Chapter 1 - Risk and Its Treatment

Question 1

Define Attitudinal (morale) Hazard

Answer 1

Carelessness or indifference to loss, which increases the frequency or severity of a loss.

Question 2

Define Avoidance

Answer 2

A risk control technique in which a certain loss exposure is never acquired, or an existing loss exposure is abandoned.

Question 3

Define Chance of Loss

Answer 3

The probability that an event will occur.

Question 4

Define Direct Loss

Answer 4

Financial loss that results directly from an insured peril.

Question 5

Define Diversifiable/Nonsystematic/Particular Risk

Answer 5

A risk that affects only individuals or small groups and not the entire economy, which can be reduced or eliminated by diversification.

Question 6

Define Enterprise Risk

Answer 6

A term that encompasses all major risks faced by a business, including pure risk, speculative risk, strategic risks, and operational risks.

Question 7

Define Enterprise Risk Management

Answer 7

Comprehensive risk management program that considers an organization’s pure risk, speculative risk, strategic risks, and operational risks.

Question 8

Define Financial Risk

Answer 8

A risk that a business firms face because of adverse changes in commodity prices, interest rates, foreign exchange rates, and the value of money.

Question 9

Define Hazard

Answer 9

Condition that creates or increases the chance of loss.

Question 10

Define Hedging

Answer 10

Technique for transferring the risk of unfavorable price fluctuations to a speculator by purchasing and selling options and futures contracts on an organized exchange.

Question 11

Define Hold-harmless Clause

Answer 11

Clause written into a contract by which one party agrees to release another party from all legal liability, such as a retailer who agrees to release the manufacturer from legal liability if the product injures someone.

Question 12

Define Human Life Value

Answer 12

For purposes of life insurance, the present value of the family’s share of the deceased breadwinner’s future earnings.

Question 13

Define Incorporation

Answer 13

A risk transfer technique that limits the liability of the business owner to the extent of the businesses assets so their personal assets are protected.

Question 14

Define Indirect/Consequential Loss

Answer 14

Financial loss occurring as the consequence or some other loss.

Question 15

Define Law of Large Numbers

Answer 15

Concept that the greater the number of exposures, the more closely will actual results approach the probable results expected from an infinite number of exposures.

Question 16

Define Legal Hazard

Answer 16

Characteristics of the legal system or regulatory environment that increases the frequency or severity of losses.

Question 17

Define Liability Risk

Answer 17

When you are held legally liable if you do something that results in bodily injury or property damage to someone else.

Question 18

Define Loss Exposure

Answer 18

Any situation or circumstance in which a loss is possible, regardless of whether a loss occurs.

Question 19

Define Loss Prevention

Answer 19

Risk management techniques aimed at reducing the probability of loss so that the frequency of losses is reduced. e.g. - defensive driving course

Question 20

Define Moral Hazard

Answer 20

Dishonesty or character defects in an individual that increases the chance of loss.

Question 21

Define Nondiversifiable/Systematic/Fundamental Risk

Answer 21

A risk that affects the entire economy or large numbers of persons or groups within the economy, which cannot be reduced or eliminated by diversification.

Question 22

Define Noninsurance Transfers

Answer 22

Various methods other than insurance by which a pure risk and its potential financial consequences can be transferred to another party, for example, contracts, leases, and hold-harmless agreements.

Question 23

Define Objective Probability

Answer 23

Long-run relative frequency of an event based on the assumptions of an infinite number of observations and of no chance in the underlying conditions.

Question 24

Define Peril

Answer 24

Cause or source of loss. The thing that does the damage: fire, collision.

Question 25

Define Personal Risks

Answer 25

Risks that directly affect an individual or family.

Question 26

Define Physical Hazard

Answer 26

Physical condition that increases the chance of loss.

Question 27

Define Premature Death

Answer 27

The death of a family head with unfulfilled financial obligations.

Question 28

Define Property Risks

Answer 28

Risk of valuable business property being damaged or destroyed that could financially harm a business.

Question 29

Define Pure Risk

Answer 29

Situation in which there are only the possibilities of loss or no loss.

Question 30

Define Retention

Answer 30

Risk management technique in which an individual or a firm retains part or all of the losses resulting from a given loss exposure. Used when no other method is available, the worst possible loss is not serious, and losses are highly predictable.

Question 31

Define Risk

Answer 31

Based on the historical definition, risk is defined as uncertainty concerning the occurrence of a loss. Numerous definitions or risk exist in the professional literature. Because of ambiguity, the term “loss exposure” is often used instead of “risk”.

Question 32

Define Risk Control

Answer 32

Risk management techniques that reduce the frequency or severity of losses, such as avoidance, loss prevention, and loss reduction.

Question 33

Define Risk Financing

Answer 33

Risk management techniques that provide for the funding of losses after they occur, such as retention, noninsurance transfers, and commercial insurance.

Question 34

Define Self-Insurance

Answer 34

Retention program in which the employer self-funds and pays part or all of the losses.

Question 35

Define Speculative Risk

Answer 35

Situation in which either profit or loss are clear possibilities.

Question 36

Define Subjective Probability

Answer 36

An individual’s personal estimate of the chance of loss.

Question 37

Define Subjective Risk

Answer 37

Uncertainty based on one’s mental condition or state of mind.

Question 38

_________ ___________ may be necessary to insure nondiversifiable risks.

Answer 38

Government assistance.

Question 39

Personal risks are risks that directly affect and individual or family. They involve the possibility of a loss or reduction in income, extra expenses or depletion of financial assets, due to: (4 items)

Answer 39

• Premature death of family head
• Insufficient income during retirement
• Poor health (medical bills and loss of earned income)
• Involuntary unemployment

Question 40

What three major burdens on society come from the presence of risk?

Answer 40

• In the absence of insurance, individuals and business firms would have to maintain large emergency funds to pay for unexpected losses
• The risk of a liability lawsuit may discourage innovation, depriving society of certain goods and services.
• Risk causes worry and fear

Question 41

Names three major risk control techniques.

Answer 41

• Avoidance
• Loss prevention
• Loss reduction

Question 42

What are three techniques of risk financing that are used to provide payment of losses after they occur?

Answer 42

• Retention (Active, Passive, Self Insurance)
• Noninsurance Transfers
• Insurance

Question 43

What are three ways risk can be transferred? (Noninsurance transfer)

Answer 43

• Transfer of risk by contracts (Hold-harmless clause)
• Hedging
• Incorporation

Question 44

What are three reasons that make insurance the most practical method for handling major risks?

Answer 44

• Risk transfer is used because a pure risk is transferred to the insurer.
• The pooling technique is used to spread the losses of a few over the entire group.
• The risk may be reduced by application of the law of large numbers.

Question 45

What is Objective Risk?

Answer 45

The relative variation of actual loss from expected loss

Question 46

What are the four major types of hazard?

Answer 46

• Physical hazard
• Moral Hazard
• Attitudinal hazard
• Legal hazard

Question 47

Names three classes of risk?

Answer 47

• Pure and speculative risk
• Diversifiable risk and nondiversifiable risk
• Enterprise risk

Question 48

Why are liability risks important?

Answer 48

• There is no upper limit with respect to the amount of loss
• A lien can be placed on your income and financial assets to satisfy a legal judgement
• Legal defense costs can be enormous