Principles of Risk Management And Insurance Chapter 1

Loss Exposure
Any Situation or circumstance in which a loss is possible, regardless of whether a loss occurs
Objective Risk
The relative variation of actual loss from expected loss
Law of Large Numbers
As the number of Exposures increase, the more closely the actual loss experience will approach the objective loss experience.
Subjective Risk
Uncertainty based on a person’s mental condition or state of mind.
Chance of Loss
The probability that an event will occur.
Objective Probabililty
The Long-Run relative frequency of an event based on the assumptions of an infinite number of observation and no change in the underlying conditions.
Subjective Probability
The individual’s personal estimate of the chance of loss
Chance of Loss>Not the Same>Objective Risk
The chance of loss may be identical for two different groups, but objective risk may be quite different. (LA vs. Philly Example pg.5)
Peril
The Cause of loss
Hazard
A condition that creates or increases the frequency or severity loss
Physical Hazard
Physical condition that increases the frequency or severity of loss
Moral Hazard
Dishonesty or character defects in an individual that increase the frequency or severity of loss
Attitudinal Hazard (Morale Hazard)
Carelessness or indifference to a loss which increases the frequency or severity of a loss
Legal Hazard
Characteristics of the legal system or regulatory environment that increase the frequency or severity of losses.
Pure Risk
Situations in which there are only the possibilities of loss or no loss. (Only outcomes are adverse(loss) and neutral (no loss).)
Speculative Risk
A situation in which either profit or loss is possible
Diversifiable Risk
A risk that affects only individuals or small groups and not the entire economy
Nondiversifiable risk
A risk that affects the entire economy or large numbers of persons or groups within the economy.
Enterprise Risk
Encompasses all major risks faced by a firm. Includes pure, speculative, strategic, operational, and financial risk.
Operational Risk
Results from the firm’s business operations
Financial Risk
Refers to the uncertainty of loss because of adverse changes in commodity prices, interest rates, foreign exchange rates, and the value of money.
Strategic Risk
Refers to the uncertainty regarding the firms financial goals and objectives.
Enterprise Risk Management
Combines into a single unified treatment program all major risks faced by the firm
Personal Risks
Risks that directly involve an individual. Includes Risk of Premature Death, insufficient retirement income, poor health, unemployment.
Human Life Value
The Present Value of the family’s share of the deceased breadwinner’s future earnings.
Property Risks
Risk of having property damaged or lost from numerous causes;
Direct loss
A financial loss that results from the physical damage, destruction, or theft of the property.
Indirect or Consequential Loss
An indirect loss is a financial loss that results indirectly from the occurrence of a direct physical damage or theft loss
Liability risks
the possibility of being held liable for bodily injury or property damage to someone else
Characteristics of Liability Risks
A: No Maximum upper limit with respect to the amount of loss B: Second, a lien can be placed on your income and financial assets to satisfy a legal judgement. C: Legal Defense Costs can be ENORMOUS.
Commercial Risks
Risks that Business Firms face, which can financially cripple or bankrupt the firm if a loss occurs. They include property, liability, business income, and other risks.
Loss of Business Income
Used to describe the loss of business Income after a large loss, i.e. lost income after a tornado. (Caterpillar).
Other Commercial Risks Include
Crime Exposures, Human Resources Exposures, Foreign Loss Exposures, Intangible Property Exposures, Government Exposures
Burden of Risk On Society
A: The size of an emergency fund must be increased. B: Society is deprived of certain goods and services. C: Worry and fear are present.
Avoidance
Just DON’T DO IT.
Loss Control
Activities that reduce the frequency and severity of losses.
Loss Reduction
Reducing the frequency of loss.
Loss Prevention
Reducing the probability of loss.
Retention
Retaining part of the financial consequences of a given risk. (Active(awareness) and Passive(Unaware))
Self-Insurance
A special form of planned retention by which part of all of a given loss exposures is retained by the firm.
Non-Insurance Transfers
Transfer of Risk by contracts, hedging price risks, Incorporation of a Business Firm
Insurance
Characterized by risk transfer, pooling, and law of large numbers. (Form of risk management)