Chapter 1 - Components of Risk

Question 1

What are some of the factors which influence what risk means to different people?

Answer 1

Age, personality, gender, wealth, nationality, life experience - time & circumstance

Question 2

What are the 3 ways risk has been used as an insurance term?

Answer 2

• To describe the type of policy cover
• As the name for the physical object being insured
• Referring to a chance of an insured loss occuring

Question 3

What is the difference between risk and uncertainty?

Answer 3

Risk - statistical probability of an event can be calculated
Uncertainty - too many variables involved to make this calculation accurately.

Question 4

How is the word ‘chance’ used in risk management?

Answer 4

Suggests loss or event which cannot be predicted or prevented; something beyond human control and in the hands of fate. Very awkward word to define but still used in risk conversations

Question 5

How is the level or risk usually assessed?

Answer 5

Frequency - How often it happens
Severity - Potential of loss, damage or destruction

Question 6

What is the difference between a peril and a hazard?

Answer 6

Peril - what gives rise to a loss, e.g. flood/fire
Hazard - what influences the effect of the peril

Question 7

What does moral hazard arise from?

Answer 7

Attitude and behaviour - dishonesty, carelessness e.g. the way a business is run (physical is opposite and includes measurable dimensions)

Question 8

What are the behaviours influencing risk perception?

Answer 8

• Voluntariness: perception of risk is reduced if we chose it voluntarily than if it is imposed up to 1000 times greater
• Controllability: More willing to accept risks they think they can control
• Dread and unknown risks: dread = those people feel have little control over e.g. nuclear accident
  Unknown risk = people have limited knowledge over e.g. solar flares
• Delay: If risk is far into the future, we may be more willing to accept it now e.g. smoking
• Man-made and natural disasters: man made is more accepted as more control, assume something could be done to reduce the effect. Natural process are accepted as acts of God or fate, where there is no redress
• Familiarity: If we get used to living with risk, perception diminishes with time
• Expected benefits: Accept risks if we perceive benefits, and even more prepared to accept risk if perceive the benefits are shared fairly.
• Media influence: Risks not in the media seen as less important

Question 9

What is ‘groupthink’ and how does it relate to group perception of risk?

Answer 9

Most risk are made by groups of people, which we think is benefitable due to diverse perspectives, but actually members depart from expected response and confirm to group pressure. More likely to happen without clear group rules e.g. voting in secret

Question 10

What are other words used to describe risk appetite?

Answer 10

Attitude, preference, tolerance and capacity

Question 11

What are some of the ways risk appetite is relevant to insurers?

Answer 11

• Technical capacity of available fund capital to fund insurance risks
• Influence on leadership
• Direction for controlling incentives

Question 12

What is the concept of risk tolerance?

Answer 12

The level beyond which a risk seeker conclude that they are realistically unable to assume the risk

Question 13

How is risk tolerance often established in organisations?

Answer 13

The types of risky activity involved in, or potential losses, generate the risk tolerance level. Based on factors such as cash liquidity, severity of damage to reputation, regulatory requirements, impact on individuals e.g. investors

Question 14

Sum up risk appetite:

Answer 14

Overall principles a company follows with respect to risk taking based on financial soundness, strategy and objective. Stated in qualitative terms, risk appetite defines how an organisation weights strategic decisions and communicates this with stakeholders with respect to risk taking. Designed to enhance management’s ability to make informed and effective business decisions while keeping risk exposure within acceptable boundaries.

Question 15

Sum up risk tolerance:

Answer 15

A company’s qualitative and quantitative boundaries around risk taking, consistent with the appetite. Qualitative risk tolerances are useful to describe companies preference or aversion to particular types of risk and quantitative risk tolerance are useful numerical limits the companies are willing to take. Is what the board of directors have prudently authorised the organisation to accept

Question 16

What is the definition of risk culture?

Answer 16

Used to describe appetite, attitude and understanding of risks that is shared by a group of people - is displayed in a mixture of formal and informal processes and behaviours, is not static and is a continuous development.

Question 17

What are the characteristics of an organisation with poor risk culture?

Answer 17

• Poor leadership of the business sending unclear messages on acceptable levels of risk
• Where risk is perceived to be managed intuitively and so is not discussed when making decisions
• Questions are never asked about what will happen if things go wrong
• Ignoring audit checks on risk management procedures
• No sanction for those taking innapropriate levels of risk

Question 18

Define a ‘risk mature’ culture

Answer 18

A preferred risk attitude where the culture of the organisation is neither risk averse nor risk seeking - meaning accepts that uncertainty is inevitable and welcomes it as an opportunity for effective risk management

Question 19

What are 3 examples of a ‘risk mature’ culture:

Answer 19

• Trained workforce
• Learning from mistakes and incidents
• Willingness to take advice and invest into improving risk

Question 20

Finish this sentence: “decisions made in the face of uncertainty involve……

Answer 20

Weighing up the potential rewards of an act against its potential adverse consequences

Question 21

How does risk influence decision making?

Answer 21

Risk management can be regarded as a decision-making process, linking the understanding of risks faced with the action to do, or not to do, something about them.
There are decisions to be taken about how to identify risks, how to measure their
significance and how they might be eliminated or reduced
* Human error can affect the decisions of individuals and result in adverse impacts.

Question 22

What are the causes of human error?

Answer 22

Mix of memory, skills, attention (or lack thereof) and mental shortcuts such as availability bias, anchoring and familiarityWha

Question 23

What is meant by availability bias?

Answer 23

Where we overestimate the probability of memorable events - v. interesting

Question 24

Explain the anchoring effect

Answer 24

Where humans rely too heavily on the first piece of information gained/offered when making decisions, like a first impression

Question 25

Explain the impact of familiarity on risk in decision making

Answer 25

Familiarity can influence ability to make decisions as tend to use options which have working in the past