CHAPTER 5 - Risk Management Techniques: Noninsurance Methods

SUMMARY:

Risk Management Techniques are the methods of treating risks. The four basic methods available for
handling risks are: Risk Avoidance, Loss Control, Risk Retention, and Risk Transfer.

RISK AVOIDANCE

 Risk Avoidance is a conscious decision not to be exposed to a particular risk of loss. It is not
always feasible, and even when it is, it is often not desirable.

LOSS CONTROL

 Involves actions to reduce losses associated with particular risks. Two methods of classifying loss
control involve FOCUS and TIMING.

FOCUS OF LOSS CONTROL

There are two forms of Loss Control that focus to 1.) Frequency of losses and 2.) Severity of
losses.

1. Frequency of Losses – loss controls that designed to lessen the chance that a person/firm will
suffer from a certain risk exposure.

- Frequency of losses is more often associated with Heinrich’s Theory or The Domino theory.
It states that employee injuries take the final place in the following sequence:
1. Heredity and Social Environment
2. Personal fault
3. Unsafe act or Physical Hazard
4. Accident
5. Resultant Injury

2. Severity of losses – loss controls that will not prevent accidents to happen but rather will
reduce the probability of injuries that a person will suffer if an accident does happen. It can be
further categorized to Separation and Duplication.

TIMING OF LOSS CONTROL involves actions prior to loss, concurrent with a loss, or after a loss
occurs.

 Expected gains from an investment in loss control should at least equal the EXPECTED COSTS in
order to justify the expenditure. But it is not necessarily easy to identify and quantify all
potential costs and benefits.
RISK RETENTION

 Involves the assumption of risk, and can be planned or unplanned. It can be either funded or
unfunded prior to a loss.

Four type of Funded Retention:

1. Use of credit
2. Establishment of a reserve fund
3. Self-insurance
4. Captive insurers.
 Large businesses can often use risk retention to a greater extent than can small firms, partly
because of their more extensive financial resources. Other factors to consider are the ability to
predict losses and the overall feasibility of the retention program.
 All else being the same, the greater the following, the greater is a firm’s ability to use risk
retention: Assets, revenues, liquidity, revenues/net worth, and retained earnings. All else being
the same, firms with lower debt to equity ratios are better able to use risk retention.

RISK TRANSFER

 Involves payment by the transferor to the transferee, who agrees to assume a risk that the
transferor desires to escape.

Five type of Risk Transfer methods:

1. Hold-harmless agreements
2. Incorporation
3. Diversification
4. Hedging
5. Insurance (covered in chapter 6)

VALUE OF RISK MANAGEMENT

Risk Management Activities such as Risk transfer ADD VALUE to a publicly traded firm by
efficiently allocating risk among the firm’s claimholders, reducing bankruptcy costs, increasing
the likelihood that obligations to debtholders are met, providing access to the real services of
insurers, and reducing expected tax liabilities.