Risk A situation involving exposure to danger Uncertainty concerning the occurrence of a loss Possibility of loss on the person or entity that is insured Probability or threat of damage injury liability loss that is caused by external of internal vulnerabilities and that may be avoided through preemptive action Peril Cause of the loss ex In an accident collision is the peril Hazard condition that increases the chance of loss physical condition that increases the frequency or Physical hazard severity of loss increases the frequency or severity of loss Moral hazard Attitudinal hazard Legal hazard The jury is out insurance regulations who cares dishonesty or character defects in an individual that Classification of Risk Pure risk or no loss earthquake Speculative risk situation in which there are only the possibilities of loss either profit or loss is possible gambling Diversifiable risk theft Nonsystematic or particular risk Affect only individuals or small groups car Nondiversifiable risk affects the entire economy or large numbers of persons or groups within the economy hurricane flood Systematic risk or fundamental risk Government asst may be necessary to insure Enterprise Risk Management combines into a single unified treatment program all major risks faced by the firm Pure risk Speculative risk Strategic risk Operational risk Financial risk Chance of loss probability that an event that causes a loss will occur Objective risk relative variation of actual loss from expected loss Source of Pure risk Personal Affects individual or family Property Destruction theft of property o direct loss is physical damage damage a fire causes a home o indirect loss is financial loss outside of physical damage Liability Its all your fault Types of personal risk Premature Death Insufficient Retirement Income Poor Health Unemployment Types of Liability Risk Premises hazards Product liability Professional liability Contractual liability Environmental impairment liability Employment related practices liability Liability Risk involve the possibility of being held legally liable for bodily injury or property damage to someone else No maximum upper limit w respect to amount of loss A lien can be placed on income and financial assets Legal defense costs can be enormous Major Commercial Risks firms face a variety of pure risks that can have serious financial consequences if a loss occurs Property risks such as damage to buildings furniture equipment harasm Liability risks suits for defective products pollution sexual Loss of business income when firm must shut down for sometime after a physical damage loss Other risks Crime exposures human resources foreign loss intangible government exposures regulation Burden of Risk on Society Large amounts of personal emergency funds would be needed to repairs damages w out proper insurance People may lose access to goods or services such as a company fearing a lawsuit that would stop producing an important product Fear and worry Techniques for managing risk Risk control Avoidance loss prevention loss reduction Risk Financing Retention self insurance transferring hedging incorporation Ch 2 Insurance and Risk Insurance the pooling of fortuitous losses by transfer of such risks to insurers who agree to indemnify insurers for such losses to provide other pecuniary benefits on their occurrence or to render services connected with the risk Characteristics Pooling of losses Payment of fortuitous claims Risk transfer Indemnification to pay you back bring you back to where u were Pooling of Large Losses Pooling spreads losses over the entire group Risk reduction is based on the Law of Large Numbers The greater the number of exposures the more closely the actual results will approach the probable results that are expected from an infinite number of exposures Basic characteristics of insurance Payment of fortuitous losses o Unforeseen unexpected and occurs as a result of chance Risk Transfer Indemnification o Pure risk transferred from insured to insurer o Insured is restored to the financial position prior to the loss Characteristics of an ideally insurable risk Large number of exposure units o To predict average loss based on the law of large numbers Accidental and unintentional loss o To assure random occurrence or events Determinable and measurable loss how much to rebuild it o To determine how much should be paid No catastrophic loss o To allow the pooling technique to work o Exposures to catastrophic loss can be managed by using reinsurance dispensing coverage over a large geographic area or using financial instruments such as catastrophe bonds Calculable chance of loss o To establish a premium that is sufficient to pay all claims and expenses and yields a profit during the policy period Economically feasible premium o So people can afford to purchase the policy o For insurance to be attractive purchase premiums paid must be substantially less than the face value or amount of policy Adverse Selection the tendency of persons with a higher average chance of loss to seek insurance at standard rates If not controlled by underwriting adverse selection results in higher than expected loss levels Adverse selection can be controlled by o Careful underwriting selection classification of appl of insure o Policy provisions ex Suicide clause in life insurance Insurance vs gambling Insurance handling already existing pure risk socially productive both Gambling Speculative risk not socially productive someone has to lose Insurance vs hedging Insurance risk is transferred by a contract involves the transfer or pure risks can reduce objective risk of an insurer Hedging involves risks that are typically uninsurable does not result in reduced risk Types of Private insurance Life and health includes individual and group health plans disability income plans long term care plans Property and Liability o Personal lines for individuals and families o Commercial lines for business nonprofit organizations government agencies Types of Government insurance Social insurance programs Other government programs o Social benefits of insurance Indemnification of loss Reduction of worry and fear Source of investment funds Loss preventions Enhancement of credit Social costs of insurance Cost of doing business o An expense loading amount needed to pay all the expenses including commissions general administrative expenses state premium tax Ch 3 Intro to Risk Management Process Risk management Process that
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