BONUS CHAPTER C MANAGING RISKLEARNING GOALSAfter you have read and studied this chapter, you should be able to:1. Identify the environmental changes that have made risk management important.2. Explain the four ays of managing risk and distinguish beteen insurableand uninsurable risk.!. "e#ne insurance policies and explain the la of large numbers and the rule of indemnity.$. "iscuss the various types of insurance that businesses can buy to manage risk.LEARNING THE LANGUAGE%isted here are important terms found in this chapter.&hoose the correct term foreach de#nition belo and rite it in the space provided.&laim %a of large numbers 'ule of indemnity(ealth maintenance organi)ations *(+,s-+utual insurance company .elf/insurance(ealth savings accounts *(.As-0referred provider organi)ations *00,s-.peculative riskInsurable interest 0remium .tock insurance companyInsurable risk 0ure risk 1ninsurable riskInsurance policy 'isk1. A 2222222222222222222222is a type of insurance company oned by stockholders.2. A ritten contract knon as a*n- 222222222222222222222 is beteen the insured and an insurance company that promises to pay for all or part of a loss.!. 3he 222222222222222222222 says that an insured person or organi)ation cannot collect more than the actual loss from an insurable risk. $. 3he threat of loss ith no chance of pro#t is called 22222222222222222222222222.4. 3he 2222222222222222222222is a principle hich states that if a large number of people are exposed to the same risk, a predictable number of losses ill occur during a given period of time.5. A chance of either pro#t or loss is called 2222222222222222222222.6. 3he chance of loss an entrepreneur takes of losing time and money on a business that may not prove to be pro#table is commonly called 222222222222222222.7. A 2222222222222222222222222is a type of insurance company oned by its policyholders.8. (ealth care organi)ations knon as 22222222222222222222222222re9uire members to choose from 1a restricted list of doctors.1:. 3he fee charged by an insurance company for an insurance policy is a 2222222222222222222.11. A*n- 222222222222222222222is one that no insurance company ill cover.12. 3he practice of setting aside money to cover routine claims and buying only ;catastrophe< policies to cover big losses is called 22222222222222222222.1!. A*n- 222222222222222222222222is a risk that the typical insurance company ill cover.1$. (ealth care organi)ations similar to (+,s except that they allo members to choose their on physicians for a fee are called 2222222222222222222222222.14. 3he possibility of the policyholder to su=er a loss is called 22222222222222222222222222.15. 3ax/deferred accounts knon as 22222222222222222 are linked to lo/cost, high deductible health insurance policies.16. 3he insured person sends a statement of loss called222222222222 to the insurance companyto re9uest payment.ASSESSMENT CHECKLearning Goal 1Understanding Business Risks1. >hat is E'+?2. >hat are the goals of E'+?a. ______________________________________________________b. ______________________________________________________c. ______________________________________________________Learning Goa 2Managing Risk!. "escribe the to kinds of risk.a. 22222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222b.2222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222$. 3he kind of risk of most concern to business people is: 2222222222222222222222222222224. %ist four methods businesses use to manage pure risk.a. 22222222222222222222222222222222c.2222222222222222222222222222222b. 2222222222222222222222222222222 d.22222222222222222222222222222225. >hat are of examples of ho can a #rm reduce risk?a. 2222222222222222222222222222222222222222222222222222222222222222222b. 2222222222222222222222222222222222222222222222222222222222222222222c. 22222222222222222222222222222222222222222222222222222222222222222226. 2222222222222222222222222 to threats is critical to risk management7. (o do some companies avoid risk?8. .elf/insurance is most appropriate hen: 222222222222222222222222222222222222222221:. >hat does it mean for a company to ;go bare< ith self/insurance, and hat is the risk?11. >hat is a @,0?12 "escribe four kinds of uninsurable risk.a.22222222222222222222222222222222222222222222222222222222222222222222222222b.22222222222222222222222222222222222222222222222222222222222222222222222222c.22222222222222222222222222222222222222222222222222222222222222222222222222d.222222222222222222222222222222222222222222222222222222222222222222222222231!. Identify the guidelines used to evaluate hether or not a risk is insurable.a. 2222222222222222222222222222222222222222222222222222222222222222222222222b.2222222222222222222222222222222222222222222222222222222222222222222222222c.2222222222222222222222222222222222222222222222222222222222222222222222222d. 2222222222222222222222222222222222222222222222222222222222222222222222222e.222222222222222222222222222222222222222222222222222222222222222222222222f. 222222222222222222222222222222222222222222222222222222222222222222222222Learning Goal 3Understanding Insurance P!icies1$. >hat makes the acceptance of risk possible for insurance companies is: 222222222222222222222222222222222222222222222222222222222222222222222222222222222222222214. (o are appropriate premiums for each policy determined?15. 3oday, many insurance companies are charging high premiums not for expected losses but for 2222222222222222222222222222222222222222222222222222222222222222222216. &an a person purchase more than one policy to cover the same risk? Explain.Learning Goal 4Insurance C"erage #r $arius Kinds # Risk17. >hat are three types of insurance to cover losses?a.222222222222222222222222222222222222222222222 b.222222222222222222222222222222222222222222222c.22222222222222222222222222222222222222222222218. >hat are four maAor options for health insurance?a. 22222222222222222222222222222222 c. 22222222222222222222222222222222b. 22222222222222222222222222222222 d. 2222222222222222222222222222222242:. >hat are the features of an (+,?21. >hat are some complaints about (+,s?22. >hat are some characteristics of a 00,?2!. >hy do most businesses and individuals choose to Aoin an (+, or a 00,?2$. "escribe the features of a health savings account.24. A maAor bene#t to you of health saving accounts is222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222222225. "escribe disability insurance.26. >ho provides orkerBs compensation and hat does it guarantee?27. >ho does professional liability insurance cover?>hat is another name for this type of insurance?28. >hat is product liability insurance?!:. 3o ensure those left behind ill be able to continue the business, entrepreneurs often buy 222222222222222222222222222222222222222222222222222222222222222222222225!1. >hat should you do about insurance coverage if you have a home/based business?!2. >hat are the issues involved in risk management and the environment?CRITICAL THINKING E%ERCISESLearning Goal 11. 3he ;environment< changes so rapidly that it is diCcult to identify all the changes that could a=ect a business in terms of risk management.Evaluate the company for hich you ork, or a company ith hich you are familiar.>hat is happening today in the environment *you remember this from chapter 1 / the economic and legal, technological, competitive, social, global business environments-?(o do the changes you have identi#ed increase the necessity for risk management for this #rm?>hat actions can the #rm take to minimi)e the risk of loss from these changes?Learning Goal 22. @usinesses have four options to avoid losses stemming from pure risk situations.'educe the risk@uy insurance to cover the riskAvoid the risk.elf/insure against the risk'ead the folloing situations, and determine hich option the #rm is choosing in each case.1se each option only once.a. 222222222222 3he president of an asbestos removal #rm in +erriam, Dansas closed his #rm for four months.b. 222222222222 A group of 26 accounting #rms formed its on insurance company to insure themselves. c. 222222222222 >orkers and visitors on construction sites are re9uired to ear hard hats. d. 222222222222 .enoret &hemical &ompany experienced a 15::E increase in its liability coverage premium. 6!. +any variables determine hich risks are insurable.1sing your text, determine hichof the folloing situations ould constitute an insurable risk.a. 2222222222223FG Enterprises ould like to buy insurance to cover loss of computere9uipment from poer surges and possible spills.b. 222222222222 Gilmores, Inc. a retail store in Dalama)oo, anted to insure against losses occurring hen a competitor, (udsons, implemented an aggressive marketing campaign.c. 222222222222 +E+& ants to buy insurance to cover losses created by a breakdon of their robotic and computer driven manufacturing systems. d. 222222222222 00I, a small manufacturing #rm, ants to insure themselves against losses createdby damage from a #re set accidentally. e. 222222222222 'esidents in +organ &ity, %ouisiana, East %ansing, +ichigan and Halley0ark,+issouri ant to buy Iood insurance. f. 222222222222 'esidents of +organ &ity, %ouisiana, hoever, face a high risk of Iooding, because the+ississippi 'iver is cutting a ne tributary through that city,and Ioods regularly.g. 222222222222 @oeing has extensive contracts ith the government to build #ghter planes.3he company ants insurance to cover losses that may occur if &ongress cuts the defense budget by over 2:E. Learning Goal 3$. Eric ons a company that makes self/darkening indshields for vehicles, .un/2/.hade.(e is aare of the risks of oning a business, and is considering various insurance plans.Eric ould like to make sure that he onBt incur any losses, and so is thinking about buying policies from to di=erent companies Aust to make sure that not only ill he be covered, butcould make money hile the company as don. Eric #gures that he ill be able to make claims on both policies if something happens, and even make money hen both companiespay on the claim. As EricBs advisor, hat ould you tell him about this plan?7Learning Goal 44. Jou are a small business oner, currently orking out of your home and you are concerned about thekinds of insurance that you should carry for your business.&urrently, your businessconsists of yourself, and ! employees. Jou have turned to a small business consultant to advise you.>hat do you think the consultant ill say about the need for insurance?PRACTICE TESTMULTIPLE CHOICE Circ!e t&e 'est ans(erLearning Goal 11. 'isk management has become an important concern for businesses today because:a. insurance companies have done such a good Aob of marketing their productsb. rapid environmental changes are becoming a maAor source of risk for companies..c. companies ant to insure themselves against potential losses.d. layers have made insurance claims a part of a companyBs legal strategicplan.2. An enterprise risk management program has as one of its goals:a. de#ne hich risks the program ill manage.b. eliminate the risk of doing business.c. insure the company from environmental disasters.d. spread the risk of doing business over time.Learning Goal 2!. >hen +acyBs orders inventory for the &hristmas season, the company has to predict hat their customers ill ant to buy that season.3he kind of risk being described isa. speculative risk.b. pure risk. .c. insurable risk.d. self/insurance$. It is hen a company has several idely distributed facilities that 2222222222222222 is the most appropriate. a. reducing the riskb. avoiding the riskc. self/insurance8d. #nding another company to take the risk9 4. An insurable risk is one in hich:a. the loss is a speci#c amount.b. the loss is not accidental.c. the risk is dispersed.d. the policyholder has no insurable interest.Learning Goal 35. 3he la of large numbers states that:a. a large number of people must make claims before an insurance company ill begin to pay out.b. if a large number of people are exposed to the same risk, a predictable number of losses ill occur during a given period of time.c. items that ill be covered by an insurance policy must not be above a certain amount, i.e. the large number hich is set by actuaries.d. if losses from an occurrence are large enough, and insurance company ill turn the policies over to a reinsurance company.6. 3he idea that an insured person or organi)ation cannot collect more than the actual loss from an insurable risk is called the:a. la of large numbers.b. rule of indemnity.c. disability insuranced. insurable interest.Learning Goal 47. A type of insurance that re9uires members to choose from a restricted list of doctors is called a:a. health maintenance organi)ation.b. preferred provider organi)ation.c. disability insurance.d. medical savings account.8. "isability insurancea. replaces all your income if you become disabled.b. starts immediately after your disability.c. is re9uired from employers.d. replaces a portion of your income.1:. If a person is inAured hen using a product and sues the manufacturer, the company is covered bya. orkers compensation.b. disability insurance.c. product liability insurance.d. business interruption insurance.1011. >hich of the folloing is true of orkerBs compensation insurance?a. It guarantees payment of ages, medical care, and rehabilitation services for employees ho are inAured on the Aob.b. ,nly employers in right to ork states are re9uired to provide orkerBs compensation insurance.c. 3he insurance does notprovide bene#ts to the survivors of orkers ho die as a result of ork/related inAuries.d. 3he cost of insurance is standard in any industry.12. @usiness concern about damage to the environment:a. is primarily restricted to companies in the 1nited .tates.b. is declining as companies add more insurance coverage as part of their strategic plans.c. has become a global issue because of concerns over issues such as climate changes.d. is primarily a concern of companies in the European 1nion and Eastern Europe.TRUE)*ALSELearning Goal 11. 22222 An enterprise risk management system includes determining ho risk management e=orts ill be coordinated across the #rm.2. 22222 Fe legislation is being passed in some areas hich aims to lessen some risk socompanies can obtain insurance coverage at a reasonable price.Learning Goal 2!. 22222 A #rm can reduce risk by establishing loss prevention programs such as #re drills, health education and accident prevention programs.$. 22222 0ure risk is the threat of loss ith no chance for pro#t.4. 22222 >hen a company ;goes bare< in terms of insurance, the company is getting the bare minimum insurance coverage from its insurance provider.5. 22222 ,ne type of risk that cannot be covered is loss from accidental inAury.Learning Goal 36. 22222 3he rule of indemnity states that you can have to insurance policies to cover the same risk of loss.7. 22222 A stock insurance company is one that insures the risk of being a stockholder.Learning Goal 48. 22222 ,ne of the complaints about an (+, is that members canBt choose their ondoctors.1:. 22222 (ealth savings accounts are tax/deferred accounts that allo you to save money for future medical expenses.11. 2222 +any professionals other than doctors and layers are buying malpractice insurance hich is also knon as professional liability insurance.1112. 2222 +ost homeonerBs insurance policies have ade9uate protection for a home based business.1!. 2222 >orkersB compensation insurance guarantees payment of ages for employees inAured on the Aob, but ill not cover medical expenses, as those should be covered by medical insurance programs.1$. 2222 &oncerns about the environment stem from issues such as global arming and ha)ards from nuclear poer plants.+u Can *ind It n t&e NetHisit the ebsite &tt,-..(((/r00ag/c0.hich is the ebsite for 'isk +anagement maga)ine.>hat are the maAor concerns addressed in the current issue of the maga)ine?(o do those concerns reIect hat e have discussed in this chapter?>hat is the 'I+.? Hisit the home page of the insurance company you currently use for car, homeoners, or other insurance policies.>hat types of products does this company o=er? 1se this companyBs ebsite to determine if you have ade9uate insurance to cover your needs.&an this company insure your small business?>hat kinds of business insurance do they o=er for your small business?12ANS1ERSLEARNING THE LANGUAGE1. .tock insurance company6. 'isk 1!.Insurable risk2. Insurance policy 7. +utual insurance company 1$.0referred 0rovider ,rgani)ation *00,-!. 'ule of indemnity 8.(ealth maintenance organi)ations *(+,s-14.Insurable interest$. 0ure risk 1:.0remium 15.+edical savings accounts *+.As-4. %a of large numbers 11.1ninsurable risk 16.&laim5. .peculative risk 12..elf insuranceASSESSMENT CHECKLearning Goal 1Understanding Business Risks1. E'+ is an enterprise risk program, designed by executives for their companies.2. 3he goals of an E'+ can include:a. de#ning hich risks the program ill manage.b. hat risk management processes, technologies, and investments ill be re9uired.c. ho these e=orts ill be coordinated across the #rm.Learning Goal 2Managing Risk!. a. .peculative risk involves a chance of either pro#t or loss.It includes the chance the#rmtakes to make extra money by buying ne machinery, ac9uiring more inventory and making other decisions in hich the probability of loss may be relatively lo and the amount of loss isknon.An entrepreneur takes speculative risk on the chance of making a pro#t.b. 0ure risk is the threat of loss ith no chance for pro#t.It involves the threat of #re,accident or loss.If such events occur, a company loses money, but if the events do not occur, the company gains nothing.$. 3he kind of risk of most concern to business/people is pure risk. 4. Kirms can manage risk bya.'educing the riskb. Avoiding the riskc. .elf/insure against the riskd. @uy insurance against the risk5. Examples of reducing risk include:13a. A #rm can reduce risk by establishing loss/prevention programs such as #re drills, health education, safety inspections, e9uipment maintenance, andaccident prevention programs.b. 'etail stores use mirrors, video cameras, and other devices to prevent shoplifting. c. +anufacturers have safety devices to protect orkers from inAury.6. Luick response is critical to risk management.7. &ompanies avoid risk by not accepting ha)ardous Aobs and by outsourcing shipping andother functions. Kor example, the threat of lasuits has driven aay some drug companies from manufacturing vaccines, and some consulting engineers refuse to ork on ha)ardous sites..ome companies are losing outside members of their boards of directors for lack of liability coverage. +any companies have cut back on their investments to avoid the risk of #nancial losses.8. .elf insurance is most appropriate hen a #rm has several idely distributed facilities.1:. >hen a company ;goes bare< the company is paying claims straight out of its budget.3his is a very risky strategy for a company. 3he risk is that the hole #rm could go bankrupt over one claim if the damages are high enough.11. A @,0 is a business onership policy.3his is a package that includes property and liability insurance, and reduces the cost of insurance.12. Kour kinds of uninsurable risk include:a.+arket risks *from price changes, style changes, ne products-b. 0olitical risks *from ar or government restrictions-c. 0ersonal risks *from loss of Aob-d. 'isks of operation *strikes or ineCcient machinery-1!. An insurable risk is evaluated using the folloing criteriaa. 3he policyholder must have an insurable interest.b. 3he loss must be measurable.c. 3he chance of loss should be measurable.d. 3he loss should be accidental.e. 3he risk should be dispersed.f. 3he insurance company can set standards for accepting risk.Learning Goal 3Understanding Insurance P!icies1$. >hat makes the acceptance of risk possible for insurance companies is the la of large numbers.14. Appropriate premiums for insurance policies are determined by using the la of large numbers.,nce the insurance company predicts the number of losses likely to occur, it can determine the appropriate premiums for each policy it issues against that loss.3he premium is supposed to be high enough to cover expected losses and still earn a pro#t for the #rm.15. 3oday many insurance companies are charging higher premiums not for expected losses but for the costs they anticipate from the increasing number of court cases and high damage aards.1416. A person canBt buy to insurance policies and collect from both for the same loss.Jou cannot gain from risk management you can only minimi)e lossesLearning Goal 4Insurance C"erage #r $arius Kinds # Risk17. 3hree types of insurance include:a. property and liabilityb. healthc. life insurance18. Kour maAor options for health insurance are:a.health care providers, such as @lue &rossM@lue .hield, b. health maintenance organi)ations *(+,s-c. preferred provider organi)ations *00,s-d. medical savings accounts *+.As-2:. (+,s o=er a full range of health care bene#ts.Emphasis is on helping members stay healthy instead of on treating illnesses.+embers do not receive bills and do not have to #ll out claim forms for routine service.(+,s employ or contract ith doctors, hospitals and other systems of health care and members must use those providers.(+,s are less expensive than comprehensive health insurance providers.21. +embers complain about not being able to choose doctors or to get the care they ant or need..ome physicians complain that they lose some freedom to do hat is needed to make people ell and that they often receive less compensation than they feel is appropriate for the services they provide.22. 0referred provider organi)ations contract ith hospitals and doctors, but do not re9uire members to choose only from those physicians. +embers can useoutside provides, for hich they pay more.+embers pay a deductible beforethe 00, ill pay any bills.>hen the plan does pay, members usually have topay part of the bill.3his payment is called co/insurance. 2!. +ost individuals and businesses choose to Aoin a 00, or an (+, because they can cost as much as 7: percent less than individual health insurance policies.2$. >ith a health savings account, you or your employer put part of the money currently spent on health insurance into a health savings account.Jou oulduse the money only for needed health care services.At the end of the year you get to keep the money you donBt spend in the account for future medical coverage.24. ,ne maAor bene#t to you of a health saving account is that the money gros tax/free until you take it out.25. "isability insurance replaces part of your income if you become disabled and unable to ork. 1sually, before you can begin collecting there is a period of time you must be disabled. 3he premiums for such insurance vary dependingon your age, occupation, and income.26. >orkers compensation insurance guarantees payment of ages, medical care, and rehabilitation services for employees ho are inAured on the Aob.15Employers in all states are re9uired to provide this type of insurance.3his insurance also provides bene#ts to the survivors of orkers ho die as a result of ork/related inAuries.3he cost of the insurance varies by the category of businessN higher risk Aobs cost more to insure than loer risk types of Aobs.27. 0rofessional liability insurance covers people ho may be found liable for professional negligence, such as layers, doctors, dentists, mortgage brokers, and real estate appraisers.3his is also knon as malpractice insurance.28. 0roduct liability insurance provides coverage against liability arising out of products sold.!:. 3o ensure those left behind ill be able to continue the business, entrepreneurs often buy life insurance that ill pay partners and others hat they need to keep the #rm going.!1. (omeonerBs policies usually donBt have ade9uate protection for a home/based business, so you may need to add an endorsement, or rider, to increase the coverage. If clients visit your oCce and or if you receive deliveries regularly, you may need home/oCce insurance, hich protects you from slip and fall lasuits and other risks associated ith visitors.+ore elaborate businesses may needother kinds of insurance.!2. 'isk management goes beyond the protection of individuals and businesses from knon risk.It no means evaluating the orldide risks and prioriti)ingthese risks so that international funds can be spent here they ill do the most good.CRITICAL THINKING E%ERCISESLearning Goal 11. Jour ansers to this 9uestion ill vary.(oever,some suggestions as to ho to minimi)e risk may include developing an enterprise risk management program for the company,to determine hat risks pose the greatest danger to the company, and ho to manage those risks.Learning Goal 22. a.Avoid riskb. .elf/insure against the riskc. 'educe the risk16d. @uy insurance to cover the risk.!. a. Jes, companies can buy insurance against the loss of computer e9uipment.b. Fo, this ould be an uninsurable risk.c. Fo,a company cannot insure againstineCcient machinery or machinerythat breaks don or doesnBt ork.d. Jes you can insure against #re damage. e. Jes, probably, unless the occurrence of loss has been too high.f. Fo, most likely because the probability of Iooding in +organ &ity is too high.g.Fo this ould be a ;political risk< and is uninsurable.Learning Goal 3$. >hile it is understandable that Eric ould be concerned about taking care of losses his business may experience, the rule of indemnity ill prevent Eric from #ling claims ith to di=erent insurance companies for the same incident.3he rule of indemnity states that an insured person or organi)ation canBt collect more than the actual loss from an insurable risk.If a company carries to policies, the to insurance companies ould calculate any loss and divide the reimbursement.Leaning Goal 44. As a small business oner located in your home, you ill need to have a regular homeonerBs policy, but there ill be additional coverage that you should consider.Jou may need a rider to cover business e9uipment, and if customers or clients call on you, you may need home oCce insurance.If you manufacture items at your home business, you should consider a business oner policy. "epending upon the type of business you on, you may ant to consider professional liability insurance or product liability insurance..ince you have employees, you may ant to check into o=ering other insurance coverage for them.Employers often o=er life insurance, disability insurance, retirement plans, and health insurance.Jou ill probably be re9uired to o=er orkerBs compensation insurance.3he cost of orkerBs compensation insurance ill be determined by your companyBs safety record, its payroll and the types of ha)ards faced by your orkers.PRACTICE TESTMULTIPLE CHOICE TRUE)*ALSE1. a 6. b 1. 3 7. K2. b 7. a 2. 3 8. 3!. a 8. d !. 3 1:. 3$. c 1:. c $. 3 11. 34. c 11. b 4. K 12. K5. b12. c 5. K 1!. K6. K 1$. 31718