Chapter 1 Flashcards
Definition of Risk:
Uncertainty concerning the occurrence of a loss
If the probability of an event occurring is either zero or one, there is no risk since there is no risk because there’s no uncertainty.
Definition of Loss Exposure:
Any situation or circumstance in which a loss is possible, regardless of whether a loss occurs.
Ex: car, laptop
A Pure Risk Is…
one in which there are only
the possibilities of loss or no loss
Example: premature depth
A Speculative Risk Is…
one in which both
profit or loss are possible
Example: business ventures, investments
Static Risk is….
From unchanging society
Ex: Pure Static Risk- random event – lightning, wind-storm, death, flooding
Dynamic Risk is…
PRODUCED BY CHANGES IN SOCIETY
Ex: increasingly complex technology, changes in legislation
Fundamental Risk is…
Affects the entire economy or large
number of persons or groups within the economy
Ex.: Flooding in Fort Worth TX, Hurricane Katrina
Particular Risk is…
Risk that affects only the individual and not the entire community or country
Ex.: Car Thefts, Bank Robberies, dwelling fires (affects only individuals)
Objective Risk is…
relative variation of actual loss from expected loss
Measurable, statistical
If a loss is certain to occur, objective risk is zero.
Subjective Risk is…
uncertainty based on a person’s mental condition or state of mind
Two persons in the same situation may have different perceptions of risk
Difficult to measure
Enterprise Risk is…
encompasses all major risks faced by a business firm, which include: pure risk, speculative risk, strategic risk, operational risk, and financial risk
Financial Risk is…
refers to the uncertainty of loss because of adverse changes in commodity prices, interest rates, foreign exchange rates, and the value of money.
Enterprise Risk Management…
combines into a single unified treatment program all major risks faced by the firm
Enterprise Risk Includes:
- Pure risk
- Financial risk
Speculative risk
Strategic risk
Operational risk
Property Risks Include:
Business property
Individually owned property
Property owned by others
Liability Risks Include:
- Business Liability Exposures (injury from a product)
Liability exposures experienced by individuals
Ex: Ford Supertruck Lawsuit
Personal Risks Include:
– Life, Health, & Loss of Income
- Premature death
- Poor Health
- Medical expenses
-Disability – loss of earned income & medical expenses
-Unemployment – depletion of financial assets
Personal Risk can be defined as:
The possibility of a loss or reduction in income, extra expenses or depletion of financial assets
How should workers save enough money for retirement to mitigate personal risks?
Save 15% of all pretax income.
Direct loss can be defined as:
A financial loss that results from the physical damage, destruction, or theft of the property, such as fire damage to a home
An indirect loss can be defined as:
An indirect loss results indirectly from the occurrence of a direct physical damage or theft loss, such as the additional living expenses after a fire to a home. These additional expenses would be a consequential loss.
Liability risk can be defined as:
The possibility of being held liable for bodily injury or property damage to someone else
Where is the maximum upper limit with respect to the amount of loss that liability risk holds?
There is no maximum upper limit. A lien can be placed on your income and financial assets
What commercial risks do businesses incurr?
- Property
- Liability risks
- Loss of business income
- Other risks, crime exposure, human resources exposure, foreign loss exposure, intangible property exposureses and government exposures.
What is the chance of loss?
The probability that an event will occur
How can objective probability be defined?
- The long-run relative frequency of an event assuming an infinite number of observations and no change in the underlying conditions
Easily Quantifiable
How can subjective risk be defined?
- The individual’s personal
estimate of the chance of loss
A person’s perception of the chance of loss may differ from the objective probability
What is the definition of peril?
Specific contingency that may cause a loss
What is the definition of hazard?
A condition that increases the chance of loss due to a peril
Name examples of natural perils that are generally insurable:
Wind-Storm
Lightning
Heart attack
Name examples of natural perils that are generally difficult to insure:
- Flood
Earthquake
Epidemic
Volcanic eruption
Mold
Name examples of human perils that are generally insurable:
-Theft
-E-commerce
- Vandalism
- Negligence
- Fire and smoke
Name examples of human perils that are generally difficult to insure:
- War
Radioactive Contamination
Civil unrest
Define physical hazards:
Physical conditions that increase the chance of loss
Give examples of physical hazards:
- Icy Roads
-Defective wiring
Define Moral Hazard:
Dishonesty or character defects in an individual, that increase the chance of loss
Name examples of moral hazards:
- Faking accidents,
- Inflating claim amounts
Define Morale Hazard:
Carelessness or indifference to a loss, which increases the frequency or severity of a loss
Give an example of morale hazard:
Leaving keys in an unlocked car(Peril is theft)
What 3 major burdens do risk pose on society?
- In the absence of insurance, individuals would have to maintain large emergency funds
- The risk of a liability lawsuit may discourage innovation, depriving society of certain goods and services
- Risk causes worry and fear
What are the 5 major methods for managing risk?
- Avoidance
- Loss control
- Retention
- Noninsurance transfers
- Insurance
What is the avoidance method of managing risk?
Steering clear of engaging in risk taking activities or bringing potentially dangerous products to market.
What is the loss control method of managing risk?
Certain activities are undertaken to reduce both the frequency & severity of losses.
What are the two loss control methods?
- Loss prevention refers to activities to reduce the frequency of losses
- Loss reduction refers to activities to reduce the severity of losses
Retrofit buildings that would prevent earthquakes and your company get a discount on insurance
What is the retention method of managing risk?
An individual or firm retains all or part of a given risk.
What is the active retention method of retention?
- Active retention means that an individual is consciously aware of the risk and deliberately plans to retain all or part of it.
Ex. An individual may retain the first $500 of physical damage to his auto by purchasing an automobile collision policy with a $500 deductible.
What is the passive retention method of retention?
Passive Retention means risks may be unknowingly retained because of ignorance, indifference, or laziness.
What is the self insurance method of retention?
Self Insurance is a special form of planned retention by which part or all of a given loss exposure is retained by the firm.
What is the non insurance method of managing risk?
- A risk may be transferred to another party by several methods:
A transfer of risk by contract, such as through a service contract or a hold harmless agreement in a contract.
The risk of a defective flat screen tv can be shifted to the retailer by the purchase of a service contract by which the retailer is responsible for all repairs after the warranty expires.
What is hedging, a noninsurance transfer of risk?
A technique for transferring the risk of unfavorable price fluctuations to a speculator by purchasing and selling futures contracts on an organized exchange
This is speculative risk
What is incorporation, a noninsurance transfer of risk?
A business firm transfers to the creditors the risk of
having insufficient assets to pay business debts
What is the insurance method of risk management?
- For most people, insurance is the most practical method
for handling a major risk
Risk transfer is used because a pure risk(loss or no loss) is transferred to the insurer.
Ex: An automobile insurance policy can be purchased covering the negligent operation of an automobile.
What is the pooling technique?
The pooling technique is used to spread the losses of the few over the entire group.
What law applying to pooling helps to reduce risk?
The law of large numbers.
