Insurance Ch.1

Chance of Loss (Probability) vs. Risk

-Chance can be 0-100% -probability of loss for two events may be the same, but the risk may be different. Consider two stocks with symmetric future price distributions. The means may be the same, but the standard deviations may be quite different. -Its possible to reduce uncertainty while increasing the likelihood of an advers outcome (loss) (russian roulette)

-Diversifiable risk vs nondiversifiable risk

-Div: Diversifiable risks are those that can have their adverse consequences mitigated simply by having a well-diversified portfolio of risk exposures. -Non: This type of risk is both unpredictable and impossible to completely avoid. It cannot be mitigated through diversification, only through hedging or by using the right asset allocation strategy

Burden of risk on society

-Emergency funds must be set aside -Loss of certain goods and services: fear of liability may lead to products being pulled from the market (drugs that may have side effects, football helmets, and "anti-terrorism technologies" (ATT's) w/o the SAFETY Act) -Fear and worry

Individual and Commercial Risks

-Individual risks: Personal risks (premature death, poor health, unemployment, and inadequate retire,emt income), property risks (direct and indirect loss), and liability risks -Commercial risks: Property risks (Direct and indirect "business income"), liability risks, personnel risks, crime, and speculative financial risks

-Objective vs Subjective Risk:

-Objective: Objective risk (aka degree of risk) is the actual losses for a sample in a given period, which can differ significantly from expected losses, and is inversely proportional to the square root of the sample size—the law of large numbers. -Subjective: Subjective risk is what an individual perceives to be a possible unwanted event. Most people realize, for instance, that it's possible for them to have an accident, or a heart attack or some other health problem. Or that they will lose money buying lottery tickets.

Speculative risk vs Pure Risk

-Speculative risk differs from pure risk because there is the possibility of profit or loss, such as investing in financial markets. Most speculative risks are uninsurable, because they are undertaken willingly for the hope of profit. Also, speculative risk will generally involve a greater frequency of loss than a pure risk, since profit is the only other possibility. -Pure risk: Pure risk is a risk in which there is only a possibility of loss or no loss—there is no possibility of gain. Pure risk can be categorized as personal, property, or legal risk.

-Enterprise Risk:

-is the process of planning, organizing, leading, and controlling the activities of an organization in order to minimize the effects of risk on an organization's capital and earnings.

Legal Hazard

A good example is the current asbestos litigation, which has bankrupted many companies, even though very few plaintiffs show any real evidence of disease, and are unlikely to ever develop any disease that can be shown, by the preponderance of the evidence, to have resulted from asbestos exposure. This type of moral hazard is often referred to as legal hazard. Legal hazard can also result from laws or regulations that force insurance companies to cover risks that they would otherwise not cover, such as including coverage for alcoholism in health insurance.

Physical hazard

A physical hazard is a physical condition that increases the possibility of a loss. Thus, smoking is a physical hazard that increases the likelihood of a house fire and illness.

Risk is defined as

A probability or threat of damage, injury, liability, loss, or any other negative occurrence that is caused by external or internal vulnerabilities, and that may be avoided through preemptive action

Attitudinal (morale) hazard

Insurance can be regarded as a morale hazard because it increases the possibility of a loss that results from the insured worrying less about losses. Therefore, they take fewer precautions and may engage in riskier activities—because they have insurance. A good example of morale hazard is when the federal government bails out financial institutions who have made bad decisions.

Moral Hazard

Moral hazards are losses that results from dishonesty. Thus, insurance companies suffer losses because of fraudulent or inflated claims. The American legal system is a moral hazard in that it motivates many people to sue simply for financial profit because of the enormous amount of money that can sometimes be won, and because there is little cost to the plaintiff, even if he loses.

Types of risk:

ObJective Risk vs Subjecctive Risk Pure Risk vs Speculative Risk Diversifiable risk vs nondiversifiable risk Enterprise risk (Enterprise risk management)

Peril and hazard definition

Peril: A specific risk or cause of loss covered by an insurance policy, such as a fire, windstorm, flood, or theft. A named-peril policy covers the policyholder only for the risks named in the policy in contrast to an all-risk policy, which covers all causes of loss except those specifically excluded. Hazard: A hazard is anything that either causes or increases the likelihood of a loss. For instance, gas furnaces are a hazard for carbon monoxide poisoning.

Techniques For Managing risk

Risk Control: risk avoidance, loss prevention and loss reduction Risk Financing: --risk retention: active vs passive (active:The process of active retention makes it possible to protect against losses of relatively small amounts that occur regularly. It is regarded as a form of self-insurance. One of the benefits of active retention is the avoidance of the administrative costs associated with seeking insurance from another party. (passive: practice in which no funds are set aside on a mathematical basis to pay for expected losses. This occurs when a risk manager is not aware of an exposure, when the cost of treating an exposure positively is prohibitive, or if the severity of a loss (should it occur) would be inconsequential.) --Risk transfer: noninsurance vs insurance