize occurrence of loss
 1. Prepare for potential loss in the most
economic way:
- Analysis of the cost of safety programs,
insurance premium paid and costs
associated with other techniques.
Pre loss 2. Reduction of anxiety:
objectives - certain loss exposure can cause anxiety
3. Meet any legal obligations:
- Install safety device for the protection of
workers, dispose of hazardous waste
materials, label consumer products
appropriately, paying workers compensation
benefit.
 1. Survival of the firm:
- After a loss, a firm can resume its partial
operations within some reasonable time
period.
2. Continue operating:
- Ability to operate after a loss is very important.
- Public utility firm, banks, bakeries etc. must
Post loss objectives continue .
3. Stability of earning :
- Earning per share can be maintained if firm
continues to operate.
4. Continued growth of firm :
- Develop products by acquisition or merging.
5. Minimize effect that a loss will have on others :
- Severe loss can effect employees, suppliers,
customers, creditors etc.
 (Building, furniture , equipment , acc receivable, inventory)
( Environment pollution, sexual harassment, defective product)
(continuing expense after loss, extra expense,)
(Death of employee, retirement, job related injury)
( Robbery, burglary, employee theft, dishonesty, fraud, theft of intellectual property)
( Life ,health, retirement plan, failure to comply with gov rules)
(terrorism, foreign currency and exchange rate risks, political risks)
(damage to companys public image, loss of goodwill)
 Measure
and analyze
the loss
• If a plant is totally destroyed by flood, the risk manager estimates that
exposure replacement cost, debris removal, demolition costs etc. will total $25
million which is the maximum possible loss.
• The risk manager also estimates that a flood causing more than $20
million of damage to the plant is so unlikely that such a flood would
not occur in 100 years. The risk manager may choose to ignore event
that occur so infrequently. Thus , for him, the probable maximum loss
is $20 million
Two types :
1. Risk control
2. Risk financing
Major advantages :
• The chance of loss is reduced to zero
if the loss exposure is never required.
• If existing loss exposure is
abandoned, chance of loss is
eliminated.

It has two major disadvantages :

1. A firm may not be able to avoid all

loss. For example, a company may
not be able to avoid the premature
death of a key executive.
2. It may not be practical to avoid the
exposure. E.g, a paint factory may
avoid loss arising from production of
paint but without the production the
firm may not be in the business.
- Rehabilitation of worker with job related injuries.
1. Risk manager use a number of methods for managing risk. For each of the
following, what method for handling risk is used? Explain your answer.

a) The decision not to carry earthquake insurance on a firm’s main manufacturing

plant
–The method for handling risk that used above is risk retention or self-insurance. Risk
retention is the risk taken by individual or organization to meet losses from a particular
risk either intentionally or unintentionally. It means to set aside the funds or assets in
order to have available cash for compensating losses that may be occurs.
b) The installation of an automatic sprinkler system in a hotel
-The method used by above is risk/ loss reduction. It is a process or steps to reduce
the degree of hazard presented by a risk which cannot be eliminated or the frequency
with which it may result in loss. For example, the risk manager wants to install an
automatic sprinkler system in the hotel is to reduce the loss in case of fire. This is
because fire sprinkler system cannot avoid the risk of fire and cannot self-retention of
the loss.
c)The decision not to produce a product that might result in a product liability
lawsuit
- Risk Avoidance . It is the action taken to avoid entirely any possibility of an
undesirable event taking place or to eliminate the risk all together by not
engaging in activities that might lead to loss. The action taken is
elimination (removal)due to the risk managers decide not to product a
product that might occur in a product liability lawsuit. So, the risk of cause
injuries, damage or loss will be eliminated.

d) Requiring retailers who sell the firm’s product to sign an agreement

releasing the firm from liability if the product injures someone.
- Risk Transfer. It can Shift the financial consequences to a third party
through contractual transfer agreements. It does not reduce risk but transfer
risk to another party. Therefore, the firm could transfer risk that products
injure customers to retailers.
Active retention : Firm is aware of the loss exposure and consciously
decides to retain part or all of it , i.e, collision loss of a fleet of company cars.

Passive retention : Failure to identify loss exposure, failure to act , i.e, a risk
manager may fail to identify all company assets that could be damaged in an
earthquake.
Retention can be effectively used under the following
conditions:

1. No other method or treatment is available:

- Insurer may be unwilling to write coverage or coverage might be too expensive.
In this case, though loss prevention can reduce frequency of loss, all losses cannot be
eliminated. In this case , it must be retained.
2. The worst possible loss is not serious :
- physical damage loss to vehicles in a large firms fleet will not bankrupt the firm
if vehicles are separated by wide distance.
3. Losses are fairly predictable :
- Retentions can be effectively used for workers compensation claim, damage to
car and shoplifting loss. Based on past experience, risk manager can estimate the
range of frequency and severity of actual loss. If losses fall within that range, it can
be paid out from company’s income.
, Assets may have to be liquified to pay loss.

, Interest must be paid on loan.

Advantages of Disadvantages of
retention: retention:

• Save on loss costs • Possible higher losses

• Save on expense • Possible higher expenses
• Encourage loss prevention • Possible higher taxes
• Increase cash flow
 Captive insurer

• Insurer owned by a parent firm for the purpose of

insuring the parent firm’s loss exposure.
• Single parent captive / pure captive is an insurer
owned by only one parent (corporation).
• Association or group captive is an insurer owned by
several parent(trade association).
( Global firms can’t obtain coverage at reasonable rate from commercial insurers.)

And to avoid undesirable financial solvency regulations.

(Because of lower operating sys, avoidance of brokers commission & retention of interest earned on
investment premiums)
(As they deal with only insurance
companies)
 Non insurance transfers
• Methods other than insurance by which a pure risk and its potential
consequences are transferred to another party.
• Examples : contracts, leases, hold-harmless agreements.
• A firms contract with a construction firm to build a new plant can specify that
the construction firm is responsible for any damage to the plant while being
built.
• Computer lease can specify that maintenance repairs and other damages are
responsibility of the computer firm.
• Hold harmless clause is when one party assumes legal liability on behalf of
another party. Example , a publishing firm may insert a hold harmless clause in
a contract by which the author, not the publisher, is legally liable if publisher is
sued for plagiarism
Advantages of Disadvantages of
noninsurance transfer noninsurance transfer

• Risk manager can transfer some • Transfer may fail as contract

potential losses that are not language is ambiguous.
commercially insurable. • If party to whom loss is transferred
• Less costly is unable to pay, firm is responsible
• Loss may be shifted to someone for the claim
who is in better position to exercise • Insurer may not give credit for the
loss control transfers
• Insurance cost may not be reduced
 Insurance

5 areas must be emphasized to use insurance :

• Selection of insurance coverage
• Selection of insurer
• Negotiation of terms
• Dissemination of information concerning insurance
coverages
• Periodic review of insurance program
 Advantages of Disadvantages of
insurance insurance
• Firm can continue to operate and • Major cost is payment of premium.
fluctuations in earnings are minimized. • Time and effort has to be spent in
• Uncertainty is reduced selecting insurer and negotiating
• Improves performance and policy terms and premiums.
productivity • Firm has to cooperate with the risk
• Services such as Risk control services, control activities of insurer.
loss exposure analysis, claim adjusting • Risk manager may have less incentive
services are availed. to implement loss control measures
• Insurance premiums are income tax as insurer will pay claim if loss
deductible as a business expense. occurs.