Principles of Risk
Management and
Insurance
Risk and Its Treatment
Chapter 1
Barbara Bellissimo
1
POLL – Test your understanding
Risk is…
1.
2.
3.
Loss exposure
Uncertainty concerning the occurrence of a loss
Difficult to measure
What is a peril?
1. A nice piece of jewelry
2. Physical condition that increases the chance of loss
3. A cause of loss
What is pure risk?
1.
2.
3.
A cause of loss
Situation where there are only possibilities of loss or no loss
Personal estimate of chance of loss
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Principles of Risk Management and Insurance
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POLL – Test your understanding
Risk is…
1.
2.
3.
Loss exposure
Uncertainty concerning the occurrence of a loss
Difficult to measure
What is a peril?
1. A nice piece of jewelry
2. Physical condition that increases the chance of loss
3. A cause of loss
What is pure risk?
1.
2.
3.
A cause of loss
Situation where there are only possibilities of loss or no loss
Personal estimate of chance of loss
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Objectives: Risks and Its Treatment
• Understand the definition of Risk
• Identify various types of risks
• Pure, speculative, diversifiable, non diversifiable,
enterprise and systemic
• Show how risk is a burden to society
• Explain the major techniques for managing risk
• Case Application and Next Steps
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Definition of Risk
• Risk: Uncertainty concerning the occurrence of a loss
• Loss Exposure: Any situation or circumstance in which a loss is
possible, regardless of whether a loss occurs
• Objective risk is defined as the relative variation of actual loss from
expected loss
• Subjective (perceived) risk is defined as uncertainty based on a
person’s mental condition or state of mind
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Chance of Loss
• Chance of loss: The probability that an event that causes a loss will
occur – has both objective and subjective aspects
• Objective probability: Long-run relative frequency of an event based
on the assumptions of an infinite number of observations and of no
change in the underlying conditions
• Subjective probability: Individual’s personal estimate of the chance
of loss
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Chance of Loss Vs Objective Risk - Example
The chance of loss may be identical for two different groups, but
objective risk may be quite different!
City
# homes
Chance of
Fire
Average #
fires
Range
Objective
Risk
Philadelphia
10,000
1%
100
75 – 125
25%
Los Angeles
10,000
1%
100
90 – 110
10%
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Peril and Hazard
• A peril is defined as the cause of the loss.
• A hazard is a condition that creates or
increases the frequency or severity of loss
• Physical
• Moral
• Attitudinal Hazard (Morale Hazard)
• Legal Hazard
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Classification of Risk
Pure Risk and Speculative Risk
• A pure risk is a situation in which there are only the
possibilities of loss or no loss (insurable)
• A speculative risk is a situation in which either profit or
loss is possible (usually non insurable)
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Classification of Risk
Diversifiable Risk and Nondiversifiable Risk
• A diversifiable risk affects only individuals or small
groups. It can be reduced or eliminated by
diversification.
• A nondiversifiable risk affects the entire economy or
large numbers of persons or groups within the economy.
It cannot be reduced or eliminated by diversification.
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Classification of Risk
Enterprise Risk
• Encompasses all major risks faced by a business,
including, pure risk, speculative risk, strategic risk,
operational risk, and financial risk
• Strategic Risk
• Operational risk
• Financial Risk
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Classification of Risks
Systemic Risk
• Risk of collapse of an entire system or
entire market due to the failure of a
single entity or group of entities that
can result in the breakdown of the
entire financial system
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Personal and Commercial Risks
Personal risks
–Premature death
– Physical disability
– Unemployment
– Old age –retirement
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Major Personal and Commercial Risks
Property risks
• Direct Loss is a financial loss resulting from the physical
damage, destruction, or theft of the property
• Indirect or consequential loss is a financial loss that results
indirectly from the occurrence of a direct physical damage or
theft
• Home/Buildings
• Possessions (furniture, artwork, jewelry, computers,
equipment)
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Major Personal and Commercial Risks
Liability risks
Possibility of being held legally liable for bodily injury or property
damage to someone else (failing to do what a reasonable person
would do)
Harm caused by negligent acts:
- On my property
- When operating a vehicle
- During manufacturing of a product
- As a result of delivering professional services
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Major Personal and Commercial Risks
Commercial Risks
• Property risks
• Liability risks
• Loss of business income
• Cybersecurity and identity theft
• Other risks – crime, HR, foreign loss, intangible property,
government
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BURDEN on SOCIETY
The presence of risk results in three major burdens on
society:
• Need for a Larger Emergency Fund
• Loss of Needed Goods and Services
• Worry and Fear
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How to Manage RISK
Risk Control
• Avoidance
• Loss prevention
• Loss reduction
• Duplication
• Separation
• Diversification
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Techniques for Managing
Risk Financing
• Retention – Active, Passive, self insurance
• Noninsurance transfers - transfers risk to another party
• Insurance – pure risk transfer, pooling, law large numbers
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APPLICATION
1. The premature death of an individual is an example of a
A.
B.
C.
D.
Pure risk
Speculative risk
Nondiversifialbe risk
Physical hazard
2. Taylor tabacco Company is concerned that the company may be held liable in a
court and ordered to pay a large damage aware to a smoker harmed by the
company’s cigarettes. The characteristics of the judicial system that increase the
frequency and severity of loss are known as:
A.
B.
C.
D.
Moral hazard
Particular risk
Speculative risk
Legal Hazard
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APPLICATION
3. The extra expense incurred by a business to stay in operation following a fire is
an example of;
A.
B.
C.
D.
Fundamental risk
Speculative risk
Direct loss
Indirect loss
4. What is an example of a noninsurance risk transfer?
A.
B.
C.
D.
Not engaging in dangerous activities
Entering into a hold-harmless agreement
Installing smoke detectors in your home
Using nonflammable building material when constructing a house
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APPLICATION
5. Cathy’s car hit a patch of ice on the road. The car skidded off the road and hit a tree.
The presence of ice on the road is best described as:
A. peril
B. subjective risk
C. physical hazard
D. indirect loss
6. A student has skipped many classes and not studied and was surprised to learn there
was test when he/she showed up for class. The student’s mental uncertainty about
whether or no he will pass the test is called
A.
B.
C.
D.
Objective risk
Objective probability
Subjective probability
Subjective risk
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APPLICATION
7. Five years ago, Shannon decided to start investing monthly in common stock of ABC Telecom
company. Her financial well being will be harmed if the price of ABC stock drops significantly. The
risk of investment loss can be reduced if she invests in other companies. The risk she faces with
regard to her investment is best described as
A. enterprise risk
B. diversifiable risk
C. pure risk
D. non diversifiable
8. The production facility for ASF Manufacturing is located in a flood plain. Although the risk of
flood is low, ASF risk manager is concerned flood could damage the plant and equipment. He
received bids on flood insurance but decided the coverage was too high relative to the risk. He
did not purchase flood insurance. Which risk management technique is ASF using with respect to
flood risk?
A.
B.
C.
D.
Active retention
Noninsurance transfer
Passive retention
Avoidance
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Next Steps
- Chapter 2/3/4
- Review Syllabus get started on reading
- Review due dates for speakerse
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