Risk Topic 3 Flashcards
What is the law of large numbers
Over time the more data you collect or the more observations that occur - your results will get closer to the accurate result
What is step 2 in the risk management process
Measure and evaluate exposure to loss
What is another way of saying the probability of loss
The frequency of loss
How is the severity of loss determined
The dollar amount of losses that do occur
How is the expected outcome/loss measured?
EL = EF * ES
What are random variables?
When the outcome depends on some chance event
What are some examples of random variables?
- Rolling dice
- Coin flip
- Car accidents
- Property fires
What is the core of risk management decision-making
Measurement of expected outcome
What does it mean to self-insure?
A company or individual sets aside a pool of money to be used to remedy an unexpected loss
What happens if a firm’s actual losses exceed their estimates?
The firm’s capital will be drained
What serves as the basis for enterprise risk management decisions and insurance company pricing decisions?
Expected Outcome
What is gross premium?
The premium paid per unit of coverage to insure a particular risk
What 3 components is a gross premium made up of?
Pure premium, risk charge, administrative costs
What is the pure premium?
The portion of the gross premium calculated as being sufficient to pay for losses only (Expected Outcome)
What happens when you break even?
Actual losses (AL) = Expected Losses (EL)
What happens when you make a profit?
Actual losses (AL) < Expected Losses (EL)
What happens when you have a loss?
Actual losses (AL) > Expected Losses (EL)
What is the additional risk insurers face called?
Estimation risk
Risk Charge
Extra charge accounting for the risk of the insurer
What are two influences of the size of the risk charge?
1) Accuracy of the estimate of the guess
2) The level of confidence in the estimate of the guess
How does lots of past information affect the risk charge?
- Low need for risk charge
What are some examples of when there would be a low need for a risk charge?
Auto and homeowner
How does not having a lot of past information affect the risk charge?
There is a high need for a risk charge
What are some examples of when there would be a high need for a risk charge?
If you insure things like terrorism, space shuttles, and the Olympics
When would there be an intermediate need for a risk charge?
When there is some estimation of risk present
What are some examples of times when there would be an intermediate need for a risk charge?
Natural disasters and floods
What is the relationship type between the risk charge and confidence level in the estimate?
There is an inverse relationship (more confidence in the level of estimate means less risk charge)
What percentage of the overall premium can administrative costs be?
They can be 20-40% of the overall risk charge
What are some examples of administrative costs?
- Wages and compensation
- Marketing and advertising
What are state premium taxes?
Sales taxes assessed on insurance premiums for policies issued in that state
What are some measures of central tendency in insurance?
The mean, expected outcome (EO), Weighted average
What is the COV
The coefficient of variation
How is COV calculated?
Standard deviation divided by the mean
How is Standard deviation calculated?
By taking the square root of the variance
What does COV determine?
The level of risk
