TUTORIAL 1
1. a) Explain the historical definition of risk
- Risk is defined as uncertainty concerning the occurrence of a loss. Example: the risk of a lung cancer
for smokers is present because uncertainty is present.
- In insurance, risk is used to identify the property or life that is being considered for insurance
- In economics and finance  risk is used when the probabilities of possible outcomes are known
b) What is a loss exposure?
Any situation or circumstance in which a loss is possible, regardless of whether a loss occurs.
Example: loss of business income, employee exposure, operational exposure
c) How does objective risk differ from subjective risk?
Objective Risk
Subjective Risk
Relative variation of actual loss from
Uncertainty based on a person’s mental
expected loss
condition or state of mind
Objective risk varies inversely with the
High subjective risk  conservative and
square root of the number of cases under
prudent behaviour
observation
Example: Assume that a motorist previously
Calculated by some measure of dispersion
arrested for drunk driving is aware that he has
(Standard deviation)
Law of large numbers:
The number of exposure units increases 
Actual loss experience will approach closely
to the expected loss experience
consumed too much alcohol. The driver may
then compensate for the mental uncertainty by
getting someone else to drive the car home or
by taking a cab
Another driver in the same situation may
perceive the risk of being arrested as slight. This
second driver may drive in a more careless and
reckless manner; a low subjective risk results in
less conservative driving behavior.
2. a) Define chance of loss
The probability that an event will occur
b) What is the difference between objective probability and subjective probability?
Objective probability
Subjective Probability
long-run relative frequency of an event
Individual’s personal estimate of the
based on the assumptions of an infinite
chance of loss.
number of observations and of no change in
the underlying conditions.
Can be determined by:
Can be differ from objective prob bcs:
1. Deductive reasoning (priori prob)
Ambiguity
Getting head from the toss of a coin Factors that influence subjective prob:
2. Inductive reasoning
Age, gender, intelligence, education,
Prob that a person age 21 will die
use of alcohol and drugs
before age 26.
3. a) What is the difference between peril and hazard?
- Peril: cause of loss
Ex : house burns, peril is the fire. Natural disaster
- Hazard: condition that creates or increases the frequency or severity of loss
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b) Define physical hazard, moral hazard, attitudinal hazard, and legal hazard.
- Physical Hazard:
a) Explain the difference between pure risk and speculative risk.
b) How does diversifiable risk differ from nondiversifiable risk?
a) Explain the meaning of enterprise risk management (ERM)
b) What types of risks are included in ERM?
c) Explain what is meant by property risks and liability risk.
AOL Company is an oil and gas company, operating in Southeast Asia. The management decided to
expand its commodity-based business to countries in Asia and Europe. What types of risk may be faced
by the company? What are the techniques that can be used to manage those risks?
There are several techniques available for managing risk. For each of the following risks and risk-control
methods, give an example of how the method can be implemented. a. Avoidance: the risk of sinking (by
human). b. Loss prevention: the risk of family head’s premature death because of a heart attack. c. Loss
reduction (in general): the risk of burning a car because of fire. d. Loss reduction (by duplication): the
risk of losing accounting documentation. e. Loss reduction (by separation): the risk of losing all money
by pickpockets during a vacation. f. Loss reduction (by diversification): the risk of our bankruptcy
because of the bankruptcy of our main customer.