RMIN Exam 1 Prep Flashcards
Risk
a calculated possibility of a negative outcome
Calculated Possibility
A probabilistic outcome (chance of loss, likelihood of loss) that is known or estimated
Ranges from 0 to 1 (0% to 100%)
Negative Outcome
- Loss
- Must be Quantifiable ($)
Frequency
- How often does a loss occur?
- Number of losses (fire, theft, collision) that courts within a specific time period
-Probability of a loss
of losses/ # of exposures
Ex: probability of a fire is .0071 per loss exposure per year
Severity
- How much does it cost when a loss does occur
- Dollar amount of loss for a specific peril (fire, theft, collision)
Total loss $/# of losses
Ex: average fire loss is $32,547
Peril
Cause of Loss
EX: fire, tornado, collision, burglary
Hazard
Condition that creates or increases the frequency and/or severity of a loss
- Doesn’t cause a loss
Physcial Hazard
a physical condition that increases the frequency and/or severity of a loss
Ex: leaking pipe, cracked sidewalk
Moral Hazard
prescence of insurance changes the behavior of the insured
Ex: using a hammer to create “hail” damage to the roof, exaggerating value of inured property, Great Recession
Moral (Attitudinal) Hazard
carelessness or indifference to a loss, which increases the frequency and/or severity of a loss
Ex: leaving car keys in an unlocked car, neglecting a tree limb growing over your roof
Legal Hazard
characteristics of legal system or regulatory environment that increases the frequency and/or severity of a loss
Ex: juries in some areas are more sympathetic than other areas (meaning larger damages awards in liability lawsuits)
Risk Classifications
Pure Risk
Speculative Risk
Diversifiable Risk
Nondiversifiable Risk
Systemic Risk
Pure vs. Speculative
Pure Risk → 2 future states (loss or no loss)
Ex: fire, cancer dog bites a visitor
Can BUY insurance
Speculative Risk → 3 future states (loss, no loss/no gain, gain)
Ex: Investment, gambling
CAN’T buy insurance
Diversifiable Risk
affects only individuals or small groups, not entire economy (car theft)
- Can be eliminated/reduced through diversification
- Risk aren’t correlated (fire, theft, collision)
Nondiversifiable Risk
affects the entire economy or large number of groups/persons within the economy
- Cannot be reduced/eliminated through diversification
Government assistance may be needed
- Risk are correlated (inflation, unemployment)
Systematic Risk
risk of collapse of an entire system or entire market due to the failure of a single entity or group of entities that can results in the breakdown of the entire financial system
Instability in the financial system due to the interdependence between players in the market
Ex: erickson and nokia phones; march 2000, a small fire occur dona single production line of a microchip plant
Personal Risk
directly affects an individuals or family; involves the possibility of loss of income, extra expenses, depletion of financial assets
What perils might be involved?
premature death, unemployment, disability/poor health, alcohol + drug addiction
Property Risk
possibility of losses associated with the destruction or theft of property
Direct loss: cost to repair or replace property damages by a peril
Indirect loss: financial loss resulting as a consequence of a direct loss
Ex: fire damages your home, you have to pay to live elsewhere whilst its repaired
Liability Risk
legal liability (financial consequences) resulting from injuries or damages you caused to someone else
- No upper limit
- Liens can be placed on income, assets seized
Loss of Business Income
if a business has to shut down for a period of time due to a physical damages loss, its unable to generate income
Types of Pure Risk
Personal
Property
Liability
Loss of Business Income
Cyber Security
Risk Financing
Techniques for funding losses
- Retention: retaining part of all of losses that can occur from a given risk
-Active: deliberately retaining risk (choosing a high deductible)
- Passive: unknowing retaining risk (not purchasing disability insurance) - Noninsurance transfer
- Insurance
Insurance
pooling of fortuitous accidental losses by transfer of suck risk to insurers, who agree to indemnify compensate insureds for such losses, to provide other pecuniary monetary benefits on their occurrence, or to render services connected with the risk
Basic characteristics of insurance
Pooling of losses
Payment of fortuitous losses
Risk transfer
Indemnification
Pooling of Losses
Purpose is to reduce variation which reduces uncertainty (risk)
Losses incurred by the few are spread over the entire group so that in the process, average loss is substituted for actual loss
History
About 5000 years ago, around the Yangtze river near China merchants distributed their cargo between several smaller vessels protecting themselves from a complete loss
Law of Large Numbers → greater the number exposures, more closely will actual results approach the probable results expected from an infinite number of exposures
