RMIN SGCHAPTER 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 tails-50% 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 experienceo 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 mindo 2 people in the same situation may have a different perceived risko if you have high subjective risk then you will probably exhibit conservative and prudent behavior- Peril: the cause of the losso 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 losso 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 trafficwithout 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 includecoverage 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 possibleo 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 economyo 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 economyo Cannot be eliminated or reduced by diversificationo Inflation, cyclical unemployment, war, natural disasterso 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 risko Strategic risk: uncertainty regarding the firm’s financial goal and objectives Business opens a new line of product that may be unprofitableo 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 valueof 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 familyo 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 haveno financial obligations Human life value= the present value of the family’s share of the deceased breadwinner’s future earningso Insufficient Income During Retiremento Poor Healtho 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/losso 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 losseso 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 elseo No max limit to liability, damages paido 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 effectso 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 livingo There must be outlays to reduce risk: locks, alarm systems, tags on merchandise, etco It can be costly to finance potential risks/losses: buy insuranceo 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 controlo Worry and fear are presento Time: opportunity cost of employee time or management timeo Losses for which we are not reimbursedCHAPTER 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 risko There is a pure risk transfer from insured to insurer- Fortuitous: random/accidental losseso 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 losso Risk reduction based