FI 341 Exam 1 Flashcards
Risk
Uncertainty concerning the occurrence of a loss
Objective Risk
Relative variation of actual loss from expected loss
Subjective Risk
Uncertainty based on a person’s mental condition or state of mind
Chance of Loss
The probability that an event will occur
Objective Probability
Long-run relative frequency of an event assuming an infinite number of observations and no change in the underlying conditions (can be determined by deductive or inductive reasoning)
Subjective Probability
Personal estimate of the chance of loss (personal perception may differ from the objective probability)
Peril
Cause of the loss (fire, windstorm, etc.)
Hazard
A condition that increases chance of loss
Physical Hazard
Physical conditions that increase the chance of loss (icy roads, defective wiring, etc.)
Moral Hazard
Dishonesty or character defects that increase the chance of loss (faking accidents, inflating claim amounts, etc.)
Morale Hazard
Carelessness or indifference to a loss because of the existence of insurance (leaving keys in an unlocked car)
Legal Hazard
Characteristics of the legal system or regulatory environment that increase the chance of loss (large damage awards in liability lawsuits)
Pure Risk
Only the possibility of loss or no loss (earthquake)
Speculative Risk
Profit, loss, or no loss are all possible (gambling)
Fundamental Risk
Affects the entire economy or large numbers of persons or groups (hurricane)
Particular Risk
Affects only the individual (car theft)
Enterprise Risk
Encompasses all major risks faced by a business firm, which include: pure risk, speculative risk, strategic risk, operational risk, and financial risk
Personal Risk
Involve the possibility of a loss or reduction in income, extra expenses, or depletion of financial assets (Poor health, Involuntary unemployment, premature death of family head, insufficient income during retirement, etc.)
Property Risk
The possibility of losses associated with the damage, destruction, or theft of property (physical damage to home due to fire, tornado, vandalism, etc.)
Direct Loss
Financial loss that results from the physical damage, destruction, or theft of the property (broken escalator)
Indirect Loss
Financial loss that results indirectly from the occurrence of a direct physical damage or theft loss (profits lost due to broken escalator)
Liability Risk
The possibility of being held liable for bodily injury or property damage to someone else
Loss Prevention
Reducing the frequency of losses
Loss Reduction
Reducing the severity of losses
Insurance (Long Definition)
The pooling of fortuitous losses by transfer of such risks to insurers, who agree to indemnify insureds for such losses, to provide other pecuniary benefits on their occurence, or to render services connected with the risk
Insurance (Short Definition)
The business of transferring pure risk from an insured to an insurer by means of a two-party contract
Adverse Selection
The tendency of persons with a higher-than-average chance of loss to seek insurance at standard rates
Underwriting
Selection and classification of applicants for insurance
Life Insurance
Pays death benefits to beneficiaries when the insured dies
Health Insurance
Covers medical expenses because of sickness or injury
Disability Plans
Pay income benefits
Property Insurance
Indemnifies property owners against the loss or damage of real or personal property
Liability Insurance
Covers the insured’s legal liability arising out of property damage or bodily injury to others
Casualty Insurance
Refers to insurance that covers whatever is not covered by fire, marine, and life insurance
Personal Lines of Insurance
Coverage that insures the real estate and personal property of the individuals and families or provide protection against legal liability
Commercial Lines of Insurance
Coverage for business firms, nonprofit organizations, and government agencies
Expense Loading
The amount needed to pay all expenses, including commissions, general administrative expenses, state premium taxes, acquisition expenses, and an allowance for contingencies and profit
Loss Exposure
Any situation or circumstance in which a loss is possible, regardless of whether a loss occurs (a plant that could possible be damaged by an earthquake, or an automobile that may be damaged in a collision)
Loss Frequency
The probable number of losses that may occur during some given time period
Loss Severity
The probable size of the losses that may occur
Maximum Possible Loss
The worst loss that could happen to the firm during its lifetime
Probable Maximum Loss
The worst loss that is likely to happen to the firm during its lifetime
Risk Control
Techniques that reduce the frequency and severity of losses
Avoidance
A certain loss exposure is never acquired, or an existing loss exposure is abandoned
Loss Prevention
Measures that reduce the frequency of a particular loss
Loss Reduction
Measures that reduce the severity of a loss after it occurs
Risk Financing
Techniques that provide for the funding of losses
Retention
The firm retains part or all of the losses that can result from a given loss
Retention Level
The dollar amount of losses that the firm will retain
Current Net Income Retention
Losses are treated as current expenses
Unfunded Reserve Retention
Losses are deducted from a bookkeeping account
Funded Reserve Retention
Losses are deducted from a liquid fund
Credit Line Retention
Funds are borrowed to pay losses as they occur
Self Insure Retention
Large numbers, captive insurers
Captive insurer
An insurer owned by a parent firm(s) for the purpose of insuring the parent firm’s loss exposures
Single Parent Captive
Owned by only one parent
Association or Group Captive
Owned by several parents
Self-insurance/Self-funding
Part or all of a given loss exposure is retained by the firm (worker’s compensation and group health benefits, for example)
Risk Retention Group
A group captive that can write any type of liability coverage except employer liability, worker’s compensation, and personal lines
Non-insurance transfer
A method other than insurance by which a pure risk and its potential financial consequences are transferred to another party
Deductible
A provision by which a specified amount is subtracted from the loss payment otherwise payable to the insured
Excess Insurance Policy
The insurer does not participate in the loss until the actual loss exceeds the amount a firm has decided to retain
Manuscript Policy
A policy specially tailored for the firm
Cost of Risk
Includes premiums paid, retained losses, outside risk management services, financial guarantees, internal administrative costs, taxes, fees, and other expenses
Financial Risk Management
The identification, analysis, and treatment of speculative financial risks
Commodity Price Risk
The risk of losing money if the price of a commodity changes
Interest Rate Risk
The risk of loss caused by adverse interest rate movements
Currency Exchange Rate Risk
The risk of loss of value caused by changes in the rate at which one nation’s currency may be converted to another nation’s currency
Enterprise Risk Management (ERM)
A comprehensive risk management program that addresses the organization’s pure, speculative, strategic, and operational risks
Strategic Risk
Uncertainty regarding an organization’s goals and objectives
Operational Risk
Uncertainty that develops out of business operations, such as product manufacturing
Personal Risk Management
Refers to the indemnification of pure risks faced by an individual or family, and to the selection of the most appropriate technique for treating such risks
Financial Risk Management
Refers to the identification, analysis, and treatment of speculative financial risks
Commodity Price Risk
The risk of losing money if the price of a commodity changes
Interest Rate Risk
The risk of loss caused by adverse interest rate movements
Currency Exchange Rate Risk
The risk of loss of value caused by changes in the rate at which one nation’s currency may be converted to another nation’s currency
Integrated Risk Management Program
A risk treatment technique that combines coverage for pure and speculative risks in the same contract
Double-Trigger Option
A provision that provides for payment only if two specified losses occur
Chief Risk Officer
Officer responsible for the treatment of pure and speculative risks faced by the organization
Underwriting Cycle
Refers to the cyclical pattern of underwriting stringency, premium levels, and profitablity
“Hard” Market
Tight standards, high premiums, unfavorable insurance terms, more retention
“Soft” Market
Loose standards, low premiums, favorable insurance terms, less retention
Combined Ratio Formula
(Paid Losses + Loss Adjustment Expenses + Underwriting Expenses) / Premiums
Capacity
Refers to the relative level of surplus
Surplus
The difference between an insurer’s assets and its liabilities (aka net worth)
Clash Loss
Occurs when several lines of insurance simultaneously experience large losses
Consolidation
Refers to the combining of businesses through acquisitions or mergers
Insurance Broker
An intermediary who represents insurance purchasers
Securitization of Risk
The transfer of insurable risk to the capital markets through creation of a financial instrument
Catastrophe Bond
Permits the issue to skip or defer scheduled payments if a catastrophic loss occurs
Weather Option
Provides a payment if a specified weather contingency (e.g. high temperature) occurs
Independent Event
The occurrence of one event does not affect the occurrence of the other event
Dependent Event
The occurrence of one event affects the occurrence of the other event
Mutually Exclusive
The occurrence of one event precludes the occurrence of the other event
Regression Analysis
Characterizes the relationship between two or more variables and then uses the characterization to predict values of a variable (for example, the number of physical damage claims for a fleet of vehicles is a function of the size of the fleet and the number of miles driven each year)
Loss Distribution
A probability distribution of losses that could occur
Time Value of Money
Must be considered when decisions involve cash flows over time
Compounding
A present value is converted to a future value
Discounting
A future value is converted to a present value
Net Present Value
The sum of the present values of the future cash flows minus the cost of the project
Internal Rate of Return
The average annual rate of return provided by investing in the project
Risk Management Information System (RMIS)
A computerized database that permits the risk manager to store and analyze risk management data
Intranet
A website with search capabilities designed for a limited, internal audience
Risk Map
A grid detailing the potential frequency and severity of risks faced by the organization (each risk must be analyzed before placing it on the map)
Value at Risk (VAR) Analysis
Involves calculating the worst probably loss likely to occur in a given time period under regular market conditions at some level of confidence
Catastrophe Modeling
A computer-assisted method of estimates losses that could occur as a result of a catastrophic event
Warranty
Statement that becomes part of the insurance contract and is guaranteed by the maker to be true in all respects
Representation
Statement made by the applicant for insurance
Concealment
Intentional failure of the applicant for insurance to reveal a material fact to the insurer
Consideration
The values that each party exchange
Agent
Someone who has the authority to act on behalf of a principal (the insurer)
Express Powers of an Agent
Powers specifically conferred on agent by agreement with principal
Implied Powers of an Agent
Powers to perform all acts incidental to agency agreement
Apparent Powers of an Agent
Authority reasonable inferred by others based on situation
Waiver
Voluntary relinquishment of a known legal right
Estoppel
Occurs when a representation of fact made by one person to another person is reasonably relied on by that person to such an extent that it would be inequitable to allow the first person to deny the truth of the representation
