2. Risk Flashcards
Common concept of Risk
The condition in which losses could happen to someone and the fact that one can’t tell for sure whether or not they will happen.
Common elements in all definitions of risk used in insurance:
- Indeterminacy: The outcome must be in question.
- Loss: At least on of the possible outcomes is undesirable.
Definition of risk
A condition of the real world in which there is a possibility of an adverse deviation from an expected or desired outcome.
Uncertainty
A state of mind characterised by doubt, based on a lack of knowledge about what will or will not happen in the future.
Peril
The cause of a certain loss that occurs.
Hazard
A condition that may create or increase the chance of a loss arising from a given peril.
3 Categories of hazards
- Physical hazards
- Moral hazard
- Morale hazard
Physical hazards
Consist of those physical properties that increase the chance of loss from the various perils.
Ex. Type of construction increases the loss from the peril of fire.
Moral hazard
Refers to the increase in the probability of loss that results from dishonest tendencies in the character of the insured person.
Morale hazard
Acts to increase losses where insurance exists, not necessarily because of dishonesty, but because of a different attitude toward losses that will be paid by insurance.
(Ex. People being more careless when having purchased insurance).
Fundamental risks
Involve losses that are impersonal in origin and consequence. They are group risks, caused for the most part by economic, social and political phenomena, although they may also result from physical occurrences.
Ex. Unemployment, war, inflation…
Particular risks
Involve losses that arise out of individual events and are felt by individuals rather than by the entire group.
Ex. Burning of a house, robbing of a bank
Speculative risk
A situation where there is a possibility of loss, but also a possibility of gain.
Ex. Gambling,
Pure risk
A situation that involve only the chance of loss or no loss.
Why do we distinguish between pure and speculative risk?
Normally only pure risks are insurable.
Insurance is not concerned with the protection of individuals against those losses arising out of speculative risks.
Speculative risk is voluntarily accepted because of its two-dimensional nature, which includes the possibility of gain.
5 General ways of dealing with risk:
- Avoidance
- Retention
- Transference
- Sharing risks
- Reduction
Avoidance of risk
Risk is avoided when the individual simply does not take on the risk.
Why can avoidance of risk be negative?
Personal advancement of the individual and progress in the economy both require risk taking.
Retention of risk
When the individual positive action to avoid, reduce or transfer the risk, the possibility of loss involved in that risk is retained.
Transferring risk
Risk may be transferred from one individual to another party who is more willing to bear the risk.
Ex. Individuals transfer risks to an insurance company.
Sharing risk
Risk is shared when there is some type of arrangement to share losses.
Reduction of risk
Risk may be reduced by:
- Loss prevention/reduction
- Controlling the severity of the loss
Meaning: Degree of risk
The likelihood of its occurrence.
Its “probability”
More risk
Larger possible size of the loss (greater potential severity).
The expected value of a loss
The probability of that loss multiplied by the amount of the potential loss.
The term “risk is used by people in the insurance business to mean either : (2)
- a peril insured against (e.g. fire)
- a person or property protected by insurance
