Principles of Risk Management and Insurance Exam 1

risk
uncertainty concerning the occurrence of loss
loss exposure
any situation or circumstance in which a loss is possible, regardless of whether a loss occurs
subjective risk
defined as uncertainty based on a person’s mental condition or state of mind
objective risk
defined as the relative variation of actual loss from expected loss
chance of loss
the probability that an event will occur
objective probability
refers to the long-run relative frequency of an event assuming an infinite number of observations and no change in the underlying conditions
subjective probability
is the individual’s personal estimate of the chance of loss; a person’s perception of the chance of loss may differ from the objective probability; ex/ chance of getting 3 lemons on the slot machine for a jackpot
peril
defined as the cause of the loss
hazard
a condition that increases the chance of loss
physical hazard
a physical condition that increases the chance of loss (icy roads, defective wiring)
moral hazard
dishonesty or character defects in an individual, that increase the chance of loss (faking accidents, inflating claim amounts)
attitudinal hazard (morale hazard)
carelessness or indifference to a loss because of the existence of insurance (leaving keys in an unlocked car)
legal hazard
refers to characteristics of the the legal system or regulatory environment that increase the chance of loss (large damage awards in liability lawsuits)
pure risk
one in which there are only the possibilities of loss or no loss (earthquake)
speculative risk
one in which both profit or loss are possible (gambling)
diversifiable risk
affects only individuals or small groups (car theft)
nondiversifiable risk
affects the entire economy or large numbers of persons or groups within the economy (hurricane)
enterprise risk
encompasses all major risks faced by a business firm, which include: pure risk, speculative risk, strategic risk, operational risk, and financial risk
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
enterprise risk management