Three rules of risk management proposed by Mehr and Hedges are discussed in this chapter. List these rules and explain the implications of each in determining what should be done about individual exposures facing a business firm.
Three rules of risk management proposed by Mehr and Hedges are:
1. Do not risk more than you can afford to lose: If one takes risk more than he can afford to lose, and outcome is unfavorable, that person can even become bankrupt. A person should take proper insurance and devise strategy to mitigate risk.
2. Do not risk a lot for a little: A person takes risk in anticipation of high return. Higher the risk, higher the expected return. The risk return ratio should be high. If one takes risk a lot for little, he is making mistake.
3. Consider the odd: One should understand the likelihood and severity of possible losses. One should assess how much he may lose and what is the likelihood of loss.
Identify the reasons for self-insurance and the disadvantages of self-insurance.
List the types of insurers as classified by legal form of ownership, and briefly describe the distinguishing characteristics of each type.
Government insurance programs may compete with those of private insurers, may involve cooperation between government and private insurers, or may be a monopoly. Give an example of a government insurance program in each of these three categories.
Distinguish among traditional risk management, financial risk management, and enterprise risk management.
Explain the dual application of the law of large numbers as it pertains to the operation of insurance.
Give examples of three uninsurable exposures and indicate why each is uninsurable.
