Assignment 1: Introduction to Risk Management Flashcards
Probability
The likelihood that an outcome or event will occur
Pure Risk
A chance of loss or no loss, but no chance of gain – always undesirable and insurance deals primarily with these risks
Speculative Risk
A chance of loss, no loss, or gain – can be desirable
Risk
The certainty about outcomes, with the possibility that some of the outcomes can be negative; quantified by knowing the probability of the possible outcomes
Uncertainty
Refers to the type and timing of an outcome
Credit Risk
The risk that customers or other creditors will fail to make promised payments as they come due (speculative risk)
Subjective Risk
The perceived amount of risk based on an individual’s or organization’s opinion – may be quite different from actual underlying risk, but can also be necessary to use because facts are often unavailable to objectively assess risk with
Objective Risk
The measurable variation in uncertain outcomes based on facts and data
Diversifiable Risk
A risk that affects only some individuals, businesses, or small groups
Nondiversifiable Risk
A risk that affects a large segment of society at the same time (for example: inflation, unemployment, natural disasters, etc.)
Systematic Risk
The potential for a major disruption in the function of an entire market or financial system – generally nondiversifiable
Quadrants of Risk
This is an approach that focuses on the risk source and who traditionally manages it. The four quadrants are hazard risks, operational risks (both pure risks), financial risks, and strategic risks (both speculative risks)
Hazard Risk
Arises from property loss exposures, liability loss exposures, or personnel loss exposures and are generally the subject of insurance (pure risk)
Operational Risk
Arises from people or a failure in processes, systems, or controls, including those involving information technology (pure risk)
Financial Risk
Arises from the effect of market forces on financial assets or liabilities (speculative risk)
Strategic Risk
Arises from trends in the economy and society, including changes in the economic, political, and competitive environments, as well as demographic shifts (speculative risk)
Components of the Financial Consequences of Risk
- Expected cost of losses or gains
- Expenditures on risk management
- Cost of residual uncertainty
Market Risk
Uncertainty about an investment’s future value because of potential changes in the market for that type of investment (speculative risk)
Liquidity Risk
The risk that an asset cannot be sold on short notice without incurring a loss (speculative risk)
Risk Management
The process of making and implementing decisions that will minimize the adverse effects of accidental losses on an organization
Traditionally this has focused on managing safety, purchasing insurance, and controlling financial recovery from losses generated by hazard risk
Loss Exposure
Any condition or situation that presents a possibility of loss, whether or not an actual loss occurs
Hazard
A condition that increases the frequency or severity of a loss
Three Elements of Loss Exposure
- The asset exposed to loss
- Cause of loss (also called a peril)
- Financial consequences of that loss
Moral Hazard
A condition that increases the likelihood that a person will intentionally cause or exaggerate a loss
Morale Hazard (Attitudinal Hazard)
A condition of carelessness or indifference that increases the frequency or severity of loss
The fundamental difference between moral hazards and morale hazards is intent (for moral hazard)
Physical Hazard
A tangible characteristic of property, persons, or operations that tends to increase the frequency or severity of loss
Legal Hazard
A condition of the legal environment that increases loss frequency or severity
Property Loss Exposure
A condition that presents the possibility that a person or an organization will sustain a loss resulting from damage (including destruction, taking, or loss of use) to property in which that person or organization has a financial interest
The maximum financial consequence of a property loss is limited by the value of the property; however, it may have an effect on the financial consequences of other types of losses
Tangible Property
Property that has a physical form (e.g. a piece of equipment)
Real Property (Realty)
Tangible property consisting of land, all structures permanently attached to the land, and whatever is growing on the land
Personal Property
All tangible or intangible property that is not real property
Intangible Property
Property that has no physical form (e.g. a patent or copyright)
Liability Loss Exposure
Any condition or situation that presents the possibility of a claim alleging legal responsibility of a person or business for injury or damage suffered by another party – results from the claim itself, not necessarily the payment of damages
In theory, the financial consequences of this are limitless, but in practice they are limited to the total wealth of the person or organization
Personnel Loss Exposure
A condition that presents the possibility of loss caused by a person’s death, disability, retirement, or resignation that deprives an organization of the person’s special skill or knowledge that the organization cannot readily replace
Personal Loss Exposure
Any condition or situation that presents the possibility of a financial loss to an individual or a family by causes such as death, sickness, injury, or unemployment
Net Income Loss Exposure
A condition that presents the possibility of loss caused by a reduction in net income – often results from property, liability, or personnel loss (examples include loss of goodwill, failure to perform, and missed opportunities)
Cost of Risk
The total cost incurred by an organization because of the possibility of accidental loss
Risk Management Benefits
- Lower expected losses
- Less residual uncertainty
(See table in notes for more details)
Pre-Loss Goals
Goals to be accomplished before a loss, involving social responsibility, externally imposed goals, reduction of anxiety, and economy
In other words, the main goals are: economy of operations, tolerable uncertainty, legality, and social responsibility
Post-Loss Goals
Risk management program goals that should be in place in the event of a significant loss
Most common goals are: survival, continuity of operations, profitability, earnings stability, social responsibility, and growth
The Risk Management Process
Step 1: Identifying Loss Exposures
Step 2: Analyzing Loss Exposures
Step 3: Examining the Feasibility of Risk Management Techniques
Step 4: Selecting the Appropriate Risk Management Techniques
Step 5: Implementing the Selected Risk Management Techniques
Step 6: Monitoring Results and Revising the Risk Management Program
