RMIN SG CHAPTER 1 Risk is when the probability of certain outcomes can be estimated for uncertainty the probabilities of these outcomes cannot be estimated Loss Exposure any situation in which a loss is possible regardless of whether a loss occurs ex hurricane damage to home Chance of Loss the probability that the event will occur ex flipping tails50 chance of loss Objective Risk the relative variation of actual loss from expected loss aka degree of risk o You insure 10 000 houses and expect 100 houses to burn down each year This year 90 burn down 10 is the variation so 10 100 means objective risk is 10 o Higher variation means higher risk Law of Large Numbers as the number of exposure units 10 000 houses increases the more closely the actual loss experience will approach the expected loss experience o Objective risk varies inversely with the square root of the number of cases ex homes o If the square root of the number of cases increases by 10 times then that means the risk will be 1 10 of what it was Subjective Risk uncertainty based on a person s mental condition or state of mind o 2 people in the same situation may have a different perceived risk o if you have high subjective risk then you will probably exhibit conservative and prudent behavior Peril the cause of the loss o If your house burns down in a fire the peril is the fire Hazard a condition that creates or increases the frequency or the severity of the loss o 4 major types Physical icy roads defective wiring in a building Moral dishonestly or character flaws in a person that increase the severity or frequency of loss faking an accident submitting a fraudulent claim intentionally burning something Morale attitudinal carelessness or indifference to a loss which increases the frequency or severity of a loss Leaving keys in an unlocked car changing lanes in traffic without signaling Legal characteristics of the legal system or regulatory environment that increase the frequency or severity of loss Adverse jury verdicts large damage awards in liability lawsuits statutes that require insurers to include coverage for certain benefits in health insurance plans alcoholism Pure Risk a situation where there are only the possibilities of loss or no loss adverse loss or neutral no loss o Premature death job related accidents damage to property from fire lightening flood earthquake Speculative Risk a situation in which either profit or loss is possible o Stock because it can decrease or increase or stay the same loss gain no loss Particular Risk diversifiable risk a risk that only effects individuals or small groups not the entire economy o Car thefts robberies home fires Systematic fundamental non diversifiable risk a risk that affects the entire economy or a large group of people within the economy o Cannot be eliminated or reduced by diversification o Inflation cyclical unemployment war natural disasters o Government assistance may be necessary to insure non diversifiable risks Enterprise Risk all major risks faced by a business firm including pure risk speculative risk strategic risk operational risk reputation risk and financial risk o Strategic risk uncertainty regarding the firm s financial goal and objectives Business opens a new line of product that may be unprofitable o Operational risk results from the firm s business operations Bank offers online banking service and incurs loss if it is hacked o Financial risk the uncertainty loss because of adverse changes in commodity prices interest rates foreign exchange rates and the value of money Food company agrees to deliver cereal at a fixed cost in 6 months may have loss is the price of grain rises Personal Risks directly affect an individual or family o Premature death death of a family head with unfulfilled financial obligations Dependents to support mortgage to be paid etc Death of a child is not considered premature because they have no financial obligations Human life value the present value of the family s share of the deceased breadwinner s future earnings o Insufficient Income During Retirement o Poor Health o Unemployment Direct Loss a financial loss that results from the physical damage destruction or theft of property Indirect consequential Loss a financial loss that results indirectly from the occurrence of a direct physical damage or theft loss o Because of a home fire you have to rent a hotel which gives you additional living expenses also have to go out to eat more often lose rental income if that was a rental property These additional expenses are consequential losses o Loss of use of property loss of business or future opportunities Liability Risks a pure risk where you are responsible for the bodily injury or property damage to someone else o No max limit to liability damages paid o Can impose liens on your future income to satisfy legal financial obligations o Even if you don t end up being liable the legal fees can be expensive Burden of Risk on Society the presence of risk results in certain undesirable social and economical effects o The size of an emergency fund must be increased To cover future losses higher saving reduces current spending and results in a lower standard of living o There must be outlays to reduce risk locks alarm systems tags on merchandise etc o It can be costly to finance potential risks losses buy insurance o Society is deprived of certain goods and services Companies stop producing products if there is a large risk of a liability lawsuit Football helmets silicon gel breast implants some birth control o Worry and fear are present o Time opportunity cost of employee time or management time o Losses for which we are not reimbursed CHAPTER 2 Insurance the pooling of fortuitous losses by transfer of such risks to insurers who agree to indemnify insureds for such losses to provide other monetary benefits on their occurrence or to render services connected with the risk o There is a pure risk transfer from insured to insurer Fortuitous random accidental losses o Intentional losses are not paid Indemnification to make whole insured is restored to condition prior to loss Pooling spreading losses incurred by a few over the entire group so that in the process average loss is substituted for actual loss o Risk reduction based on the law of large numbers Involves the grouping of a large number of exposure units There should be a large number of similar exposure units that are subject to the same perils o Pooling implies 1 sharing of losses by