Small Business Discussion Board 13 & 14

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Chapter_23_Managing_Risk.pdf

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Small Business Management, 18e

Longenecker/Petty/Palich/Hoy

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Managing Risk in the Small

Business

Chapter 23

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Learning Goals:

 Define business risk, and explain its two

dimensions.

 Identify the basic types of pure risk.

 Describe the steps in the risk management

process, and explain how risk management

can be used in small companies.

 Explain the basic principles used in evaluating

an insurance program.

 Identify the common types of business

insurance coverage. © 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or

service or otherwise on a password-protected website for classroom use.

What is Business Risk?

 Risk

The possibility of suffering harm or loss.

 Business Risk

The possibility of losses associated with the assets and the

earnings potential of a firm.

 Market Risk

The uncertainty (gain or loss) associated with an investment

decision.

 Pure Risk

The uncertainty associated with a situation where only loss or

no loss can occur—there is no potential for gain (only

downside).

Only form of risk that is insurable.

23–4

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Basic Types of Pure Risk:

Property

 Real Property

Land and anything physically attached to the land,

such as buildings

 Personal Property

Machinery, equipment, furniture, fixtures, stock, and

vehicles

 Replacement Value of Property

The cost to replace or replicate property at today’s

prices

 Actual Cash Value (ACV) An insurance term that refers to the depreciated

value of a property 23–5

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Basic Types of Pure Risk:

Property (cont.)

 Actual Cash Value (ACV)

An insurance term that refers to the depreciated

value of a property

 Peril

A cause of loss, either through natural events or

through the acts of people

 Direct Loss

A loss in which physical damage to property

reduces its value to the property owner

23–6

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Basic Types of Pure Risk:

Property (cont.)

 Indirect Loss

A loss arising from inability to carry on normal

operations due to a direct loss to property

23–7

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Liability Risks: Statutory Liability

 Workers’ Compensation Legislation

Laws obligating the employer to pay the

employee for an employment-related injury

or illness, regardless

of fault.

23–8

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Business Activity-Related

Liability Risks

 Contractual Liability

Performance or financial obligations (risks)

that firms assume when entering into

contracts with other parties

 Indemnification Clause

A contractual clause that requires one party

to assume the financial consequences of

another party’s legal liabilities.

23–9

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Liability Risks: Contractual

Liability  Torts

Wrongful acts or omissions for which an injured

can take legal action against the wrongdoer for

monetary damages

 Establishing Negligence

A legal duty between parties to act (or not to act)

to cause injury (damage)

A failure to provide the appropriate standard of care

The presence of actual injury or damages

Action that was proximate cause of injury or

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Liability Risks: Contractual

Liability (cont.)

 Reasonable (Prudent Person) Standard

The typical standard of care, based on what a

reasonable or prudent person would do

under similar circumstances.

 Compensatory Damages

Economic or noneconomic damages intended

to make the claimant whole, by indemnifying

the claimant for any injuries or damage arising

from the negligent action

23–11

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Torts: Types of Compensatory

Damages

 Economic Damages

Compensatory damages related to an

economic loss, such as medical expense, loss

of income, or the cost of property

replacement/restoration

 Noneconomic Damages

Compensatory damages for such losses as

pain and suffering, mental anguish, and loss of

consortium

23–12

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Torts: Types of Compensatory

Damages

 Punitive Damages

Damages intended to punish wrongdoers for

gross negligence or a callous disregard for the

interests of others and to have a deterrent

effect

23–13

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Product Liability

 Manufacturing Defect

A defect resulting from a problem that occurs

during the manufacturing process causing the

product to subsequently not be made according

to specifications.

 Design Defect

A defect resulting from a dangerous design, even

though the product was made according to

specifications.

23–14

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Product Liability (cont.)

 Marketing Defect

A defect resulting from failure to convey to the

user that hazards are associated with a product

or to provide adequate instructions on safe

product use.

23–15

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Sources of

Tort Liability

Automobile Liability

Product Liability

Completed

Operations Liability

Premises Liability

Operations Liability

Professional Liability

Employers’ Liability Directors and

Officers Liability

© 2017 Cengage Learning. All Rights Reserved. May not be copied, scanned, or duplicated, in whole or in part, except for use as permitted in a license distributed with a certain product or service or otherwise on a

password-protected website for classroom use.

Personnel Risks

 Personnel Risks

Risks that directly affect individual employees,

but may have an indirect impact on a business

as well.

Premature death

Poor health

Insufficient retirement income

23–17

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Risk Management

 Risk Management

Involves ways of coping with risk that are

designed to preserve assets and the earning

power of a firm.

Involves finding the best way possible to

reduce the cost of dealing with risk.

Insurance is only one of several approaches

to minimizing the pure risks a firm is sure to

encounter.

23–18

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Implement the decision.

Evaluate risks.

The Process of Risk Management

Identify and understand risks.

Select methods to manage risks.

Review and evaluate.5

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Risks on the Road to Success23.1

Risk Management in the Small

Business

 Risk Management Differences from Large

Firms:

Small businesses pay insufficient attention to

analyzing potential risk.

Large firms can assign responsibilities for risk

management to a specialized staff manager.

Risk management is not something that

requires immediate attention—until

something happens.

23–21

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Risk

Control

Loss

Prevention

Loss

Reduction

Loss

Avoidance

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Risk Transfer

Partially Self-

Funded Program Risk Retention

Self-Insurance Specific Stop

Loss Limit

Aggregate Stop

Loss Limit

Risk

Financing

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Basic Principles of a Sound Insurance Program

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Evaluating an

Insurance Program

Identify business

risks that can be

insured

Relate premium costs

to probability of loss

Secure coverage for

all major potential

losses

Common Types of Business

Insurance

 Property and Casualty Insurance

Named-peril approach

Identifies the specific perils covered.

All-risk approach

Defines the perils covered by stating that all direct

damages to property are covered except those

caused by perils specifically excluded.

Coinsurance provision

Property must be insured for at least 80% of its

value or a penalty will be applied to any covered

loss. 23–25

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Coinsurance Example If an insured building had a replacement value of $500,000, the 80

percent policy limit would require that the property be insured for at

least $400,000 ($500,000 x 0.80). If the building was insured for only

$300,000 and an insured loss of $100,000 occurred, the recovery

would be limited to $75,000, calculated as follows:

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Property and Casualty Insurance

(cont.)

 Business Interruption Insurance

Reimburses for lost income plus continuing

expenses due to direct loss impacting

business revenues.

 Commercial General Liability (CGL)

Coverage

Covers bodily injury and property damage for

which the business is liable.

23–27

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Property and Casualty Insurance

(cont.)

 Automobile Insurance

Protects against liability and physical damage to

a vehicle resulting from insured perils such as

collision, theft, vandalism, hail, and flood.

 Workers’ Compensation Insurance

Provides benefits to employees for medical

expenses, loss of wages, and rehabilitation expenses,

as well as death benefits for employees’ families.

 Crime Insurance

Coverage against employee dishonesty. 23–28

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Property and Casualty Insurance (cont.)

 Business Owner’s Policy (BOP)

A business version of a homeowner’s policy,

designed to meet the personal property and general

liability insurance needs of small business owners

 Advantages of BOP

A lower premium than would otherwise be required

to purchase all coverages separately

Automatic inclusion of business interruption

insurance

Automatic replacement value protection, as opposed

to actual cash value protection

23–29

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Property and Casualty Insurance (cont.)

 Package Policy

A policy for small businesses that do not qualify

for a BOP that combines property insurance and

commercial general liability insurance.

 Advantages of Package Policy

A lower premium than would otherwise be required

to purchase all coverages separately

Ease of adding other coverages more economically

Inclusion of business interruption insurance

Inclusion of crime insurance.

23–30

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Miscellaneous

Policies

Umbrella

liability

policies

Professional

liability

policies

Inland

marine

policies

Cyber

liability

policies

Life and Health Insurance

 Health Insurance

Coverage for medical care at hospitals,

doctors’ offices, and rehabilitation facilities,

that usually includes outpatient services and

prescription drugs.

 Health Maintenance Organization (HMO)

A managed-care network that is less

expensive than that of a PPO but limits

employees’ choices of medical care providers

more than a PPO does.

23–32

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Life and Health Insurance (cont.)

 Preferred Provider Organization (PPO)

A managed-care network that provides health

insurance that is generally more expensive

than an HMO but offers a broader choice of

medical providers

 Key-Person Insurance

Provides benefits upon the death

of a firm’s key personnel.

23–33

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Life and Health Insurance (cont.)

 Disability Insurance

Provides benefits upon the disability of a

firm’s partner or other key employee.

Disability buyout insurance

Key-person disability insurance

23–34

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Key Terms

actual cash value (ACV)

aggregate stop loss limit

all-risk approach

automobile insurance

business interruption insurance

business owner’s policy (BOP)

business risk

coinsurance clause

commercial general liability (CGL)

insurance

compensatory damages

crime insurance

design defect

direct loss

disability buyout insurance

disability insurance

economic damages

funds transfer fraud

health maintenance organization

(HMO)

indemnification clause

indirect loss

key-person life insurance

loss avoidance

loss prevention

loss reduction

manufacturing defect

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Key Terms

market risk

marketing defect

named-peril approach

noneconomic damages

package policy

partially self-funded program

peril

personal property

personnel risks

preferred provider organization

(PPO)

proximate cause

punitive damages

pure risk

real property

reasonable (prudent person) standard

replacement value of property

risk control

risk financing

risk management

risk retention

risk transfer

self-insurance

specific stop loss limit

torts

workers’ compensation insurance

workers’ compensation legislation

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Key Terms

commercial general liability (CGL) insurance

automobile insurance

crime insurance

business owner’s policy (BOP)

package policy

health insurance

health maintenance organization (HMO)

preferred provider organization (PPO)

key-person insurance

disability insurance

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