Overview – What is Risk? / Risk in Our Society

Question 1

What is risk?

Answer 1

♣ Uncertainty Concept - risk = uncertainty
♣ Objective Risk - the observed number of losses within a certain time frame for a particular sample.
♣ Subjective Risk - uncertainty based on one’s mental condition or state of mind.

Question 2

Chance of loss

Answer 2

♣ Objective Probability - A priori-by logical deduction such as in games of chance (mathematical)
♣ Subjective Probability - a personal estimate of the chance of loss. It need not coincide with objective probability and is influenced by a variety of factors including age, sex, intelligence, education, and personality.

Question 3

Peril definition

Answer 3

Probable cause (such as an earthquake, fire, theft) that exposes a person or property to the risk of damage, injury, or loss, and against which an insurance cover (policy) is purchased. CAUSE OF LOSS

Question 4

Hazard definition and types

Answer 4

♣ Physical hazard – physical condition that increases the chance of loss. Examples are icy streets, poor designed intersections, and dimly lit stairways. Not the cause of the loss, but the condition that caused the loss.
♣ Moral hazard – carelessness or indifference to a loss because of the existence of insurance.

Question 5

Basic categories of risk

Answer 5

♣ Pure and speculative risk
♣ Diversifiable and non-diversiable risks
♣ Entreprise risks - static and dynamic

Question 6

Pure risk

Answer 6

a situation where there are only the possibilities of loss or no loss.

Question 7

Speculative risk

Answer 7

a situation where either profit or loss is possible. Chance of a gain investing in the stock market.

Question 8

Law of large numbers

Answer 8

A statistical axiom that states that the larger the number of exposure units independently exposed to loss, the greater the probability that actual loss experience will equal expected loss experience.

Question 9

Diversifiable risk

Answer 9

affects/unique to a business. If you plan your operations in a certain mode, risk is diversifiable. For example, having some factories located in nonearthquake areas or hotels placed in numerous locations in the United States diversifies the risk.

Question 10

Non-Diversifiable risk

Answer 10

affects the larger economy (inflation, regulatory delays…)

Question 11

Enterprise Risk (static & dynamic)

Answer 11

♣ Static – not affected by the economy (tornadoes…). Situation not significantly affected by thebusiness environmentand which remains constantover time, such asreal property. Static risk are insurable.
♣ Dynamic - Exposure to loss from changes in the environment, such as fashions, people’s tastes, and regulatory requirements.Dynamic risksare not insurable.

Question 12

Types of pure risks

Answer 12

♣ Personal Risks
♣ Property Risks
♣ Liability Risks
♣ Commercial Risks

Question 13

Personal Risks (pure risks)

Answer 13

Basic, personal risks are premature death, old age, poor health, and unemployment.

Question 14

Property Risks (pure risks)

Answer 14

Types of losses include direct physical damage losses, theft losses, indirect or consequential losses, and extra expenses.

Question 15

Liability Risks (pure risks)

Answer 15

Risk to a company arising from the possibility of liability for damages resulting from the purchase, ownership, or use of a good or service offered by that company. Liability risk can be identified and mitigated through careful product design and testing, but may also be inherent in the nature of the product to some extent, as in the case of automobiles or pharmaceutical supplies. Perils include negligence, breach of warranty, and absolute liability.

Question 16

Absolute liability

Answer 16

You are liable no matter what. For example, when blasting a building.

Question 17

Commercial Risks (pure risks)

Answer 17

♣ Property risks
♣ Liability Risks
♣ Loss of Business Income - pay back loan
♣ Other Risks – Crime / Human Resources / Foreign Loss Exposures / Intangible Property Exposures / Government Exposures

Question 18

Methods of Handling Risk

Answer 18

♣ Avoidance
♣ Retention (assumption of risk - active and passive)
♣ Noninsurance Transfers (contracts, hedging)
♣ Loss Control (prevention & reduction)
♣ Insurance

Question 19

Insurance definition

Answer 19

transfer the loss to a third party. By far the prevalent way of dealing with risk.

Question 20

Risk management definition

Answer 20

Process that identifies loss exposures face by an organization and elects the appropriate technique to handle them.

Question 21

Risk Management Process (4 steps)

Answer 21

1. Identification,
2. Analysis (measurement)
3. Selection of risk management techniques
4. Implementation.
   (5. Continual eveluation)

Question 22

Financial statements

Answer 22

How much loss can an enterprise handle? where is “cash”? if overseas, may be cost barriers to bringing back to U.S. (taxes)?

Question 23

Variance definition

Answer 23

tells us about the likelihood and magnitude actual outcome will differ from expected outcome.

Question 24

Objectives of Risk Management (pre-loss)

Answer 24

1. Economy goal - prepare for loss in most economical way.
2. Reduction of anxiety - “happy worker…”
3. Meet externally imposed obligations
4. Creditors
5. Legally imposed
6. Contractually imposed

Question 25

Objectives of Risk Management (post-loss)

Answer 25

1. Survival of the firm 2. Continued operations (?) 3. Stability of earnings 4. Continued growth 5. Social responsibility

Question 26

Identifying Potential Losses (cost of risk)

Answer 26

1. Calculate expected cost 2. Determine possibility of loss control and cost associated with it 3. Determine possibility of loss financing 4. Is internal Risk Reduction Available? 5. Residual Uncertainty – what if insurance company fails?

Question 27

Identifying Potential Losses (cost trade offs)

Answer 27

1. Expected Losses/Loss Control 2. Loss Financing of Expected I ndirect Loss - installing fire door minimizes risk of fire spreading to other operations. 3. Loss Financing of Residual Uncertainty

Question 28

Identifying Potential Losses (types of potential loss)

Answer 28

1. Physical damage to property 2. Loss of income 3. Liability lawsuits 4. Death or disability of key persons 5. Losses from job-related injuries or disease 6. Losses from fraud, criminal acts, and employee dishonesty 7. Employee benefits loss exposures

Question 29

Identifying Potential Losses (tools for recognizing loss exposures)

Answer 29

1. Physical inspection 2. Survey form 3. Flow chart 4. Financial statements 5. Past loss experience

Question 30

Evaluating Potential Losses - Key Concepts

Answer 30

♣ Loss frequency ♣ Variance ♣ Skewedness - loss possibilities are not uniform. ♣ Correlation - how do the variables affect one another? ♣ Loss severity

Question 31

Consequential or indirect losses

Answer 31

nonphysical losses such as loss of business. For example, a firm losing its clients because of street closure would be a consequential loss.

Question 32

Moral hazards

Answer 32

hazards that involve behavior that can be construed as negligence or that borders on criminality. They involve dishonesty on the part of people who take out insurance (called “insureds”).

Question 33

Morale hazards

Answer 33

In contrast to moral hazards, do not involve dishonesty. Rather, morale hazards involve attitudes of carelessness and lack of concern. As such, morale hazards increase the chance a loss will occur or increase the size of losses that do occur.