This is the second part of the Module 1. plz refer the first part before this. This slide is prepared for the MBA students under the finance specialization, with special reference to Kannur university students. Thanks to My Vimal Jyothi- Chemperi students

1. INSURANCE & RISK MANAGEMENT
,
Jinuachan Vadakkemulanjanal
Vimal Jyothi Institute of Management & Research,
Chemperi PO, Kannur Dr , Kerala-670632 www.vjim.ac.in
jinuachan@gmail.com; +91-9447373415; 04602213399; 2212240
SEMESTER III- FINANCE-Elective Course MBA3E33
Part 2
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2. Plz Down load the Part 1 before this slide of
this module.
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3. Course outcome
Objective To develop an understanding among
students about identifying analyzing and
managing various types of risk. Besides the
students will be in a position to
understand principles of insurance and its
usefulness in business
Pedagogy Lectures, Assignments, Practical exercises,
Case discussion and Seminars etc
Elective
Course
4 Credits * 4 teaching hrs. * Per week
3Hrs. IAT & End Sem. Exam * Marks
20+80 3Insurance & Risk management VJIM

4. Module-1
Slide: Part 1A
Concept of Risk, Types of Risk,
• Managing Risk, Sources and Measurement of Risk
• Slide: Part 1B
• Risk Evaluation and Prediction.
• Application of Statistical Techniques in Risk
Avoidance.
• Disaster Risk Management.
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5. • Risk-Averse
• Risk-Neutral
• Risk-Taker (Risk-Seeker, Risk-Lover)
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6. Measurement of Risk
• Statistical measures are used for the Risk
measurement based on historical data of
investment risk and volatility.
• The modern portfolio theory (MPT)is a standard
financial and academic methodology for assessing
the performance of a stock or a stock fund as
compared to its benchmark index.
• Risk Management Measurement Tools combines
qualitative and quantitative approaches
to measuring and managing risk.
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7. Risk identification/measurement tools
• Risk Management Measurement Tools
combines qualitative and quantitative
approaches to measuring and managing risk.
• Identify the loss exposure as in pure risk
1. Exposure check list
2. Financial statement analysis
3. Flow charts of the process
4. Contract Analysis-
5. Liability analysis
6. Onsite inspections
7. Statistical analysis of historical data
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8. Risk Evaluation
Criteria
• Frequency of the loss/ damage- lightening
• Maximum possible losses- partial/complete
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9. Risk Evaluation and Prediction
• Risk mapping / risk profiling
-Arrange the possible risk in matrix: Frequency
& Severity
-Analysis insurance cover for each
-Evaluvate the uncovered risk
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10. Statistical models
• Probability: 0-1
• Probability distribution study
• Measure of Center tendency: ẋ,
• Expected value of loss: Σ(amt x Probability)
• Median/ mode analysis
• Variance and SD (σ)
• Risk study: Coefficient study(%)
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11. calculate
• SJR computer Ltd has experienced the
following numbers of losses(in 000) in the past
10yrs: 3, 4,3,3,1,0,2,2,3,3. Calculate the mean,
median, mode, Variance, SD, coefficient of
variance for this loss due to monsoon.
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12. Probability distribution
• Empirical prob distribution
• Theoretical prob distribution: binomial, normal,
poisson
• Binomial distribution ( probability of x events in n possible times)
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13. 13Insurance & Risk management VJIM

14. Normal distribution
• The large observations exhibit Center limit
theory- normal distribution
• SD and mean will enable the analysis
• Loss on fire in furniture manufacturing firm:
Max loss 1000L, Mean- 500L, SD- 150L, n-500
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15. 15Insurance & Risk management VJIM

16. Inference..
• 68% - 1 σ
• 95% - 2 σ
• 99% - 3 σ
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17. Poisson Distribution
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18. Assignment problems
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19. • The mean λ of P distribution is its variance, so
σ=√ λ
• Best tool to calculate probability for more than
50 exposures, p =0.1 or less
• It is used, If less 50, but with multiple exposure
• Other: Gama, Log normal, Negative Binomial,
pareto
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20. • Number of trucks-10; Probability of accidents=
p=0.1. Calculate the probability of 3 losses.
(0,1,2,3,4)
Expected loss frequency, λ=.01x10=1.0
Probability of 3 loss= 1-( probability of 1+2+3)
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21. http://www.intmath.com/counting-probability/13-poisson-probability-
distribution.php
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22. Integrated Risk measures- VAR
1. Value at Risk- VAR. identify risk at various
probability levels. by banks
• VAR provides numerical statement of max
expected loss at a time and its probability.
• Correlate the categories of risk
2.Risk adjusted return on capital (RAROC)
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23. Application of Statistical Techniques in Risk
Avoidance -ch8
-Risk avoidance is the elimination of hazards, activities
and exposures that can negatively affect an
organization's assets.
-Whereas risk management aims to control the
damages and financial consequences of threatening
events
-Risk avoidance seeks to avoid compromising events
entirely.
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24. Techniques in Risk Avoidance
– Avoid risks if possible:
– Implement appropriate loss control (risk
reduction) measures
Risk retention + transfer to insurance
– Select the optimal mix of risk retention and risk
transfer
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25. 25
Avoid Risks if Possible
• Risks that can be eliminated without an adverse
effect on the goals of an individual or business
probably should be avoided
-Property granted at township/at to CRY- sell or
maintain the risk and return…
• Without a systematic identification of pure risk
exposures
– Some risks that easily could be avoided may
inadvertently be retained
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26. 26
Loss Control Measures
• For risks that a business or individual cannot or
does not wish to avoid
– Consideration should be given to available loss
control measures
• The costs and benefits of loss control
alternatives
– Should recognize that loss control will always be
used in conjunction with either risk retention or risk
transfer
• The selection between risk retention and risk
transfer as the optimal risk management
technique may change after loss control
expenditures are made
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27. 27
Analyzing Loss Control Decisions
• Capital budgeting techniques from finance and
accounting can be applied to risk management
decisions regarding loss control
• For example, Cole Department Store has been
experiencing substantial shoplifting losses and
occasional vandalism to its building
– The company is considering hiring 24-hour security guards
to decrease the frequency and severity of these losses
• Its estimated annual cost of the protection is $60,000
– Covers salaries and employee benefits for the guards
– Cole estimates that the presence of security guards will
decrease shoplifting losses by $30,000 and vandalism
losses by $20,000
• Additionally its insurance premiums are expected to decrease by
$5,000
– Should Cole hire the guards?
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28. 28
Analyzing Loss Control Decisions
• After examining only the financial
considerations
– Since the estimated $55,000 in savings is less than
the estimated $60,000 cost of hiring the guards
• The firm should not hire the guards
• However the company should consider
whether there are any additional relevant
factors that may have been overlooked
– For instance, will the presence of the security
guards make employees feel safer?
– Will the firm be able to hire better employees?
– Will customer relations be enhanced by the
presence of a guard?
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29. 29
Analyzing Loss Control Decisions
• In the Cole Department Store example all the
benefits and costs were expected to happen in
the same year
• When a longer period of time is involved the
calculations become more complicated
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30. 30
Optimal Mix of Risk Retention and Risk Transfer
• As stated, loss control decisions should be made as
part of an overall risk management plan
– It considers the techniques of risk retention and risk
transfer
• Often both of these techniques will be used
– The relevant question becomes
» What is the appropriate mix between these two techniques?
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31. 31
General Guidelines
• As a rule, risk retention is optimal for losses that
have a low expected severity
– With the rule becoming especially appropriate
when expected frequency is high
• Another general guideline applies to risks that have
a low expected frequency but a high potential
severity
– In this situation, risk transfer is often the optimal
choice
• When losses have both high expected severity and
high expected frequency
– It is likely that risk transfer, risk retention, and loss
control all will need to be used in varying degrees
• What constitutes “high” and “low” loss frequency
and severity in applying the preceding guidelinesInsurance & Risk management VJIM

32. 32
Guidelines for Using Different Risk Mgt Techniques
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33. 33
Selecting Retention Amounts
• In many situations both risk retention and risk transfer will
be used in varying degrees
– It is important to determine the appropriate mix of
these two risk management techniques
• Both capital budgeting methods and statistical procedures
may be used in selecting an appropriate retention level
– With insurance purchased for losses in excess of that
level
• But because the price of insurance does not necessarily
vary proportionately with different levels of retention
– The appropriate mix between retention and transfer is
not an exact science
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34. 34
The Deductible Decision
• Selecting a particular deductible level is one way of
mixing risk retention and risk transfer
• Deductibles help lower the cost of insurance as well
as increase its availability
• Deductibles may also make management more loss
conscious
– Because a firm must absorb losses within the deductible
level
• However, as a general rule, risk managers do not
accept a deductible unless
– The firm can afford the associated losses
– Sufficient premiums savings will result
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35. 35
The Deductible Decision
• Hall Shoe Corporation operates 100 shoe stores in
100 cities
• All stores
– Are located in suburban shopping centers
– Have similar construction characteristics
– Have the same fire rating
– Have a value of $150,000
• Table below shows the firm’s losses for the past
twelve months
– Are typical of its loss experience during the past several
years
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Table 8-3: Hall Shoe Corporation’s Fire
Losses
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37. 37
The Deductible Decision
• From Table 8-3 Hall Shoe’s risk manager can determine that
– The mean loss was $8,000
– The median loss was $2,500
– The standard deviation is about $11,000
– The loss frequency is five fires per year per 100 stores
• The firm is willing to retain no more than $10,000 in fire
losses during the year
– In effect, it wants to have an aggregate deductible equal
to $10,000
• The risk manager must determine the size of the per-
occurrence deductible that should be selected in order to
absorb no more than $10,000 in losses during the year
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38. 38
The Deductible Decision
• The firm has more than 50 loss exposures
• The probability of loss is less than 10%
–These two characteristics indicate that the
Poisson distribution may be suitable to use in
simulating losses
• In this case because the mean is distorted by the
$30,000 loss
– The median is the better measure of central tendency
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39. 39
The Deductible Decision
• Using the Poisson distribution and an average loss
frequency of five per year
– The probability of losses can be computed as shown in
Table 8-4
• For example, the probability of no losses at all would be
– (50e-5) ÷ 1 = 0.0067
• Therefore the probability of one or more losses is one minus
0.0067, or 0.9933
• If Hall Shoe Corporation chooses a deductible of $1,000 per
occurrence there is a
– 0.0318 chance that its losses will equal or be greater
than $10,000
– 0.0681 chance that the losses will equal or be greater
than $9,000, etc.
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40. 40
Table 8-4: Probability of Losses Using a Poisson
Distribution with m = 5
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41. 41
The Self-Insurance Decision
• The possibility of self-insurance is another way of mixing
risk retention and risk transfer
• The same statistical techniques used to select deductibles
can be used in choosing a retention level for a self-
insurance program
• The cash flow advantage of funds set aside in a reserve
fund is an additional factor that must be considered in
assessing value of self-insurance
– Because losses are not always paid out in the year in
which the event producing them occurs
• A company has the use of self-insurance funds for varying periods
– May earn interest on them until such a time as the losses are actually
paid
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42. 42
The Self-Insurance Decision
• In assessing the financial aspects of a self-insurance
program
– The value of operating funds to the firm must also be
considered
• If the monies in the reserve fund are invested in a
liquid form that can be readily converted to cash
– The firm may experience some loss because the funds
might have been more profitably used in the business as
working capital
• Known as an opportunity cost of funds
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43. 43
The Self-Insurance Decision
• Even though it may be clear that a firm can
save money in the long run with self-insurance
– Management may prefer stable, predictable
insurance premiums each year
• Some companies prefer to avoid the details of
managing self-insurance programs
– Rather, focusing on their main operations
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44. 44
The Self-Insurance Decision
• The following conditions are suggestive of the types
of situations where self-insurance is both possible
and feasible
– The firm should have a sufficient number of objects so
situated that they’re not subject to simultaneous
destruction
• The objects should also be reasonably similar in nature
and value so that the calculations of probable losses will
be accurate within a narrow range
– The firm must have accurate records or have access to
satisfactory statistics to enable it to make good estimates
of expected losses
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45. 45
The Self-Insurance Decision
• The firm must make arrangements for administering
the plan and managing the self-insurance fund
– Someone must pay claims, inspect exposures, implement
appropriate loss control measures, keep necessary records,
and take care of the many administrative details
• It may be possible to contract for these services to be
done by an independent third-party administrator
• The general financial condition of the firm should be
satisfactory
– Firm’s management must be willing and able to deal with
large and unusual losses
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46. Disaster Risk Management
• Disaster Risk Reduction (DRR) aims to reduce the
damage caused by natural hazards like
earthquakes, floods, droughts and cyclones,
through an ethic of prevention. Disasters often
follow natural hazards.
Ref: https://www.unisdr.org/we/inform/terminology
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47. Millions
of inhabitants
are at risk.
In the past 20 years,
31,835 Filipinos have
reported been killed
and 94,369,462 people
have been affected by
disasters.
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48. Disaster Risk Management
Framework
Risk
Assessment
Risk
Reduction
Risk
Financing
Disaster
Preparedness
and Recovery
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49. 49Insurance & Risk management VJIM

50. 50Insurance & Risk management VJIM

51. Down load the Part 1 before this slide of this module.
Please do rate or comment.