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Risk Control Fundamentals

Learning Objectives

1. Discuss the definition of risk control and its role in the risk management process. (p. 2)

2. Discuss the five primary types of risk control techniques. (p. 8)

3. Discuss the four types of contractual transfer and the principal elements of the three classifications of hold harmless agreements. (p. 12)

4. Discuss the three approaches to loss control. (p. 28)

5. Explain the requirements of the administration of risk control programs. (p. 31)

Learning Objective #1: Discuss the definition of risk control and its role in the risk management process.

I. Risk Control

A. Definition of risk control: any conscious action or inaction to minimize, at the optimal cost, the probability, frequency, severity, or unpredictability of loss

B. The focus of risk control should be on solutions that will prevent or reduce actual harm or the cost of loss, not providing for funds to be paid in compensation

C. Risk control is a people process – individuals must be involved in all aspects of an effective risk control program

II. Role of Risk Control in the Risk Management Process

A. Identification of exposures

B. Incident analysis

C. Cost-benefit analysis

A. Methods used to identify exposures

1. Checklist and survey

a. Identifies physical hazards

b. Identifies administrative processes and procedures

c. Identifies good or best practices for industry

2. Flowchart

a. Graphically and sequentially identifies concentration in values and process bottlenecks

b. Identifies internal interdependencies within an organization and supplier/consumer chain

3. Insurance policy review

a. Uninsured exposures must be identified and addressed with a risk control plan

b. Provides an understanding of the organization’s philosophy of risk tolerance

c. “Additional Benefits” or policy sub-limits for potential financial exposures

4. Physical inspections

a. Informational visits to critical sites to discover unknown or hidden exposures, perils, hazards, and special problems, or problems not identified by other methods

b. Provide educational opportunities for staff related to risk control objectives and management’s commitment to safety and loss control

5. Compliance review – identifies exposures created from non-compliance with regulations and laws

6. Internal policies and procedures review – identifies exposures due to inadequate or ineffective internal policies and procedures

7. Non-insurance contract review

a. Identifies obligations and compliance assumed by the organization in non- insurance contracts

b. Identifies risks that have been or may be transferred to others

8. Experts – use of third-party firms or individuals to help identify exposures, perils, and hazards

9. Financial statement analysis

a. Sources of the organization’s revenue

b. Sources of the organization’s cash flows

c. Business and financial partners

d. Asset/income protection needs

10. Loss data analysis

a. Identifies frequency of incidents and frequency/severity trends of losses and claims

b. Identifies causal factors affecting frequency and severity

c. Provides opportunities to identify integrity issues related to loss data

d. Identifies anomalies, e.g., time of day, day of week, time of year, etc.

B. Incident analysis

1. Tracking incidents without regard to subsequent accidents, losses, occurrences or claims

2. Reporting procedures, tracking, and review specific to organization

3. By tracking and analyzing incidents, risk control techniques can be applied:

a. More timely or proximate to the event

b. To preempt, avoid, or minimize the chance of similar incidents in the future

c. To reinforce risk control issues involved or related to employees

d. To demonstrate due diligence or reasonable investigation in defense of subsequent claims or losses

4. An effective Risk Management Information System (RMIS) can improve the incident analysis process

C. Cost-benefit analysis

1. Financial decision-making tool for risk control alternatives

2. Comparison of costs (cash outflows) with benefits (reduction in losses and other cash inflows) over time to measure rate of return

3. Losses, probabilities, interest rates, and cash flows require assumptions that may not be valid over time or achievable

4. Treatment options with the best rate of return may not be in accordance to regulations or compatible with philosophy or goals of management

Note: Be aware that a cost-benefit analysis could be legally construed as placing a monetary value on safety or the value of a human life.

Learning Objective #2: Discuss the five primary types of risk control techniques.

III. Five Primary Risk Control Techniques

1. Avoidance 2. Prevention 3. Reduction (pre-loss and post-loss) 4. Segregation/separation/duplication 5. Transfer (contractual, physical or both)

A. Avoidance

1. Risk avoidance is complete elimination of an exposure to avoid the chance of a loss; avoidance eliminates both positive and negative outcomes

Example –a drug company terminates the manufacturing of a new product due to its adverse side effects

2. Risk avoidance is a self-sufficient risk control technique. No further action may be required. Exposure may still be present from past activities, e.g., products in the food chain, manufactured products in the field.

3. Difficult sale to management

a. May be in conflict with goals and profit motives of the organization

b. Activity may be inherent to the organization’s identity or mission

c. Risk manager may lack appropriate decision-making authority

B. Prevention

1. Goal is to reduce the frequency of types of claims that cannot be eliminated, e.g., driver safety training

2. The term “prevention” implies an action taken to break the sequence of events that leads to a loss or that makes the event less likely

3. Allows entities to conduct operations that might otherwise have been avoided

C. Reduction

1. Goal is to reduce the severity or financial impact from losses that are not prevented

2. Pre-loss – reduction activities applied before the loss, e.g., fire suppression equipment

3. Post-loss – reduction activities applied after the loss, e.g., claims administration

D. Segregation/separation/duplication

1. Goal is to reduce overall severity

2. Segregation – an isolation of an exposure from other exposures, perils, or hazards, e.g., computer room

3. Separation – the spread of exposures or activities over several locations

a. Divide a single asset or operation into two or more locations or activities

b. If one separated asset or operation suffers a loss, the other must have sufficient capacity to meet the needs

4. Duplication – the use of back-ups for critical systems or operations

a. Duplicate asset or activity kept in reserve

b. Duplicate asset or activity not exposed to the same loss

E. Transfer

1. Goal is to reduce risk to the organization by transferring some or all of the risk to another party

2. Physical transfer – shifts some or all of an operational function or exposure to an outside source

3. Contractual transfer – shifts responsibility of certain liabilities to another party

Learning Objective #3: Discuss the four types of contractual transfer and the principal elements of the three classifications of hold harmless agreements.

IV. Contractual Transfer

A. Contractual transfer – assumption or limiting exposures of certain liabilities relating to another party

B. Four types of contractual transfer

1. Hold harmless or indemnification agreement

2. Exculpatory agreement or clause

3. Waiver of subrogation

4. Limit of liability or liquidated damages clause

1. Hold harmless or indemnification agreement – affirmative assumption of the financial consequences for liabilities of another through a contract

Note: Indemnitee – the one who is owed the obligation from another

Indemnitor – the one who owes the obligation to another

2. Exculpatory agreement or clause – pre-event exoneration of the fault of one party that results in any loss or specified loss to another

3. Waiver of subrogation – pre-event relinquishment

of the right of one or both parties’ insurers to seek recovery from a culpable party’s insurance carrier for loss payments made to the insured

4. Limit of liability or liquidated damages clause – pre-event limitation of the amount, type, or method of calculation of damages available by one or both parties to an agreement

C. Effect on tort liability (liability for negligence)

1. Hold harmless agreements do not absolve the indemnitee from its tort liability to a third party

2. Exculpatory agreement absolves the tort liability between one or both parties but does not apply to third parties

3. Waiver of subrogation does not absolve tort liability of the parties, but prevents insurers from any recovery of loss payments based on such tort liabilities

4. Limit of liability clause does not absolve the tort liability of one or both parties, but it caps or limits the recovery of damages to the amount specified in the agreement

D. Funding

1. Hold harmless agreements require the indemnitor to be able to provide funding or financing of assumed liabilities

2. Exculpatory clause has no affirmative obligation to provide funding except that which is required to absorb loss

3. Waiver of subrogation is the same as exculpatory except the loss is absorbed by the insurer under an insurance contract

4. Limit of liability requires funding or financing of amounts payable for damages as defined in the contract

5. Written contract may have bearing on how an insurance contract responds

E. Statutory limitations

1. Hold harmless agreements may be subject to anti- indemnity statutes depending upon the specific terms of the agreement and the jurisdiction

2. Exculpatory clause is generally not subject to anti-indemnity statutes

3. Waiver of subrogation is not subject to anti-indemnity statutes

4. Limit of liability clause is not subject to anti-indemnity statutes

F. Creating a risk control program for contractual review

1. Identify what contracts or agreements will be reviewed

2. Determine who will be responsible for reviewing which types of contracts

3. Ensure access to and review all appropriate contracts, incoming and outgoing

4. Monitor, evaluate and suggest revisions in contractual language to be consistent and compatible with risk management programs and to be in compliance with changes in the law

G. Recognize the practical problems in a contractual review process

1. Control of which party drafts the agreement

2. Input of risk manager

3. Reasonableness and achievability of agreements

4. Attorney input is required, but most attorneys are not experts in risk management or insurance terms

5. Understanding and complying with insurance provisions within the contract

6. Laws governing contractual interpretation are dynamic and may vary by jurisdiction, e.g., safe workplace acts, sole negligence, and anti- indemnity statutes

H. Common issues with contractual review

1. Contractual transfer attempts to shift risk, but the underlying risk still exists

2. Transferee is expected to perform or assume certain responsibilities, but transferee or its insurer may fail to do so

3. Little or no control of transferee’s performance outside of litigation

4. Morale hazards exist because of out-of-sight, out- of-mind attitude

5. Contractual transfers should not be substituted for normal business responsibility or more appropriate risk control techniques

6. Vicarious liability for negligent selection or supervision of contracting party

Comparison of Contractual Transfers

Hold Harmless

Agreements Exculpatory Agreements

Waivers of Subrogation

Limit of Liability Clause

D ef

in iti

A contractual arrangement whereby one party (the indemnitor) assumes the liability inherent in a situation, thereby relieving the other party (the indemnitee)

Pre-event exoneration of the fault of one party that results in any loss or specified loss(es) to another

Pre-event relinquish- ment of the right of one or both parties’ insurers to seek recovery from culpable party for loss payments made to insured

Pre-event limitation of the amount, type or method of calculation of damages available by one or both parties to an agreement

To rt

Does not absolve the indemnitee from its tort liability to a third party

Absolves the tort liability between one or both Parties to contract – does not apply to 3rd parties

Does not absolve tort liability of the parties, but prevents insurers from any recovery of loss payments based on such tort liabilities

Does not absolve the tort liability of one or both parties; however, it “caps” recovery amount of damages between the parties

Fu nd

in g

Requires indemnitor to be able to provide funding/financing of assumed liabilities

No affirmative obligation to provide funding except that which is required to absorb loss

Same as exculpatory, except the loss is absorbed by insurer under insurance transfer

Requires funding or financing of amounts payable for amount of damages as defined in contract

A nt

i- in

de m

ni ty

pp lic

at io

n May be subject to anti- indemnity statutes

Not subject to most anti-indemnity laws

Not subject to anti- indemnity laws

Usually involves bills of lading, cargo, freight, or cartage

G en

er al

on si

de ra

tio ns

If too broad, may void entire indemnity obligation

May be construed as a waiver of subrogation if claim is brought by a parties’ insurer

Typically, must be entered into prior to any loss payment by insurer to be binding on the insurer

May be the exclusive remedy of a party for any/all claims under contract w/o regard to amount of true loss

V. Hold Harmless Agreements

A. Hold harmless agreement – a contractual arrangement whereby one party (the indemnitor) assumes the liability inherent in a situation, thereby relieving the other party (the indemnitee)

1. Hold harmless agreements may include the indemnitee’s cost of settlements or judgments paid to a third party and/or the costs of defense or legal fees

2. Hold harmless agreements may require indemnification at the conclusion of a claim/suit or require the indemnitor to assume the indemnitee’s actual defense obligation during the claim/suit

3. Anti-indemnity statutes may limit or prohibit contractual transfers, and differ by jurisdiction and type of hold harmless agreement

4. Hold harmless agreements may be unenforceable if found to be against public policy; this may occur when there is a huge disparity in bargaining positions between the indemnitor and indemnitee and the terms of the hold harmless agreement are deemed to be unconscionable

B. Three classifications of hold harmless agreements (see the following exhibits for details)

1. Limited (mine) – assumes responsibility for indemnitee’s liability for indemnitor’s negligence only

2. Intermediate form (mine and ours) – Limited + responsibility for full indemnification of the indemnitee if there is any negligence on the indemnitor’s part or if the indemnitor is partially negligent, he/she pays 100%; this classification applies to agreements requiring indemnification for ALL occurrences arising out of the indemnitor’s operations, excluding only the liability arising from indemnitee’s sole negligence

3. Broad form (yours, mine, and ours) – Limited + Intermediate + indemnitor agrees to be responsible for indemnitee’s sole negligence; can include other parties’ negligence

Three Classifications of Hold Harmless Agreements

Limited – Indemnitor assumes responsibility for indemnitee’s liability for indemnitor’s negligence only. This classification applies to agreements requiring indemnification for occurrences arising out of the indemnitor’s operations. Example: Party A reaffirms responsibility for his own negligent acts. Party B has acquired a contractual right to indemnity where the basic tort law of the jurisdiction may or may not entitle him to it absent contractual transfer. Intermediate – Limited + responsibility for full indemnification of the indemnitee if there is any negligence on the indemnitor’s part or if the indemnitor is partially negligent, he/she pays 100%; this classification applies to agreements requiring indemnification for ALL occurrences arising out of the indemnitor’s operations, excluding only the liability arising from indemnitee’s sole negligence. Example: Party A reaffirms responsibility for his own acts and agrees to assume full responsibility for joint and/or concurrent negligence of both parties. In many such contracts (especially construction contracts), Party A will agree to assume responsibility for all events except those resulting from the sole negligence of Party B; i.e., 100%, for all concurrent negligence situations. Does not apply to events arising from the sole negligence of Party B or the negligence of another subcontractor or entity beyond indemnitor and indemnitee.

Three Classifications of Hold Harmless Agreements

(continued)

Broad – Limited + Intermediate + Indemnitor agrees to be responsible for Indemnitee’s sole negligence. Can include negligence of other parties.

This classification applies to agreements requiring complete indemnification of the indemnitee for all occurrences without reference to negligence – can even include those situations arising from the sole negligence of another entity.

Example: Party A assumes responsibility for all liability without regard to fault of himself and/or Party B. Here Party A assumes not only the responsibility of his acts, plus any acts arising from joint and/or concurrent negligence of Party A & Party B, but also includes those situations that result from the sole negligence of Party B. This extreme variant may require Party A to assume responsibility for the negligent acts of some other entity, over whom Party A has no control, which results (or may result) in a claim being made on Party B.

Note: these Broad Form agreements would appear to be totally unreasonable, since they would include even losses that do not arise from the indemnitor’s negligence and may involve situations in which the Indemnitor has no control or involvement. Nevertheless, the courts may enforce such agreements that do not violate a statute or public policy. Generally, the courts will require the intent of the parties to enter into such an agreement to be expressly reflected in the contract (absolutely clear and unequivocal) and may require specific consideration to be enforceable.

Introduction to Diamond Creek Resorts International, Inc.

Diamond Creek Resorts International, Inc. (DCRI) is one of the leading firms in the hospitality sector. It operates a number of resort hotels in destination locations, and provides five star lodging, fine dining, championship golf courses, casinos, top-flight entertainment, up-scale shopping, luxury spas, and business meeting facilities in North America.

DCRI has six resort hotels:

o Diamond Creek Coastside is located on the Pacific coast north of San Diego. This facility features a golf course, spa, shopping complex, and convention center.

o Diamond Creek Lake Tahoe is located in Nevada near Lake Tahoe. This facility features a golf course, spa, ski complex, a casino, and entertainment center.

o Diamond Creek Naples is located in Naples, Florida. This facility features two golf courses, a luxury spa, a meeting center, an up-scale shopping complex, and a variety of water-related activities, including parasailing, and scuba/snorkeling cruises.

o Diamond Creek Atlantic City is located in Atlantic City. This facility features a spa, shopping complex, a casino, entertainment venue, convention center, and operates a fleet of tour buses that includes a Broadway tour as well as sightseeing and gaming tours on the Atlantic coast from Maine to Virginia.

o Diamond Creek French Lick is located in French Lick, Indiana (the hometown of NBA great Larry Byrd). This facility features a world-class spa, golf, and convention center, and operates bus tours to near-by historic and scenic sites.

o Diamond Creek Cancun is located in Cancun, Mexico. This facility features golf, a spa, and water-related activities such as parasailing, scuba, snorkeling, deep-sea fishing, and tours into the jungle to visit the Mayan ruins at Tikal, Chichen Itza, and other notable sites.

All sites have luxury hotels with a wide array of food service, ranging from snack shops to buffets to up-scale fine dining.

DCRI maintains its corporate office in Denver, where the corporate jet is kept at Denver International Airport. It has a fully staffed risk management department headed by Mary Donner, CRM, CIC. She is ably assisted by two risk analysts, a safety professional, and a claims administrator. Mary reports to Sarah Parker, the DCRI Chief Financial Officer.

Sarah and Mary, as the CFO and risk manager, know much more about DCRI and its operations than do Rachel and Ralph, the account executive and CSR of Invino Veritas Insurance Brokers, even though Rachel and Ralph have handled the DCRI account for five years. They placed the property and liability insurance coverage with AGEM Insurance Company five years ago, when Rachel’s brother, Frank, was the lead underwriter. Frank left AGEM last year, and was replaced by Kim.

Skills Application Scenarios

Facts: DCRI (the indemnitee) hires Igor Interior Contractors (the indemnitor) to remodel a buffet line in one of the casinos while the buffet operation continues. The work is being done under a contract with a hold harmless agreement.

Limited Form

(Scenario 1) Igor knocks over a display of desserts. A buffet patron slips on a banana cream pie and is injured. Igor will indemnify DCRI for the damages.

(Scenario 2) Igor knocks over the desserts, informs the DCRI buffet manager who does not clean up the food promptly. A patron slips and is injured. The failure of DCRI to respond to notification creates a shared liability situation; therefore, Igor is only required to indemnify DCRI for its proportionate share of the total liability. DCRI may not seek payment for DCRI’s potential negligence, if any, in failing to clean up the hazard in a timely manner.

Intermediate Form

(Scenario 2 continued) Igor is responsible for at least his proportionate share of damages, and Igor must assume responsibility for DCRI’s joint or comparative fault.

(Scenario 3) A DCRI employee knocks over the dessert display and a patron slips and is injured. DCRI cannot obtain indemnity from Igor for the damage as it arises from the sole negligence of DCRI; i.e., Igor is not involved in the acts that produced the loss, even though it was present in the area.

Broad Form

(Scenario 3 continued) Now, Igor is responsible for losses arising from the sole negligence of DCRI as Igor has taken responsibility for the premises generally.

(Scenario 4) A DCRI patron (or another unrelated contractor or vendor on site) knocks over the dessert display, and a DCRI patron slips and is injured. Igor is still liable.

(Scenario 5) An earthquake destroys the casino and a patron is killed by falling debris. Igor may be contractually liable for the death of the patron and the damage to the casino building.

C. Examples of contracts commonly containing hold harmless agreements (see Appendix for sample wording)

1. Construction agreements

2. Service contracts

3. Purchase orders

4. Usage permits

5. Leases and rental agreements

D. Contractual provisions requiring review and analysis

1. Insurance clauses

2. Liability clauses

3. Hold harmless or indemnification clauses

4. Mutual release clauses

5. Waiver of subrogation clauses (including mutual waiver of subrogation)

Learning Objective #4: Discuss the three approaches to risk control.

VI. Approaches to Risk Control

A. Financial approach – measures the net cost benefit and recovery of the investment in loss control programs

B. Systems approach – the organization’s systems cause accidents, even though individuals do what they are told to do with the tools and equipment provided

1. Risk identification and classification, training, equipment maintenance

2. Tracking risk exposures on a flowchart

3. Hazard Evaluation Index (page 30)

C. Practical approach

1. Grass roots support (see Appendix 7, pgs 11-13 for Customer Satisfaction Survey)

2. Top management support

3. Incentive and reward programs

4. Accountability for risk control initiatives

5. Budgeting for safety

6. Willingness of all to compromise and cooperate

D. Challenges of approaches to loss control

1. Need to compromise

2. Finding funding for safety initiatives

3. Supervisor involvement and support

Stanford University Hazard Evaluation Index ACTION GUIDE 1-4 Initiate corrective action if and when appropriate 5-9 Initiate corrective actions when practical 10-15 Initiate all reasonable corrective actions ASAP 16-25 Immediate corrective action must be taken

5 5 10 15 20 25

4 4 8 12 16 20

3 3 6 9 12 15

2 2 4 6 8 10

1 1 2 3 4 5 1 2 3 4 5

Severity

PROBABILITY (Over life of condition)

1. Remote Extremely unlikely to occur 2. Low Possible but unlikely to occur 3. Moderate Moderate risk of occurrence 4. High Likely to occur 5. Probable Very likely to occur in immediate future

SEVERITY 1. Slight Minor first-aid injuries Losses under $50.00 2. Appreciable Injuries requiring a Losses between $50.00 and

Physician’s attention $1,000 3. Serious 1 or more serious Losses between $1,000 and

injuries or illnesses $100,000 4. Severe A death or disabling Losses between $100,000 and

injury or illness $1 million 5. Catastrophic Multiple death Losses over $1 million

Probability

Learning Objective #5: Explain the requirements of the administration of risk control programs.

VII. Administration of Risk Control Programs

A. Requires acquisition and allocation of resources

1. Internal

2. External

a. Agent or broker

b. Insurance carrier

c. Consultant

d. Third-party administrator

e. Legal counsel

B. Requires consideration of alternative treatments and their relative costs and benefits

Skills Application Scenario

Mary Donner, DCRI’s risk manager, is considering several options for risk control techniques to provide burglary protection for the warehousing facilities in high crime areas.

What are the possible alternative solutions to this problem? What are the potential costs and benefits of each solution?

C. Requires effective communication throughout the organization and with third parties

1. Information resource – forward copies of articles of interest to managers, e.g., important changes in law, recent legal cases, new safety devices or techniques

2. Claim reviews/suit committees – arrange for other managers to attend quarterly loss or claims review meetings; invite other managers and executives to visit risk management offices for a first-hand look at safety and risk control

3. Stewardship report – annual report to executive management showing total cost of risk, claims activities, new loss control activities, status of ongoing risk control programs, etc.

4. Newsletters and bulletins – outline success stories, employees with accident free records, etc.

5. Make site visits, educate and attend unit and organizational meetings

6. Employee and third party – post-claim/loss response showing genuine care and concern

VIII. Conclusion and Summary

A. Risk control is a people process.

B. Successful risk control programs are based on careful risk identification and risk analysis.

C. Successful risk control programs incorporate all five risk control techniques or a combination of the techniques.

D. Contractual transfer of risk is one of the most significant risk control techniques to an organization. A contract review program is a key component of the risk control program in order to classify hold harmless provisions in contractual transfers and determine their impact.

E. Administration of a risk control program requires prioritization, implementation, coordination, follow-up, and communication throughout the organization.

Review of Learning Objectives

1. Discuss the definition of risk control and its role in the risk management process. (p. 2)

2. Discuss the five primary types of risk control techniques. (p. 8)

3. Discuss the four types of contractual transfer and the principal elements of the three classifications of hold harmless agreements. (p. 12)

4. Discuss the three approaches to loss control. (p. 28)

5. Explain the requirements of the administration of risk control programs. (p. 31)

Notes