RMI Exam 1 Study Guide Spring 2016 Does danger risk No Frequency Likelihood How often can it occur Severity Impact How bad is it when it does occur Expected Value Take frequency multiplied by severity gives you the expected value Loss Measures what is likely to occur Risk profile Take some measures of frequency down side of chart and some measures of severity across top of chart Standard deviation How far is it from what we expected to happen to what actually happened Pure Risk 2 potential outcomes There either will or will not be a loss Speculative Risk Can easily be diversified e g Stock Particular Risk A risk that affects one individual at any given time e g Heart Attack Fundamental Risk A risk that affects a group of people e g Flood Static Risk A risk that does not change throughout time Probability of an earthquake Dynamic Risk A risk that changes throughout time Chance that someone will steal my identity Gets easier harder depending on technology Core Risk Primary risk that cannot be avoided Pharmaceutical company if their product will kill someone Secondary risk Not part of core function avoidance is a choice How much healthcare will cost for their employees Personal Risks Things that affect you individually o Life health divorce Property Risks Risk of loss to the things that you own Liability Risks You being responsible for things you failed to do what a normal person would do in a set of circumstances o Hitting someone in a car o Getting in a fight at a bar Financial Risks Making or losing money Exposure Person or property facing risk of loss The apartment or personal items in apartment Peril The immediate cause of loss Fire in apartment Hazard Anything effecting frequency or severity of loss The fact that you are storing gas cans near the fireplace Physical hazards Property conditions Hole in your porch more likely someone falls Moral hazard Behavioral changes Driving more reckless because you have an airbag Eating unhealthy because you think your doctor can keep you alive with medicine Societal hazards Legal or cultural Smoking considered a hazard Abortion becoming illegal or legal Burden of Risk on Society 1 Need for Larger Emergency Funds 2 Loss of Needed Goods and Services 3 Fear and Worry Rules of Risk Management Don t risk more than you can afford to lose Don t risk a lot for a little Consider the odds The Risk Management Process 1 Determination of objectives 2 Identification of risks 3 Evaluation of risks 4 Consideration of alternatives selection of the tool 5 Implementing the decision 6 Evaluation and review Pre Loss i Economy Want to be efficient ii Reduction in Anxiety Reduce fear and worry of employees iii Make sure not damaging environment abide by laws iv Social responsibility give back to community and get involved Post Loss i Survival Make sure organizations stays around ii Continue operations iii Stabilize earnings iv Continue to growth v Social responsibility Loss Frequency how frequently does a loss occur Loss Severity measure of how bad it is when it does happen Central tendency What s most likely to occur Measures of variation How far away the extremes are away from the mean Law of large numbers Helps insurance companies diversify their losses Variance Calculation Loss Value Expected Loss 2 Probability of Loss Standard deviation equation Square root of Variance Coefficient of variance standard deviation Expected Loss Loss control Reducing amount of risks faced by a company Prevention Aimed at frequency Reducing number of time loss occurs Reduction Reducing amount of severity Loss Financing Retention You pay for it Loss Financing Transfer Find someone else to pay for it Ex Insurance Scientific Risk Definition Probability of a person suffering an adverse effect from some activity or exposure over a given period of time involvement Why might Innovations be risky Innovations make us feel safer lead to us changing our habits because we feel safer which may create more risk Ex Four wheel drive more people driving in snow driving less safe because they feel safer more risk Five Rules of Thumb to Minimize Risk 1 Recognize that you need a model 2 Acknowledge your model s limitations 3 Expect the unexpected 4 Understand use and user 5 Check the infrastructure Incorrect Model a model whose internal logic or underlying assumptions themselves are wrong and there is an error NOT okay to use Incomplete Model We know there is information missing but we try to predict as best as we can anyways Systemic Risk Everyone does the same thing so a problem effects everyone at the same time Ex Associated Press twitter account was hacked A lot of financial traders use models that scan twitter accounts and news organizations so that they can sell right away These models responded and sold automatically when the information wasn t actually true Important characteristics of model Workings of model are transparent Consistently applied Results can be reproduced and verified by others Consequences of Innovation Pace of innovations in some industries is very high so changing infrastructure to accommodate every innovation that comes along is infeasible Decision Theory Used to determine optimal strategies where a decision maker is faced with several alternatives and an uncertain or risky pattern of future events How do you make decisions when faced with risk Steps of Decision Making Process 1 Identification of possible Identification of all the courses of action 2 outcomes 3 4 Determination of the pay off function 5 Choosing from among various alternatives Payoff table Matrix of conditional values associated with possible combinations of actions and events Opportunity Loss or Regret Amount of profit foregone by not adopting the optimal course of action or that which would give the highest pay off for each possible event Laplace principle Based on the fact that we do not know the probability of the possible outcomes assume that all outcomes are equally likely Pick an action average all possible outcomes and pick the highest one highest payout Maximin Deals with profit Consider minimum pay offs resulting from the adoption of various strategies Choose the maximum profit Minimax Deals with Cost Consider max cost associated with each alternative Choose the alternative that minimizes this max cost Maximum likelihood principle First consider event most likely to occur pick highest probability Take that probability as the given pick the column with the highest value of that probability
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