Chapter 1: Risk and Its Treatment Flashcards
Enterprise Risk
Encompasses all of the major risks faced by a business
-Pure and speculative
-Strategic
-Operational
-Financial
Strategic Risks
Uncertainty regarding a firm’s financial goals and objectives
Operational Risks
Uncertainty resulting from the firm’s business operations
Risk
Uncertainty concerning the occurrence of a loss (auto accident, lung cancer, failing a class)
Loss Exposure
Any situation or circumstance in which a loss is possible, regardless of whether or not a loss occurs
Physical Hazard
A physical condition that increases the chance of loss
-ice, broken door lock
Morale (Attitudinal) Hazard
Carelessness or indifference to loss
-“Did I leave that burner on?”
Financial Risks
Uncertainty die to adverse changes in commodity prices, interest rates, foreign exchange rates, and the value of money
Objective Risk (degree of risk)
The relative variation of actual loss from expected loss
-may be measured using standard deviation or CV
-law of large numbers
Subjective Risk
Uncertainty based on a person’s mental condition or state of mind
-High subjective risk usually results in conservative/prudent behavior (and vice versa)
Chance of Loss
The probability that an event will occur
Objective Probability
Measurable, predictable outcomes (At infinity)
-Dice (deductive reasoning)
-Mortality Rates (inductive reasoning)
Subjective Probability
An individual’s personal prediction of an outcome
-I’m feeling lucky (lottery/catastrophe outcome)
Peril
The cause of a loss
Hazard
A condition that creates or increases the chance of a loss
Morale (Attitudinal) Hazard
Dishonesty or character defects in an individual that increase the chance of a loss
-Insurance fraud, inflating claims
-“The insurer has plenty of money” response
Legal Hazard
Characteristics of the legal system or regulatory environment that increase the frequency or severity of losses
-Environmental cleanup, swimming pools, adverse jury verdicts
Pure Risk
A situation in which there are only the possibilities of loss or no loss
-Hurricanes
Speculative Risk
A situation in which there are only the possibilities of loss or no loss
-Hurricanes
Non-diversifiable (Systematic) Risk
Risk that affects the entire economy, large numbers of persons, or groups
-Catastrophes and wars, recession or rapid inflation, cyclical unemployment
Diversifiable (Nonsystematic) Risk
Risk that affects specific individuals or groups
(not the entire economy)
- Car wreck
- Dwelling fires
