RMIN 4000 1st Edition Final Exam Study Guide Lectures 1 32 Lecture 1 January 8 Introduction Risk Management Have Insurance losses increased through time Insurance losses have increased greatly in the past century Katrina was number one Then Japan 2011 earthquake and tsunami 3 of the top 15 losses over 40 years happened within the last 3 years Earthquakes caused these 3 events Mostly property and human losses One reason for an increase in losses is because there are more things to be damaged Another reason for an increase in losses is because people decide to live near the coast and insurance it What is Risk Risk is uncertainty In the words of Costanzia Seinfeld Before we can manage risk we must understand Risk How we spot risk How do we avoid Risk And what makes it so Risky Risk uncertainty about chance timing or amount of loss Risk of Sudden Premature death Life Insurance Risk of poor health Health Insurance Risk of car accident Car Insurance Risk of house fire Home insurance Etc What are Loss Exposures Loss exposures are anything exposed to loss whether or not you actually have a loss What is chance of loss Chance of loss is simply the probability that an event will occur What are the different types of risk Objective Risk and Subjective risks are the two types of risk Objective Risk is the degree of risk Objective Risk is defined as the relative variation of actual results from expected results Can be measured across time and individuals For Example 10 000 cars Expect 1 of carts to have a loss 100 losses but worst year had 110 losses Thus objective risk is 10 100 10 Higher variation is higher risk Variance is the difference between expectation and maximum value divided by expectation More exposure will result in actual results getting close to calculated results Subjective Probability defined as uncertainty based on a person s mental condition or state of mind It may differ across individuals and time High subjective risk results in conservative and prudent behavior Low subjective risk results in less conservative behavior Ex A person who has had a speeding ticket will be more likely to drive slow because he has a high subjective risk for speeding as compared to a person who perceives the risk of getting caught very low will drive more reckless and fast because he has a low subjective risk How does the Law of Large Numbers affect Variance If there are a lot of exposures then the actual results will approach what we want them to be Very important concept in risk management Law of Large Numbers suggests that bigger exposure the lower the variance will be How do you calculate Expected Loss Expected loss is equal to the summation of the probability of the loss multiplied by the amount of loss For Instance Loss Probability Loss X Probability 0 50 0 100 50 50 Expected Loss is equal to 50 00 See Worksheet on ELC for more practice How do you calculate Variance Variance is equal to the summation of Loss Expected loss 2 X Probability of loss See worksheet on ELC for more practice How do you find Standard Deviation Standard Deviation is the square root of variance What does the Variance say about the risk A lower variance indicates a less riskier action while a greater variance shows that there is more risk involved Lecture 2 January 10 What are the 3 Risk Altitudes Risk Averse Risk is too scary avoid risk if and when possible will pay extra to remove risk from a set of outcomes Will pay more than the expected loss to cover the loss Risk Seeker Taker Risk is too fun enjoy risk will gamble on a big payout and not take many precautions to avoid risk Will rather take the risk than pay the expected loss to cover the loss Risk Tolerant Risk neutral Risk is just right Will evaluate risk and will strive to pay no more than the expected loss plus the reasonable markup to avoid risk People can have different attitudes in different aspects of their life Will be willing to pay expected loss or less to cover the loss Lecture 3 January 13 What are perils and hazards Perils are defined as the cause of the loss For instance cause of someone s death damage to property Hazard is a condition that increases the chance of a loss Hazards make a loss more likely to happen What are the different types of hazards Physical Hazard is a physical condition that increases the frequency or severity of loss Moral Hazard is dishonesty or character defects in an individual that increase the frequency or severity of loss Morale Hazard is careless or indifference to a loss which increase the frequency or severity of a loss Legal Societal Hazards refers to characteristics of the legal system or regulatory environment that increase the frequency or severity of losses What are the different types of Risk Pure Risk is risk where you have a chance of loss or no loss and no chance of gain Ex car accident Speculative Risk is chance of loss no loss or gain Ex stock market starting a business Particular Risk or diversifiable Risk is a risk that affects only individuals as individuals Fundamental Risk or Systematic risk non diversifiable risk is a risk that affects a large number of individuals or the entire economy Enterprise Risk Management is a term that encompasses all major risks faced by a business firm include pure speculative strategic operational and financial Commercial Risk is those risks faced by business operations including corporations partnerships and even sole proprietorships Ex risk associated with opening new business Personal Risks are those risks that apply to individuals 4 major personal risks 1 Premature death 2 Poor health 3 Unemployment 4 Insufficient income during retirement Property risks is the risk of having property damaged or lost from numerous causes Direct Loss defined as a financial los that results from the physical damage destruction or theft of property Indirect Loss is defined as a financial loss that results indirectly from the occurrence of a direct physical damage or theft loss If it is a risk that you will be financially responsible for the Life Health or Income to someone else and or damaging someone else s stuff it is a Liability risk What are properties of Liability Risk Liability Risks are form of pure risk that most people face you can be held legally liable if you do something that results in bodily injury or property damage to someone else 1 No maximum upper limit 2 Liens on future wages can be imposed 3 May result in legal defense costs regardless of merit of claim What are the