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Fundamentals Course on Risk Management and Insurance


Undergraduate business education requires an understanding of how businesses, individuals, and societies deal with risk.  Students who are being trained to be general managers and those that intend to specialize in particular areas need a general framework for dealing with risk and broad knowledge of risk management and insurance, including important public policy issues.  For students who plan to work in risk management and insurance, including business or non-business students who might seek actuarial careers, a conceptual framework also is needed for understanding institutional details and as a basis from which new ideas will evolve.

Since the institutional structure is constantly changing in the modern, global environment for risk management, it is important for students to acquire general concepts that can be applied to new sets of problems, new types of risk, and new institutional structures.  In addition, an introductory course in risk management and insurance should stimulate critical thinking and promote development of problem solving skills to better prepare students regardless of their chosen fields.

To this end, the major objectives of a course on the fundamentals of risk management and insurance include:

1.      Provide students with a conceptual framework (a) for making risk management decisions to increase business value and individual welfare,  (b) for understanding risk-shifting through pooling and key features of insurance markets, and (c) for understanding the effects of and rationale for public policies that affect risk and its allocation.

2.      Provide students with broad knowledge of business risk management and public policy issues in order to better prepare students for their future roles as managers and citizens.

3.      Acquaint students with the essential details of insurance contracts and insurance markets as a risk management tool emphasizing questions of “how” and “why” insurance contracts are designed and used and the manner in which insurance markets function as compared to other financial instruments and markets utilized in risk management.

4.      Help students understand the relationship between risk management and other functional areas of business education and practice including marketing, production, quantitative and statistical analysis, accounting, and finance.

5.      Enhance the ability of students to think analytically and critically and to solve problems in order to better prepare them to confront the myriad of opportunities and problems that confront managers in the global business environment.

Topical Outline

A fundamentals course on risk management and insurance that focuses primarily on the following significant topics would be ideal:

1.      Introduction to Risk Management

Major types of business risk; distinguishing features of pure risk; risk management process; risk management methods including loss control, loss financing, and internal risk reduction through diversification and investments in information.

2.      Objectives of Risk Management

Risk and business value; value maximization through reducing the cost of risk; incentives to maximize value; other objectives of risk management including objectives for non-profit / public enterprises; private versus social costs of risk and possible conflicts between business and societal objectives.

3.     Risk Measurement and Diversification through Risk Pooling

Alternative meanings of risk; basic concepts in probability and statistics including expected value, variance, and correlation; risk reduction through pooling independent losses; risk pooling with correlated losses.

4.      Demand for Insurance and Risk Reduction by Individuals

Risk aversion; factors affecting demand for insurance; judgement proof problem and its consequences; functions and effects of compulsory insurance.

5.      Demand for Insurance and Risk Reduction by Businesses

Closely held firms; widely held firms with diversified shareholders;  possible redundancy of risk reduction by the firm when shareholders are diversified; indirect effects of risk reduction that can increase expected cash flows including reducing the probability of costly financial distress and ensuring availability of  funds to undertake profitable investments.

6.      Economics of Insurability through Risk Pooling Arrangements

Ideal conditions for risk pooling; major problems including administrative costs, correlated losses, moral hazard, and adverse selection; enhancing insurability through contractual provisions including deductibles, coinsurance, and limits; enhancing insurability through legal doctrines dealing with moral hazard, information disclosure by prospective insureds, resolution of coverage disputes; rationale and performance of government insurance arrangements as responses to contracting problems in private markets.

7.      Default Risk in Risk Pooling Arrangements

Contracting costs for risk pooling arrangements; stock and mutual arrangements; insolvency risk with fixed premium contracts; reducing insolvency risk through capital and reinsurance; insurance solvency rating agencies; insolvency experience; solvency regulation including monitoring, risk-based capital requirements, and government guarantees of insurer obligations.

8.      Economics of Insurance Pricing

Expected claim costs and risk classification including incentive effects of insurance pricing on behavior and loss control; investment income and timing of claim payments; administrative and capital costs; causes of volatility in insurance prices including underwriting cycles and large shocks to insurer capital; government regulation of rate changes and risk classification factors.

9.      Insurance Compared to Hedging

Introduction to hedging through forwards, futures, options, and swaps; basis risk; institutional structure and counter party risk in derivative markets; differences between risk reduction through hedging and insurance; capital market alternatives to traditional insurance/reinsurance arrangements (e.g., catastrophe risk derivatives and Act of God bonds).

10.  Loss Financing

Framework for choosing optimal risk retention / insurance including assessment of major benefits and costs; retention characteristics of insurance contracts including loss sensitive insurance contracts for large firms; financing losses with captive insurers and industry pooling arrangements; tax, accounting, and regulatory factors affecting loss financing.

11.  Risk Management Decision Making

Comparing benefits and costs of risk management methods; qualitative and quantitative approaches to loss forecasting including computer simulation of loss distributions; making decisions based on the net present value criterion; illustrations for loss control and loss financing.

12.  Economic Functions of the Legal Liability System

Cost internalization and optimal deterrence of harm; compensatory and punitive damages; alternative liability rules and effects on deterrence; liability for actions of agents and independent contractors; limited liability, risk shifting,  and the judgment proof problem; liability for harm compared to safety regulation; efficiency of the U.S. liability system.

13.  Business Tort Liability Exposures

Products liability including the rationale and effects on safety of alternative legal doctrines; theory and performance of strict liability as implicit insurance against product injury; officers and directors liability; environmental liability; key aspects of business liability insurance.

14.  Responsibility / Liability for Harm to Employees

Economic rationale and safety effects of workers’ compensation laws; incidence of workers’ compensation costs; compensable injuries and optimal benefit design; role of the legal system; workers’ compensation insurance including experience rating, self-insurance, and government insurance; liability for wrongful termination; liability under Americans with Disabilities Act.

15.   Fundamentals of Employee Benefits

Overview of benefit packages, including life, health, and disability; economic rationale for employer provided benefits including administrative cost savings, tax advantages to employees, reduced adverse selection, and effects on employee productivity and retention of employees; relation to individual insurance / savings and social security.

16.  Economics of Heath Care Financing

Fee-for-service medical expense plans; moral hazard and excessive utilization; health maintenance organizations and other forms of managed care; causes of health care cost inflation; the uninsured problem; Medicare / Medicaid cost-shifting to the private sector; proposals for mandatory employment-related coverage; other reform proposals.

17.  Pensions and Retirement Plans

Tax advantages and effects on employee productivity / turnover; types of plans including defined benefit plans, defined contribution plans, ESOPs, and 401(k) plans; vesting and portability; funding; default risk with defined benefit plans; growth in prevalence of defined contribution plans.

18.  Social Security

Coverage / benefits under OASDHI; financing including the economics of pay as you go funding versus full funding; inter-generational and intra-generational income transfers; effects on savings and capital formation; effects of shrinking social security and expanding private tax-sheltered savings.