Assignment 1: Introduction to Risk Management

Question 1

Probability

Answer 1

The likelihood that an outcome or event will occur

Question 2

Pure Risk

Answer 2

A chance of loss or no loss, but no chance of gain – always undesirable and insurance deals primarily with these risks

Question 3

Speculative Risk

Answer 3

A chance of loss, no loss, or gain – can be desirable

Question 4

Risk

Answer 4

The certainty about outcomes, with the possibility that some of the outcomes can be negative; quantified by knowing the probability of the possible outcomes

Question 5

Uncertainty

Answer 5

Refers to the type and timing of an outcome

Question 6

Credit Risk

Answer 6

The risk that customers or other creditors will fail to make promised payments as they come due (speculative risk)

Question 7

Subjective Risk

Answer 7

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

Question 8

Objective Risk

Answer 8

The measurable variation in uncertain outcomes based on facts and data

Question 9

Diversifiable Risk

Answer 9

A risk that affects only some individuals, businesses, or small groups

Question 10

Nondiversifiable Risk

Answer 10

A risk that affects a large segment of society at the same time (for example: inflation, unemployment, natural disasters, etc.)

Question 11

Systematic Risk

Answer 11

The potential for a major disruption in the function of an entire market or financial system – generally nondiversifiable

Question 12

Quadrants of Risk

Answer 12

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)

Question 13

Hazard Risk

Answer 13

Arises from property loss exposures, liability loss exposures, or personnel loss exposures and are generally the subject of insurance (pure risk)

Question 14

Operational Risk

Answer 14

Arises from people or a failure in processes, systems, or controls, including those involving information technology (pure risk)

Question 15

Financial Risk

Answer 15

Arises from the effect of market forces on financial assets or liabilities (speculative risk)

Question 16

Strategic Risk

Answer 16

Arises from trends in the economy and society, including changes in the economic, political, and competitive environments, as well as demographic shifts (speculative risk)

Question 17

Components of the Financial Consequences of Risk

Answer 17

1. Expected cost of losses or gains
2. Expenditures on risk management
3. Cost of residual uncertainty

Question 18

Market Risk

Answer 18

Uncertainty about an investment’s future value because of potential changes in the market for that type of investment (speculative risk)

Question 19

Liquidity Risk

Answer 19

The risk that an asset cannot be sold on short notice without incurring a loss (speculative risk)

Question 20

Risk Management

Answer 20

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

Question 21

Loss Exposure

Answer 21

Any condition or situation that presents a possibility of loss, whether or not an actual loss occurs

Question 22

Hazard

Answer 22

A condition that increases the frequency or severity of a loss

Question 23

Three Elements of Loss Exposure

Answer 23

1. The asset exposed to loss
2. Cause of loss (also called a peril)
3. Financial consequences of that loss

Question 24

Moral Hazard

Answer 24

A condition that increases the likelihood that a person will intentionally cause or exaggerate a loss

Question 25

Morale Hazard (Attitudinal Hazard)

Answer 25

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)

Question 26

Physical Hazard

Answer 26

A tangible characteristic of property, persons, or operations that tends to increase the frequency or severity of loss

Question 27

Legal Hazard

Answer 27

A condition of the legal environment that increases loss frequency or severity

Question 28

Property Loss Exposure

Answer 28

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

Question 29

Tangible Property

Answer 29

Property that has a physical form (e.g. a piece of equipment)

Question 30

Real Property (Realty)

Answer 30

Tangible property consisting of land, all structures permanently attached to the land, and whatever is growing on the land

Question 31

Personal Property

Answer 31

All tangible or intangible property that is not real property

Question 32

Intangible Property

Answer 32

Property that has no physical form (e.g. a patent or copyright)

Question 33

Liability Loss Exposure

Answer 33

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

Question 34

Personnel Loss Exposure

Answer 34

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

Question 35

Personal Loss Exposure

Answer 35

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

Question 36

Net Income Loss Exposure

Answer 36

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)

Question 37

Cost of Risk

Answer 37

The total cost incurred by an organization because of the possibility of accidental loss

Question 38

Risk Management Benefits

Answer 38

1. Lower expected losses
2. Less residual uncertainty
   (See table in notes for more details)

Question 39

Pre-Loss Goals

Answer 39

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

Question 40

Post-Loss Goals

Answer 40

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

Question 41

The Risk Management Process

Answer 41

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