Chapter 5 - Risk Management Flashcards Preview

Intro To Finance > Chapter 5 - Risk Management > Flashcards

Flashcards in Chapter 5 - Risk Management Deck (50):

Capitalization of Earnings method

A method of calculating life insurance needs using gross income, and riskless rate of return. Uses a fraction. Can also be further adjusted to account for taxes, personal consumption, and inflation.


Disability Insurance

Insurance that provides replacement income to the insured while unable to work due to illness or accident.


Financial needs method

A method of calculating life insurance needs based on the income replacement and lump-sum needs of the survivors.



A condition that creates or increases the likelihood of a loss occurring
Can be classified as physical, moral, or morale.


Homeowner’s insurance coverage

A package policy covering dwelling, dwelling extensions, personal property, loss of use, medical payments for visitors, and liability


Human Life Value (HLV) Method

A method of calculating life insurance needs that uses projected future earnings after taxes and individual consumption to determine the Family’s Share of Earnings (FSE)


Liability Risk

A risk that may cause financial loss


Life Insurance

An income replacement insurance in case of the unexpected death of the insured.


Loss Frequency

The expected number of losses that will occur within a given period of time


Loss Severity

The potential size or financial damage of a loss


Moral Hazard

A character flaw or level of dishonesty an individual possesses that causes or increases the chance for a loss
(Active flaw)


Morale Hazard

Indifference to losses based on the existence of insurance
(Passive flaw)


Named-Perils Policy

A policy that provides protection against losses caused by the perils that are specifically listed (named) in the policy.


Open-Perils Policy

Policies that cover all risks of loss that are not specifically excluded from the contract.
Also called “all-risks” policies.



The proximate or actual cause of a loss.
(e.g. fire, liability, accidental death)


Personal Automobile Policy (PAP)

A package policy that protects against loss due to damage to the owned automobile, damage to the property of others, and bodily injury to the insured, family members, and others.


Personal Liability Umbrella Policy (PLUP)

A policy that provides excess liability coverage and legal defense for clients (against possible claims) that exceeds the limits of underlying policies in place (homeowner and auto)
Usually sold in millions of dollars of coverage.


Personal Risk

A risk that may cause the loss of income or cause an increase in the cost of living.


Personal Risk Management

A systematic process for identifying, evaluating, and managing pure risk exposures faced by an individual.


Physical Hazard

A tangible condition or circumstance that increases the probability of a peril occurring


Property Risk

A risk that may cause the loss of property (home, automobile, etc.)


Pure Risk

A risk for which there is a possibility of loss, but no possibility of gain.


Risk Avoidance

Avoiding an activity so that a financial loss cannot be incurred


Risk Reduction

Implementing activities that will result in the reduction of the frequency and severity of a loss


Risk Retention

The state of being exposed to a risk and personally retaining the potential for loss


Risk Transfer

Transferring or shifting the risk of loss through an insurance policy or warranty.


What are the four insurable risk requisites?

accidental, measurable, have statistically significant data available for probability forecasting, and not catastrophic for the insurer.


What are the seven unique legal requirements of an insurance contract?

An insurance contract will be unilateral, aleatory, adhesive, have indemnity, be created in good faith, insurable, and conditional on premium payments.


Insurance on the person covers what four areas?

Life, Health, Disability and Long Term Care


What types of personal insurance focus on income replacement?

Life and Disability insurance


What are the four definitions of job ability for a disability policy?

Own Occupation, Any Occupation, Hybrid (of “own” and “any”), and Partial Disability


What is an Elimination Period?

The period of time between the accident and the first payout of disability insurance. Commonly around 3 to 6 months.


Noncancelable insurance

Fixed premiums to pay, and can’t have the policy cancelled by insurer or insured


Guaranteed Renewable Insurance

The insurance continues while the insured pays the premium. The premium can possibility increase during renewal periods.


What are the ADLs considered to receive long term care?

Eating (feeding), Bathing, Dressing, Toileting, Transportation (walking), continence (bladder control)


How many ADLs can a person not complete to be considered for Long term care?

Two or more


What is an ADL?

Acts of Daily Living


What does it mean when an insurance policy is aleatory?

The amount of money an insured person gives to the insurance company may not be the same as what an insurance policy will end up spending on the insured. (Uneven financial input/output)
May never have to make a claim.


What are the six steps of the Personal Risk Management Process?

1. Determine Objectives (Risk Philosophy)
2. Identify Exposed Risks
3. Evaluate Risks on the Matrix
4. Determine and Select Alternatives
5. Implement the Plan
6. Review the plan periodically


What happens during the “Determine Objectives” step of the Risk Management Process?

Understand the client’s overall philosophy for managing risk.
Prior-Protection versus Post-Redeption


What happens during the “Identify Exposed Risks” step of the Risk Management Process?

Understand as many of the insurable risks the client has, including personal, property, and liability risks.


What happens during the the “Evaluate Risks” step of the Risk Management Process?

Plot the perils/risks on the matrix of Loss Frequency and Loss Severity


Catastrophic Financial Risks

Perils that lead to severe financial hardship


What should be done to a risk with High Frequency and High Severity?

Risk Avoidance


What should be done to a risk with Low Frequency and High Severity?

Risk Transfer


What should be done with a risk that has High Frequency and Low Severity?

Risk Reduction or Risk Retention


What should be done with a risk that has Low Frequency and Low Severity?

Risk Retention?


What is a good method of protecting against retained risk?

Creating an Emergency Fund


What are two reasons for the “Reviewing Plan” step of the Personal Risk Management Process?

1. The process changes over time and exposures change.
2. Judgement errors can be revised


How to Calculate the Human Life Value Method for Life Insurance?

Annual Earnings (less) Taxes and Personal Consumption = FSE
Expected age of retirement (less) Current Age = WLE
Calculate Present Value (PV) of
Annual Payment (FSE), NPer (WLE), and Interest [(1.06/1.03)-1] (real rate of return?)