Exam 2 notes - Topic 6 Module 1 Risk Management...

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Topic 6 Module 1 Risk Management Alternatives – Risk Financing Options (Step 3) Risk Financing Goals/Objectives Given that a loss has occurred, Risk Financing deals with sources of funds to pay for losses Either you pay for losses or someone pays for losses External Funds-where someone external to the firm pays for the loss Internal Funds – where you pay for the losses Alternative Risk Financing Strategies Tools: Risk Transfers of the Finance Type (External Funds) Seek funds from unrelated third parties to pay for losses Common Misinterpretation Transfer the Risk You may own a house and have a property loss exposure and a liability loss exposure You can sell the house to someone else and then you no longer have the property loss exposure and the liability loss exposure But we’re really interested in transferring the financial responsibility for payment of the loss to a third party Where we still have or own the activity or asset exposed to the loss Risk Transfers of the Financing Type (External) Insurance – Transfers the Financial Responsibility of the loss to the insurer (buy a contract) Non-insurance risk transfers of the financing type Leases Tenant is financially responsible for all property losses while occupying the property Hold-Harmless Agreement Engage a Contractor Make the contractor responsible for all liability loss exposures Example: in new constructions at Temple University. Temple insisters on a hold harmless agreement with the contractor. NOTE: In all 3 types of risk transfers of the financing type of the external sources of funding, the financial responsibility can bounce back- meaning: if the third party now becomes insolvent and unable to pay, then the financial responsibility can bounce back to the owner. For example if your friends trash the apartment that you signed the lease and you don’t have the funds to repair and recover the apartment, then you may either leave the apartment or let the owner know that you can’t pay for the damages. In this case, the owner, besides taking you to court to try and recover any damages, would have to repair and recover the apartment out of their own funds if they want to continue to generate revenues from the apartment. Risk Transfers of the Financing Type (Internal) Retention A firm or individual engaging in retention assumes financial responsibility for losses that occur. They “Retain the Exposure to the loss” Individual Retention Examples: Not buying Insurance Underinsured : low policy limits Insurance contract with a deductible Types of Retention
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Active Retention A firm or Individual Retains the Exposure to Loss Known Decision Passive Retention A Firm or Individual Retains the Exposure to Loss May be unaware that they’ve retained the exposure to the loss.
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