BAF2206: PRINCIPLES OF RISK MANAGEMENT AND INSURANCE
CAT
SEP DEC 2025 2025
1. Describe the term risk (2 marks)
2. Pazuri ltd has been facing losses due to frequent occurrence of uncertainties.
They have approached you to help them identify the possible causes of the risk
and mode of corrective action. Describe the process you would recommend they
undertake. (10 marks)
3. Explain the objectives of risk management. (6 marks)
4. Describe the elements of a valid insurance contract (10 marks)
5. Explain the principle of contribution (2 marks)
6. Distinguish between property insurance and life insurance. (2 marks)
7. After purchasing a comprehensive health insurance policy, Sarah becomes less
cautious about her health, missing doctor appointments and engaging in risky
activities. Discuss how this scenario demonstrates moral hazard and how
insurers can mitigate it.
(5 marks)
8. While applying for life insurance, Alex failed to disclose that he was a regular
smoker. He dies two years later due to a smoking-related illness. Examine the
consequences of non-disclosure in light of the principle of utmost good faith. (
5 marks)
ANSWERS
1. Describe the term risk
Risk means the chance of something going wrong or not happening as planned. It is the
possibility of loss or damage caused by uncertain events in business or life.
2. Process to identify causes of risk and corrective actions
To help Pazuri Ltd deal with the risks and losses, I would recommend the following simple
process:
1. Identify the risks:
Find out what problems or uncertainties are causing the losses — for example, poor
management, market changes, or equipment breakdown.
2. Analyze the risks:
Look at how serious each risk is and how often it happens.
3. Find the main causes:
Understand why these risks are happening — maybe because of lack of training, poor
planning, or weak control systems.
4. Plan corrective actions:
Think of ways to reduce or stop the risks, such as training workers, improving systems, or
buying insurance.
5. Put the plan into action:
Apply the solutions in the company and make sure everyone follows them.
6. Monitor and review:
Keep checking to see if the actions are working and make changes when needed.
3.
The main goal of risk management is to reduce or control the impact of possible losses in a
business. Its key objectives are:
1.
2.
3.
4.
To identify risks: Find out what could go wrong before it happens.
To reduce losses: Take steps to prevent or minimize the damage when risks occur.
To protect business resources: Keep the company’s people, property, and money safe.
To ensure business continuity: Make sure the business keeps running even when
problems arise.
5. To support decision-making: Help managers make better and safer business decisions.
6. To create confidence: Give owners, employees, and investors peace of mind knowing that
risks are being managed.
4.
For an insurance contract to be valid and legal, it must have the following elements:
1. Offer and acceptance: One party offers to be insured, and the insurer accepts the offer.
2. Consideration (premium): The insured pays money (called a premium) in exchange for
protection from the insurer.
3. Legal capacity: Both parties must be legally allowed to enter into a contract — for
example, they must be adults and of sound mind.
4. Legal purpose: The contract must be for a lawful reason, not for illegal activities.
5. Insurable interest: The person insured must have a financial interest in the thing or
person being insured (e.g., you can insure your car, not your neighbor’s).
6. Utmost good faith: Both sides must be honest and share all important information.
7. Indemnity: The insurer agrees to compensate the insured for actual losses only — not to
make a profit.
8. Proximate cause: The loss must be directly caused by a risk covered in the policy.
9. Subrogation: After paying a claim, the insurer can take legal action against the party that
caused the loss.
10. Contribution: If more than one insurance policy covers the same risk, each insurer shares
the payment of the loss.
5.
Explain the principle of contribution
The principle of contribution means that if a person has the same property insured with more than one
insurance company, all the insurers will share the cost of the loss. This prevents the insured from making
a profit by asking full payment from each company.
6. Distinguish between property insurance and life insurance


Property insurance: Protects physical things like houses, cars, or businesses against loss or
damage. It only covers financial losses and is valid for a short period, usually one year.
Life insurance: Protects the life of a person. The insurer pays a fixed amount when the
person dies or after a set period. It is long-term and also helps with saving or investment.
7. Moral hazard and how insurers can reduce it.
This shows moral hazard because after getting insurance, Sarah stops taking care of her health.
She feels safe since the insurance will pay if she gets sick, so she becomes careless.
Insurers can reduce this by:
1.
2.
3.
4.
Asking people to pay part of the medical cost (co-payment).
Giving discounts or rewards for healthy habits.
Checking claims carefully to spot careless behavior.
Encouraging regular health checkups.
8.
The principle of utmost good faith means both the insurer and the insured must be honest and
share all important information when making an insurance contract.
In this case, Alex did not tell the insurer that he was a smoker. This is non-disclosure, which
breaks the rule of utmost good faith.
The result is:


The insurance company can refuse to pay the claim because the contract was based on
false or incomplete information.
The policy may be cancelled since it was not made in full honesty.