Test (Chapters 1-4) 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
0 (calculated possibility)
0%; impossible event (no risk)
0.5 (calculated possibility)
highest risk (most uncertainty)
1 (calculated possibility)
100%; certain event (no risk)
negative outcome
loss; must be quantifiable (in $)
frequency
the number of losses that occur within a specified time period; probability of a loss
frequency equation
number of losses/number of exposures
severity
the dollar amount of loss for a specific peril
severity equation
total losses ($)/number of losses)
peril
cause of loss (ex: fire, windstorm, flood, collision, burglary, etc.)
hazard
condition that creates or increases the frequency and/or severity of a loss; does not cause a loss
four types of hazards
physical, moral, morale (attitudinal), legal
physical hazard
a physical condition that increases the frequency and/or severity of a loss (ex: pipe breaking; electrical)
moral hazard
the presence of insurance changes the behavior of the insured (ex: using a hammer to create “hail” damage to a roof; exaggerating the value of insured property)
morale 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 increase the frequency and/or severity of a loss (ex: juries in some jurisdictions are more sympathetic than other areas)
pure risk
2 future states (loss or no loss); ex: auto accident, fire, flood, cancer, slip & fall; can buy insurance for this risk
speculative risk
3 future states (loss, no loss/no gain, gain); ex: investment, gambling; cannot buy insurance for this risk
diversifiable risk
affects only individuals or small groups (car theft); can be reduced or eliminated by diversification; risks are not correlated
nondiversifiable risk
affects the entire economy or large numbers of groups/persons within the economy; cannot be reduced/eliminated through diversification; government assistance may be needed to insure; risks are correlated (inflation, unemployment)
enterprise risk
encompasses all major risks faced by a business firm (pure, speculative, strategic, operational, financial risks)
systemic 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 result in the breakdown of the entire financial system; instability in the financial system due to the interdependency between the players in the market
types of pure risk
personal, property, legal liability, loss of business income, cyber security