Risk Management and Insurance

Risk Management and Insurance Every business faces risks. Risks take many forms, ranging from natural disasters to robberies to increased competition. Risk management is the process of anticipating possible problems (risks) and putting plans in place to cope with certain risks if they become real. This chapter will focus on one of the most common ways for businesses and individuals to manage risk: insurance. https://vbcourse.knowledgematters.com/assignment/startReading/132049

The value of insurance • UK-based insurer Lloyd's, which has been in the insurance business for over 400 years, defines insurance as the transfer of risk from an individual or business to someone else: • . . . business owners also want to protect themselves against the financial consequences of something untoward happening, and this is where insurance comes in. In effect, the business can transfer the risk away from themselves and on to someone else. This transfer of risk is the basis of all insurance . . . https://vbcourse.knowledgematters.com/assignment/startReading/132049

The value of insurance • For example, if a risk (say, a fire) becomes a reality (your business burns to the ground), how will your business recover or rebuild? In most cases, it costs quite a bit of money to do so, usually more than the business has available, so insurance companies promise to provide such money when and if one of its customers files an insurance claim, a request to be paid as agreed in the insurance contract. However, many businesses don’t ever file a claim, and insurance companies have developed methods to know how much they should charge in premiums in order to make sure they always have money available to pay the number of claims they expect to receive in a given time period. https://vbcourse.knowledgematters.com/assignment/startReading/132049

Kinds of insurance businesses carry • There isn’t just one type of insurance. Most companies carry a variety of insurance policies. These might include: • Liability insurance: Every business, large or small, needs to have general liability insurance. This type of insurance policy protects a business if its employees, products, or services cause property damage or bodily injury to a third party. • Property insurance: This type of insurance protects businesses if their property (such as laptops, inventory, etc.) is, for example, stolen or damaged by fire. One part of this policy could provide compensation for lost revenue if the business is closed for a period of time due to circumstances beyond the business’s control. • Commercial auto insurance: As the name implies, this insurance policy protects the company’s vehicles. It can also cover employees who drive their own vehicles while conducting company business. • Workers’ compensation insurance: This type of insurance protects workers who’ve been injured at work. It can compensate workers for lost wages if they’re unable to return to work for an extended period of time. • Alternatively, a business owner’s policy (BOP) often combines all these types of insurance into one policy. A BOP typically costs less for the business owner than buying all the different types of insurance separately. https://vbcourse.knowledgematters.com/assignment/startReading/132049

Types of insurance that companies provide to their employees • Many companies, especially those with so-called white-collar workers, offer insurance to their employees. These insurance policies often include the following: • Health insurance: This covers both routine and preventative care (e.g., annual physicals, mammograms) as well as emergency room care (e.g., cases where the person is rushed to the hospital). • Dental insurance: As with health insurance, dental insurance covers preventative care (e.g., regular dental exams and X-rays) as well as fillings, root canals, crowns, and braces. • Life insurance: Life insurance gives employees peace of mind, knowing that if the employee dies, his or her family members will receive financial compensation to help them adjust to the loss of the employee’s income. A life insurance policy typically makes a lump-sum (or one-time) payment to the individual named by the employee as the beneficiary of the life insurance policy. • These policies are often subsidized by the employer, who may pay a percentage of the monthly insurance premiums as part of their employees’ benefits plan, with the employees responsible for paying a smaller percentage through payroll deductions. https://vbcourse.knowledgematters.com/assignment/startReading/132049

Types of insurance that companies provide to their employees • Most employee insurance policies have different levels of coverage and out-of-pocket expenses such as copays and deductibles. Out-of-pocket expenses are those costs that aren’t covered by the insurance policy and must be paid by the insured. One of the most common out-of-pocket expenses is the copay, which is a small amount that the insured employee is responsible for paying when he or she visits a physician or a dentist. • A deductible may also come into play. This is an amount (typically a few thousand dollars) that an employee must pay for medical or dental care before insurance begins paying. For example, an employee might need to pay the first $2,000 of his or her medical and dental expenses before being responsible for just a copay for an office visit. These out-of-pocket expenses don’t apply in the case of life insurance. The more an employee pays for an insurance policy, the less he or she typically is required to pay in deductibles and copays. https://vbcourse.knowledgematters.com/assignment/startReading/132049

Types of insurance that companies provide to their employees • Some businesses, especially small ones with only a handful of employees, may provide little or no insurance to their employees. If they do provide insurance policies, they may provide only what’s called catastrophic coverage, meaning that the insurance will only cover death or severe physical injury. Such policies are often more affordable to workers. • Self-employed individuals, such as contractors, may opt to buy insurance policies on the open market. These policies tend to be more expensive than employer-provided policies because they don’t leverage the economies of scale possible through a group insurance policy. • The poor may also receive free or reduced-cost health care through a combination of state and federal government plans. Under the federal health care law commonly known as “Obamacare,” most Americans will be required to have health insurance by January 2014 or face tax penalties. The federal government, working with the states, will provide free or low-cost insurance coverage options to the poor in order to meet this mandate. https://vbcourse.knowledgematters.com/assignment/startReading/132049

Coverage limits • Most insurance policies do not pay out an infinite amount of money, either yearly or throughout the life of the policy (typically as long as the premiums are paid or an individual is employed by the company). Many policies have yearly coverage limits, or caps, on the dollar amount of claims that a policyholder can file, in total and for specific health needs, over a given period of time. These caps are designed to ensure that the insurance company has sufficient financial resources available to pay most claims by most policyholders over a given period of time. Long term, the caps are also designed to make sure the insurance company is not contractually obligated to pay out more in claims than it has cash on hand, the largest portion of which is derived from insurance premiums. https://vbcourse.knowledgematters.com/assignment/startReading/132049

Replacement cost vs. actual cash value • Some types of insurance policies, including homeowners insurance, now offer options for both cash value and actual replacement costs for the loss of property (home or other possessions). Replacement cost is a dollar amount calculated by the insurance company to represent the cost of replacing your property with new items of the same type and quality. Actual cash value means you’ll get the cash value of the property, minus what’s called depreciation, which accounts for the length of time you owned the item plus normal wear and tear since you purchased it. • A cash value option is a newer feature of insurance policies, and the cash you receive could be 10 percent less (or more) than the replacement cost. The advantage of cash value is that it provides cash in a time of need, rather than just replacing damaged or stolen possessions. In most cases, however, insurance agents typically recommend policies that include replacement cost instead of actual cash value because they aren’t discounted for depreciation. For example, if your two-year-old camera is stolen and you have replacement cost coverage, the insurance company will give you money to buy a camera of equal value. If your two-year-old camera is stolen and you opted for an actual cash value policy, you’ll receive the cash equivalent to the price of the camera minus two years’ worth of depreciation, which means you’ll need to add money to the insurance payout in order to buy the same camera that had been stolen. https://vbcourse.knowledgematters.com/assignment/startReading/132049

When you might self-insure • While many individuals and businesses pay for an insurance policy provided by an insurance company, it is possible to self-insure. If you think about it, the value of a third-party insurance policy is that it provides a pool of money that can be tapped when needed. But if an individual could also save that amount of money and put it into an emergency fund, thus making third-party insurance unnecessary, at least in ordinary circumstances. Therefore, self-insurance means that rather than buying, say, health or dental insurance by paying monthly premiums to an insurance company, individuals save enough money to pay for those health or medical expenses themselves. Sometimes a self-insured individual will take out an inexpensive health insurance plan to cover truly catastrophic events that require a long hospital stay and would cost tens or even hundreds of thousands of dollars. • Individuals might self-insure or opt for inexpensive catastrophic coverage because they dislike paying large sums to insurance companies for coverage they might not need. The self-insured may instead effectively pay themselves the monthly insurance premiums and put those funds in mutual funds or other investments, thus allowing their personal self-insurance fund to grow. Then they’ll tap that pool of money only if needed. Put another way, self-insurance transfers the risk from the insurance company to the self-insured individual. https://vbcourse.knowledgematters.com/assignment/startReading/132049

Key Terms • Actual cash value: An insurance claim payout of the cash value of an insured item, minus depreciation, if the item is damaged, lost, or stolen. • Actuarial table: A table of statistical data, derived using calculus and the laws of probability, that shows the likelihood of a risk, such as death, occurring to an individual in a certain profile (which can include age, gender, location, race, medical history, etc.). • Copay: A small amount that an insured employee is responsible for paying when he or she visits a physician or a dentist. • Coverage limit: The maximum amount of money an insurance company will pay for a given injury or ailment within a given period of time. https://vbcourse.knowledgematters.com/assignment/startReading/132049

Key Terms • Deductible: An amount (typically a few thousand dollars) that an employee must pay for medical or dental care before insurance begins paying. • Depreciation: The loss in monetary value of an item based on such factors as the length of time it’s been owned plus normal wear and tear since its purchase. • Insurance: A system of risk transference in which a third party (the insurer) agrees to assume a certain degree of financial liability if a given scenario comes to pass. If the risk does become actual, the insurer will financially compensate the policyholder for a previously agreed upon amount. https://vbcourse.knowledgematters.com/assignment/startReading/132049

Key Terms • Replacement cost: A dollar amount calculated by the insurance company to represent the cost of replacing your property with new items of the same type and quality. • Risk: A term that refers to a state of uncertainty about events in the future. In common usage, it’s defined as the chance or possibility something might go wrong as well as what happens if something goes wrong. • Self-insurance: A concept wherein individuals save enough money to pay for health or medical expenses themselves rather than buying health or dental insurance and paying monthly premiums to an insurance company. https://vbcourse.knowledgematters.com/assignment/startReading/132049

Risk Management and Insurance