Ch28: Accepting risk

Question 1

Risk appetite

Answer 1

A statement of the max amount and types of risk that an individual or organization is prepared to take on, in order to meet their objectives

Question 2

Define risk profile, risk limits, and risk capacity

Answer 2

Risk profile: Description of the risk exposures of an organization

Risk limits: Guidelines that set limits on acceptable actions

Risk capacity: Volume of risk that an organization can take on as measured by some consistent measure

Question 3

Insurable risk must satisfy (3)

Answer 3

• Policyholder must have an interest in the risk being insured, to distinguish between insurance
  and a wager.
• A risk must be of a financial and reasonably quantifiable nature
• Amount payable in the event of claim must bear some relationship to the financial loss
  incurred.

Question 4

Principle of pooling of risks

Answer 4

Insurers take on risks in return for premium because in doing so they can combine and pool risks together = greater certainty in the future payments they are likely to have to make on the occurrence of an insured event. Law of large numbers = the more risks are insured the more likely it is that the average outcome is close to the expected outcome.

Question 5

Desirable characteristics of risk event to be insurable (6)

Answer 5

• Individual risk events should be independent of each other
• Probability of the event should be relatively small
• Large numbers of potentially similar risks should be pooled in order to reduce the variance and
  hence achieve more certainty
• There should be an ultimate limit on the liability undertaken by the insurer
• Moral hazard should be eliminated as far as possible because these are difficult to quantify
• There should be sufficient existing statistical data/info to be able to estimate the extent of risk
  and likelihood of occurrence