Risk Management and Insurance FIN 403

Reading. Page 187 – 195 Risk ManagementPage 199 – 203 InsurancePages 211 – 212, 216 – 221, 227 – 233.

Learning Objectives1. To develop the concept and practice of a five-stage

personal risk-management process:a. Identifyb. Evaluatec. Controld. Financee. Monitor

2. To understand the theoretical role of insurance in financing personal risks.

Risk management is a life skill.Where is risk management useful?a) Personal financesb) Healthc) Personal safetyd) Businesse) National securityf) Environmentg) Others… (small and large business, public parks,

when travelling, in relationships, etc.) A funny saying to amuse you “only the paranoid survive

disasters!”

Speculative RiskSpeculative Risk involves loss and gain, but in uncertain

amounts.a) Lottery Tickets have almost no chance of winning and

you will almost always lose your bet, but people still play the game.

b) Common shares (investments) offer unknown dividends (profits) and the potential to lose the entire investment.

c) It is a risk to quit a secure job and start your own business, however the risk is lessened if you are well prepared.

Each of these examples may cost you money or make you money.

SpeculationThe formal financial definition of ‘speculative risk’ does not

include gambling.Speculative Risks have a probability of winning and a

probability of losing. Think about math classes and probability formulas. The more information you have about a problem, the more likely you will be to choose to stay away from the problem road and choose the road to success.

Question. I want to invest in oil (2011). Should I choose companies that are exploring, with the potential for new profits, in the Atlantic Ocean of Newfoundland, Canada, or in the desert of Libya?

Why.

Pure RiskPure risk involves the possibility of loss, only. Early death,

disability and theft of your car are all pure risks. Pure risks are ones that happen to us without us having made a

conscious choice to seek them out. This is different that speculative risk, where we will have

investigated and researched and weighed the potential for gain and loss.

Question. What is different about people who choose to seek profit from pure risks, from those who seek profit from speculative risks?

Answer. The difference is that one is gambler while the other is a professional, subject matter expert that has thoroughly investigated the risk by looking at the risks by using the SWOT model (strengths, weaknesses, opportunities and threats)

The 5 Step Process to Managing RiskStep 1

Question. Many people do not think about risks. What are some common mistakes that people make?

They say, “It won’t happen to me.” They don’t know the difference between types of protection

and do not assess their own need before going shopping.They listen to a salesperson who is very good at showing the

positives which will benefit the commission sale and fail to look insightfully at needs of the client / customer.

Profit motivates Self Interest. Beware of the salesman.“An educated consumer is the best customer”

The only person who can successfully look out for your best interests is YOU.

Step 1 (continued)

Question. What are the 3 life-cycle changes as related to risk and the need for insurance?

a) Personal or life and healthb) Propertyc) Liability to others for our actionsWhat are some examples of different life-cycle risks?d) Your parents may be dependent upon you for health

care and financial support.e) Disabled child. Who can summarize our previous

discussion about my friend with a child with a serious disability? Bonus…

Third Party LiabilityMost people are only familiar with third party liability.Example: Automobile / car insurance. Mandatory in Canada.If we cause another person a loss, we are liable /

responsible for the other person’s losses.Example: If you accidentally kill someone, you will may

be responsible for the present value of their lifetime earnings.

Example: Property damage. If I did not cut down a tree that was likely to fall, and it falls onto power lines, I will be responsible for cost to repair the lines.

Common Law as it applies to TortsCommon Law = Determined by court decisions over a long

period of time, rather than by statutes (law makers / politicians).

Tort = Legal wrongs or injuries one person causes another.The court will not find you responsible for someone else’s

losses as long as you take reasonable care.Example: a hurricane blows down a healthy tree, on your

property, onto your neighbors car is different than if a minor wind storm blows down an obviously unhealthy tree. In the second case, if your neighbor had insurance to cover a tree falling on his car, his insurance company would take legal action against you to reimburse their expenses incurred in repairing his car.

Tort law and businessLimited (incorporated) Companies: as the name implies, the

responsibility is limited to the company and not the individual investors in the company, beyond the amount they invested. Companies have insurance to protect their investors.

Unincorporated businesses and professionals are personally liable without limit for losses they cause. They risk everything they own, including their homes, retirement investments, etc. They may have insurance, but if they failed to take the proper precautions, the insurance company will not pay and the individual will be responsible.

Welcome to the world of taking responsibility for your own actions!

In class exercise and group homeworkOpen your note books and prepare to write your observations.

While watching the video, write down the risks that you see. Be prepared to explain why they are risks and how you could protect yourself from liability?Assignment: You have been contracted to walk the property, identify the risks and write up your observations and recommend solutions in a professional report. You can use anything that Mr. Silver says in class, in your paper. You will only see the video once so if you choose to use your imagination when writing, please do so, but be realistic. The paper should be approximately 2 pages in length. The format: All papers must include a cover page with Name, Student Number and email address of each group member. Due date: Friday November 25th. Hard copy only. No email submissions. The best paper(s) will read to the class as an example of good work and future expectations. This exercise can be found on the website.

Optional Slides

RiskAvoidance

RiskShifting

RiskAssumption

RiskReductionWays to

ManageRisk

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Coverage and Type of Risk

• Pure Risk.– Personal risks, property risks, and liability risks are

types of pure risk. – Insurable, chance of loss, not gain.– Accidental, unintentional.– Nature and financial loss of the risk can be

predicted.• Speculative Risk.– Chance of loss or gain, such as starting a business.– Uninsurable.

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