Hazard RiskCHAPTER 3

Hazard Risk Defined No universal definition, but typically described as Pure Risk

The type of risk that may result in only a negative outcome

Three categories: Personnel risk – uncertainty related to losses to a firm due to death or incapacity of key employee; Property risk – uncertainty related to loss of wealth due to damage to property; Liability risk – uncertainty related to the financial responsibility from injury or damages to third party

Measuring Hazard RiskIt is very important to categorize risks to analyze them accurately.

Measuring the Frequency and the severity of the potential loss Loss Prevention reduces the frequency of losses Loss reduction reduces the severity of a loss

Risk Management Techniques Avoidance – Reduce the probability of loss to zero

Separation – disperse a particular activities over several locations

Duplication – involves relying on backup copies, etc., if primary asset is lost

Diversification – involves providing a range of products to be used by a variety of customers

Risk Control◦ Hazard Reduction◦ Loss Reduction

Transferring of Risk◦ Insurance, hedging or other transfer mechanism

How is Insurance Involved with RM?Insurance is only one of several risk management techniques;

Insurance is a device for sharing, transferring, and reducing risk that combines a sufficient number of exposure units to make individual losses collectively predictable.

Insurance Terminology Peril – the cause of a loss

Hazard – a condition that causes a peril;◦ A condition that increases the frequency or severity of a loss;◦ Four types:

◦ Physical – a tangible characteristic that impacts the frequency or severity◦ Morale – carelessness or indifference to a loss◦ Moral – intentionally causing or exaggerating a loss ◦ Legal – a condition in the legal environment that impacts the frequency or severity of a loss

Liability – a legally enforceable obligation to pay damages to a third party

Types of Loss ExposuresProperty Loss Exposures

Liability Loss Exposures

Personnel Loss Exposures

Net Income Loss Exposures

Must also consider (not listed in this chapter)

Management Liability Exposures

Corporate Governance Liability Exposures

Three Ways to Examine Losses:Elements of Loss Exposures

Asset Exposes to Loss

Cause of Loss

Financial Consequences of Loss

Property Assets Exposed to LossTangible property

Real Property

Personal Property

Intangible Property

Property Causes of LossPhysical Perils

Natural

Human

Economic

Financial Consequences of loss Loss of Use

Loss of income derived from the property

Extra expenses incurred to continue operations

Example in personal scenario: Extra living expenses

May be total or partial

May be temporary or permanent

Liability Exposures Asset exposed - the financial payment that must be made including:

Economic and Non-economic damages Settlement costs Litigation costs Legal fees

Cause of loss – filing of claim or notice of lawsuit

Financial Consequences of Loss Potentially unlimited or limited to the assets or earnings potential of the organization or person

Personnel Loss ExposuresAsset Exposed to Loss – the value a person adds to a organization

Cause of Loss – the loss of the person’s contribution through Death Disability Retirement Voluntary separation including resignation Involuntary separation, including firing or layoff

Financial consequences of Loss Contingent on wither permanent or temporary, total or partial (death or disability)

Net Income Loss ExposuresAsset Exposed – the future cash flows into the entity

Cause of loss – the outcome that may cause a decline in the potential future cash inflows: Damage to property Liability losses Personnel Losses Business risk such as losing market share, loss of good will, failure to anticipate growth potential or

failure of product to perform or failure of contractor to perform as scheduled.

Financial Consequences of Loss – degree of loss varies by cause of loss but may involve A decline in revenues An increase in expenses Both a decline in revenues and an increases in expenses

Classification of Commercial Insurance (Table on p. 3.17)

Property Coverage◦ Commercial Property – Building and Personal Property (BPP)◦ Business Income - called Consequential Loss insurance, also called time element coverage and business

interruption coverage; covers loss of income and extra expenses.

Key Terms Monoline vs.. package policy (e.g., fire vs. package commercial package policy) Named perils vs. all-risks (now called direct physical loss coverage) Replacement cost vs. actual cash value Insurance-to-value provisions with coinsurance provision

E.g.., 80% coinsurance clause on homeowners policy

Industrial All-risk (Special Risk) policies – perils and coverages are tailored to individual needs

Commercial Coverage (cont.)Builders’ Risk coverage – unique risk of buildings under construction

Limits increase as project progresses Addresses the myriad of different insurable interests involved in buildings under construction such as

Building owner Contractor Subcontractor

Provides additional coverage for unique perils such as increased likelihood of theft, windstorm and fire to materials left in the open E.g., copper wiring - http://articles.latimes.com/2013/aug/18/local/la-me-0819-copper-thefts-20130819

Equipment Breakdown coverage, including Boiler and Machinery, electrical and mechanical equipment

Fidelity and Crime Insurance – for perils such as employee dishonesty, computer fraud, extortion, forgery, theft and robbery

Commercial Coverage (cont.)Surety Bonds – guarantees to one party (the obligee) that the principal will fulfill an obligation or promise to perform Different from insurance in that surety bonds are three-party agreements involving a principal, surety,

and an obligee; Surety is answerable to the obligee if the principal defaults; surety does not expect a loss. Insurer is responsible to the insured; insurer expects losses in aggregate

General Liability InsuranceProvides coverage when the insured becomes legally obligated to pay damages

The insured may become legally obligated to pay damages due to a legal wrong for which the civil law provides a remedy in the form of damages.

Key terms: Tort – a wrong or wrongful act or an omission, other than a crime or a breach of contract, that invades a

legally protected right; Indemnify – to return someone to a pre-loss condition Occurrence (vs. accident) – a continuous or repeated exposure to harmful conditions; liability policies

also include an accident which is a sudden, unexpected event; Claims-made Form – coverage for damages that are claimed during the policy period

http://www.irmi.com/online/insurance-glossary/terms/c/claims-made-policy.aspx Asbestos

http://www.asbestos.com/legislation/history.php

Commercial Coverage (cont.)Commercial Auto – may provide liability and property coverage for business-owned vehicles

Workers Compensation – provides for the cost of medical care and rehabilitation for injured workers and lost wages and death benefits for dependents of persons killed in work-related accidents (III Fact Book 2013) WC systems and benefits vary by state History of Workers Compensation - http://www.ncbi.nlm.nih.gov/pmc/articles/PMC1888620/

Employers Liability – provides coverage when employees are allowed to sue employers for a situation that is outside the scope of WC or in a dual role as employer as well as manufacturer of product that caused damage, then employee may seek damages under employers liability

Professional Liability or E and O – coverage for failure to perform a professional duty or to conform to appropriate standards (typically excluded under GL policies)

Management Liability PoliciesDirectors and Officers Liability – covers directors and officers of a company for negligent acts or omissions and for misleading statements that result in suits against the company Examples: http://www.cnapro.com/pdf/D&O%20Product%20Summary_6-21-07.pdf There are numerous forms of D and O coverage (see III Fact Book, p. 185) Timeline of D and O coverage - http://www.mynewmarkets.com/articles/181645/do-timeline

Employment Practices Liability (EPL) – losses from laws that protect employees against discrimination, sexual harassment, unfair wage practices, and other prohibited employer practices May be purchased either as a stand-alone EPL policy or endorsed onto the D and O policy; (III FACT

book, p. 187)

Fiduciary Liability - covers fiduciaries of an employee benefit plan against liability claims alleging breach of their fiduciary duties involving discretionary judgment

Miscellaneous Commercial Coverage

Aircraft Insurance – specialized coverage that requires expertise to underwrite; somewhat unique in that it may be:

Potentially catastrophic – if high concentration of key employees in one plane or if plane crashes into highly concentrated area http://news.google.com/newspapers?nid=1842&dat=19911212&id=4U4gAAAAIBAJ&sjid=0McEAAAAIBAJ&pg=5903,1773128

Limited spread of risk – most companies who have Commercial Insurance do not have their own plane

Ocean marine – to cover the vessel, liability and cargo

Environmental Insurance – the need is obvious after several oil spills in recent history; Was Exxon Valdez the largest? http://www.mnn.com/earth-matters/wilderness-resources/stories/the-13-largest-oil-spills-in-history