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This chapter has examined the variety of alterna- tives available to individuals and organizations when considering how to handle pure risks. Organizations use loss-control techniques to decrease their expo- sure to financial loss in two ways: by reducing the frequency at which losses occur and by reducing the severity of losses if they should occur. Risk-transfer techniques shift the financial responsibility for losses away from the organization and onto another party, such as an insurer or some other third party via con- tractual arrangements. Loss-financing techniques are arrangements that can be used to pay for losses, in- cluding external sources of financing like insurance, and internal arrangements such as risk retention or self-insurance programs.
As shown in Table 4-1 , no single method can solely be used to handle all risks. Instead, risk-handling needs vary depending on firm size and on the frequency and severity characteristics of the loss exposure.
Once the risk management department has selected the best technique with which to handle its loss exposure, it must take the steps to imple- ment that technique. For example, if a large firm decides to self-insure a loss exposure, it must hire actuarial consultants to forecast losses, arrange financing to pay for expected losses, and assemble a staff or hire third parties to manage the self- insurance program. If a firm plans to purchase insurance protection from a loss, it must deter- mine the amount of insurance to buy, consider whether it will hire a broker to assist in soliciting bids from insurers, and develop a process to deter- mine which insurer best fits the firm’s needs. In this regard, proper execution of a well-developed risk management plan will enable the firm to reduce its susceptibility to financial losses arising from pure risk.
Summary
1. How is loss prevention different from loss reduc- tion? 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 disadvan- tages) of a self-insurance program?
10. Describe the benefits associated with using captive insurers as a loss-financing technique.
11. Describe how loss frequency and loss severity affect a firm’s choice of risk-handling techniques.
