Part 7 PowerPoint Presentation by Charlie Cook Copyright © 2003 South-Western College Publishing. All rights reserved. All rights reserved. Risk and Insurance

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PowerPoint Presentation by Charlie CookPowerPoint Presentation by Charlie Cook

Copyright Copyright © © 2003 South-Western College Publishing.2003 South-Western College Publishing. All rights reserved.All rights reserved.

Risk and Risk and InsuranceInsurance

2424

Financial Management in the Entrepreneurial Firm

12e

Copyright © by South-Western College Publishing. All rights reserved. 24–2

Looking AheadLooking AheadLooking AheadLooking Ahead

After studying this chapter, you should be able to:

1. Define risk and explain the nature of risk.

2. Explain how risk management can be used in coping with business risks.

3. Describe the risks associated with different types of assets, both physical and human.

4. Explain the basic principles used in evaluating an insurance program and the fundamental requirements for obtaining insurance.

5. Identify the different types of insurance coverage.


What is Risk?What is Risk?What is Risk?What is Risk?

• Risk–The chance that a situation may end in loss or

misfortune.

• Market Risk–The uncertainty of a gain or a loss associated with

an investment decision.

• Pure Risk–The uncertainty associated with a situation where

only loss or no loss can occur—there is no potential for gain (only downside).


Risk ManagementRisk ManagementRisk ManagementRisk Management

• Risk Management–Ways of coping with risk that are designed to

preserve assets and the earning power of a firm.

• The Process of Risk ManagementStep1: Identify risks.

Step 2: Evaluate risks.

Step 3: Select methods to manage risk.

Step 4: Implement the decision.

Step 5: Evaluate and review.


Methods to Manage RisksMethods to Manage RisksMethods to Manage RisksMethods to Manage Risks

• Risk Control–Minimizing potential losses by avoiding or

reducing risk.

• Risk Avoidance–Preventing risk by choosing not to engage in

hazardous activities.

• Risk Financing–Making funds available to cover losses that cannot

be managed by risk control.


Methods to Manage Risks (cont’d)Methods to Manage Risks (cont’d)Methods to Manage Risks (cont’d)Methods to Manage Risks (cont’d)

• Risk Transfer–Buying insurance or making contractual

agreements with others to transfer risk.

• Risk Retention–Choosing—whether consciously or

unconsciously, voluntarily or involuntarily—to manage risk internally.

• Self-Insurance–Designating part of a firm’s earnings as a cushion

against possible future losses.


Tools For Managing RiskTools For Managing RiskTools For Managing RiskTools For Managing Risk

High Frequency Low Frequency

High Severity Risk avoidance Risk reduction

Self-insurance Contractual agreements

Low Severity Risk reduction Risk retention

Risk retention

TABLE 24-1

Copyright © by South-Western College Publishing. All rights reserved. 24–8Fig 24-1

Fire

PropertyRisks

NaturalDisasters

Burglary andBusiness Swindles

Shoplifting

On-PremiseInjury

CompetitionfromFormer

Employees

Loss ofKey

Executives

EmployeeDishonesty

Bad Debts

ProductLiability

PersonnelRisks

CustomerRisks

Bankruptcy

The Wheel of The Wheel of MisfortuneMisfortune

The Wheel of The Wheel of MisfortuneMisfortune


Risk Management and the Small FirmRisk Management and the Small FirmRisk Management and the Small FirmRisk Management and the Small Firm

• Risk management differences from large firms:–It is more difficult for small firms to get insurance

coverage.–Large firms can assign responsibilities for risk

management to a specialized staff manager.–Risk management is not something that requires

immediate attention.


Classifying Risk by Type of AssetClassifying Risk by Type of AssetClassifying Risk by Type of AssetClassifying Risk by Type of Asset

Property RisksProperty RisksProperty RisksProperty Risks

FireFireFireFire

Natural DisastersNatural Disasters“Acts of God”“Acts of God”

Natural DisastersNatural Disasters“Acts of God”“Acts of God”

Customer RisksCustomer RisksCustomer RisksCustomer Risks

EmployeeEmployeeDishonestyDishonesty

EmployeeEmployeeDishonestyDishonesty

Competition fromCompetition fromFormer EmployeesFormer Employees

Competition fromCompetition fromFormer EmployeesFormer Employees

Personnel RisksPersonnel RisksPersonnel RisksPersonnel Risks

On-PremisesOn-PremisesInjuryInjury

On-PremisesOn-PremisesInjuryInjury

Product LiabilityProduct LiabilityProduct LiabilityProduct Liability

Burglary andBurglary andBusiness SwindlesBusiness Swindles

Burglary andBurglary andBusiness SwindlesBusiness Swindles

Loss of KeyLoss of KeyExecutivesExecutives

Loss of KeyLoss of KeyExecutivesExecutives Bad DebtsBad DebtsBad DebtsBad Debts

ShopliftingShopliftingShopliftingShoplifting BankruptcyBankruptcyBankruptcyBankruptcy


Insurance for Small BusinessInsurance for Small BusinessInsurance for Small BusinessInsurance for Small Business

• Basic Principles of a Sound Insurance Program–Identify insurable business risks

Workers’ compensation and automobile liability insurance are required by law.

–Limit coverage to major potential lossesAvoid overspending insurance resources.

–Relate premiums to probability of lossInsure most improbable but critical losses first.


Requirements for Obtaining InsuranceRequirements for Obtaining InsuranceRequirements for Obtaining InsuranceRequirements for Obtaining Insurance

• The risk must be calculable so that premiums can be calculated.

• The risk must exist in large enough numbers to allow the law of averages to work.

• The insured property must have commercial value.

• The policyholder must have an insurable interest in the property or person insured.


Types of InsuranceTypes of InsuranceTypes of InsuranceTypes of Insurance

• Commercial Property Insurance–Coverage that protects against losses associated

with damage to or loss of property.Coinsurance clause

• Business Interruption Insurance–Coverage of lost income and certain other

expenses while the business is being rebuilt.

• Dishonesty Insurance–Coverage that protects the firm against

employees’ crimes.


Types of Insurance (cont’d)Types of Insurance (cont’d)Types of Insurance (cont’d)Types of Insurance (cont’d)

• Surety Bonds–Coverage that protects against another’s failure to

fulfill a contractual obligation.

• Credit Insurance–Coverage that protects against abnormal bad-debt

losses.


Commercial Liability InsuranceCommercial Liability InsuranceCommercial Liability InsuranceCommercial Liability Insurance

Type Coverage

General Liability Insurance Protects against lawsuits brought by customers.

Employer’s Liability Insurance Protects against lawsuits brought by employees who suffer injury.

Worker’s Compensation Insurance

Obligates the insurer to pay employees for injury or illness related to employ-ment.

Key-Person Insurance Protects against the death of a firm’s key personnel.

Disability Insurance Protects against disability of a firm’s partner or other key employee.

Documents

Part 7 PowerPoint Presentation by Charlie Cook Copyright © 2003 South-Western College Publishing. All rights reserved. All rights reserved. Risk and Insurance