1.8 Risk Management

Question 1

Risk

Answer 1

A condition where the chance, likelihood, probability or potential for a loss exists; Uncertainty concerning a loss.

Question 2

Management

Answer 2

The determination of what types of protection are required to meet an insured’s needs using:
• A survey of the insured’s operations, health, assets and exposures that could give rise to losses.
• Assessment of potential loss frequency and severity.
• Physical inspections, applications or medical exams used for underwriting help manage a risk.

Question 3

Speculative Risk

Answer 3

Situations where there is a chance or possibility for loss, no loss or gain (i.e., gambling).

Question 4

Pure Risk

Answer 4

Situations where there is no chance for gain, only loss. Only pure risks can be insured (For instance, the possibility of damage to property caused by a fire or other natural disaster; or the possibility of financial loss as a result of premature death).

Question 5

Loss

Answer 5

Reduction, decrease, or disappearance of value. The basis of a claim for damages under the terms of an insurance policy.

Question 6

Peril

Answer 6

The cause of a loss.

Question 7

Hazard

Answer 7

A specific condition that increases the probability, likelihood, or severity of a loss from a peril.

Question 8

Three Types of Hazard

Answer 8

1. Physical Hazard - A physical condition that increases the probability of loss; use, condition, or occupancy of property.
   • Example: Flammable material stored near a furnace.
2. Moral Hazard - Dishonest tendencies that increase the probability of a loss; certain characteristics and behaviors of people.
   • Example: An insured burns down his/her own house to collect the insurance payout.
3. Morale Hazard- Attitude that increases the probability of a loss.
   • Example: Indifference or carelessness of leaving one’s house or vehicle unlocked.

Question 9

Loss Exposure

Answer 9

The condition of being at risk for a loss. Purely by existing, property and people are at risk for loss.

Question 10

Adverse Selection

Answer 10

An imbalance created when risks that are more prone to losses than the average (standard) risk are the only risks seeking insurance within a specific marketplace. For example, only those living in earthquake-prone areas seek to buy earthquake insurance. High-risk exposures tend to seek or continue insurance at a higher participation rate than the average risk exposures do.

Question 11

The ways of managing risk are:

Answer 11

S

Sharing
• Investments of a large number of people may be pooled by use of a corporation or partnership.

T

Transfer
• Transferring the risk from one party to another, such as from a consumer to an insurance company.
• Transfer the uncertainty of loss via a contract.

A

Avoidance
• Elimination of the risk.
• Avoid the activity that gives rise to the chance of loss.
• After potential areas of hazards have been identified, it may be found that some exposure to risk can be eliminated, but it is impossible to avoid all risk.

R

Reduction
• Minimizing the chance of loss, but not preventing the risk. For example, sprinkler systems, burglar alarms, pollution controls and safety guards on machinery.
• Pooling or spreading the risk among a large number of persons or entities.

R

Retention
• Assume the responsibility for loss.
• Self insure the entire loss or a portion of the loss. Choosing deductibles is a method of risk retention.
• It might be economically practical for an insured to not insure each exposure to loss and instead insure only those risks that threaten financial stability security.

Question 12

Insurable risks must include:

Answer 12

Large number of homogenous units or groups with the same perils. ◦ Law of Large Numbers – As the number of units in a group increases, the more likely it is to predict a particular outcome.
◦ Auto insurance losses are the easiest type of insurance loss to predict precisely because the number of units insured is so great.

• The chance of loss must be calculable. A statistical expectation of loss is used by insurers to calculate premiums.
• The loss must be measurable (definite and verifiable in terms of amount, cause, place and time).
• The premiums must be affordable.
• From the perspective of the insured, the loss must be accidental in nature.
• Catastrophic perils are not covered; examples include war, nuclear hazard and illegal operations.