Risk Management Definitions
Objective Risk
-The relative variation of actual loss from expected loss -Declines as the number of exposures increases -Varies inversely with the square root of the number of cases under observation
Insurable Risk
-There must be a large number of exposure units -The loss must be accidental and unintentional -The loss must be determinable and measurable -The loss should not be catastrophic -The chance of loss must be calculable -The premium must be economically feasible
Casualty Insurance
A broad field of insurance that covers whatever is not covered by fire, marine, and life insurance
Hazard
A condition that creates or increases the frequency or severity of loss
Aleatory Contract
A contract where the values exchanged may not be equal but depend on an uncertain event
Direct Loss
A financial loss that results from the physical damage, destruction, or theft of the property
Indirect Loss
A financial loss that results indirectly from the occurrence of a direct physical damage or theft loss
Risk Retention Group
A group captive that can write any type of liability coverage except employers' liability, workers compensation, and personal lines
Principle of Utmost Good Faith
A higher degree of honesty is imposed on both parties to an insurance contract than is imposed on parties to other contracts
Valued Policy Law
A law that exists in some states that requires payment of the face amount of insurance to the insured if a total loss to real property occurs from a peril specified in the law
Fortuitous Loss
A loss that is unforeseen and unexpected by the insured and occurs as a result of chance
Excess Insurance
A plan in which the insurer does not participate in the loss until the actual loss exceeds the amount a firm has decided to retain
Valued Policy
A policy that pays the face amount of insurance if a total loss occurs
Risk Management
A process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating such exposures
Deductible
A provision by which a specified amount is subtracted from the loss payment otherwise payable to the insured
Risk Transfer
A pure risk is transferred from the insured to the insurer, who typically is in a stronger financial position to pay the loss than the insured
Avoidance
A risk control technique in which a certain loss exposure is never acquired, or an existing loss exposure is abandoned
Loss Reduction
A risk control technique that reduces the severity of a particular loss.
Cost of Risk
A risk management tool that measures certain costs in a rick management program
Diversifiable Risk
A risk that affects only individuals or small groups and not the entire economy, which can be reduced or eliminated by diversification
Nondiversifiable Risk
A risk that affects the entire economy or large numbers of persons or groups within the economy, which cannot be reduced or eliminated by diversification
Enterprise Risk Management
A single unified treatment program of all major risks faced by the firm
Speculative Risk
A situation in which either profit or loss is possible
Pure Risk
A situation in which there are only the possibilities of loss or no loss
Self-Insurance
A special form of planned retention by which part or all of a given loss exposure is retained by the firm
Warranty
A statement that becomes part of the insurance contract and is guaranteed by the maker to be true in all respects
Loss Prevention
Aims at reducing the probability of loss so that the frequency of losses is reduced
Enterprise Risk
All major risks faced by a business firm
Reinsurance
An arrangement by which the primary insurer that initially writes the insurance transfers to another insurer part or all of the potential losses associated with such insurance
Active Risk Retention
An individual is consciously aware of the risk and deliberately plans to retain all or part of it
Retention
An individual or a business firm retains part or all of the losses that can result from a given risk. Used when no other method is available, the worst possible loss is not serious, and losses are highly predictable
Captive Insurer
An insurer owned by a parent firm for the purpose of insuring the parent firm's loss exposures while reducing premium costs, providing easier access to a reinsurer, and perhaps easing tax burdens
Single Parent Captive (Pure Captive)
An insurer owned by only one parent, such as a corporation
Association or Group Captive
An insurer owned by several parents
Loss Exposure
Any situation or circumstance in which a loss is possible, regardless of whether a loss occurs
Law of Large Numbers
As the number of exposure units increases, the more closely the actual loss experience will approach the expected loss experience
Attitudinal Hazard
Carelessness or indifference to a loss, which increases the frequency or severity of a loss
Legal Hazard
Characteristics of the legal system or regulatory environment that increase the frequency or severity of losses
Hold-Harmless Clause
Clause written into a contract by which one party agrees to release another party from all legal liability
Indemnification
Compensation to the victim of a loss, in whole or in part, by payment, repair, or replacement
Commutative Contract
Contract in which the values exchanged by both parties are theoretically equal
Personal Lines
Coverage that insure the real estate and personal property of individuals and families or provide them with protection against legal liability
Liability Insurance
Covers the insured's legal liability arising out of property damage or bodily injury to others; legal defense costs are also paid
Risk Management Manual
Describes in some detail the risk management program of the firm
Moral Hazard
Dishonestly or character defects in an individual that increase the frequency or severity of loss
Consequential Loss
Financial loss occurring as the consequence of some other loss
Social Insurance
Government insurance programs with certain characteristics that distinguish them from other government insurance programs. Programs are generally compulsory; specific earmarked taxes fund the programs; benefits are heavily weighted in favor of low-income groups; and programs are designed to achieve certain social goals
Material
If the insurer knew the true facts, the policy would not have been issued, or it would have been issued on different terms
Property Insurance
Indemnifies property owes against the loss or damage of real or personal property caused by various perils
Concealment
Intentional failure of the applicant for insurance to reveal a material fact to the insurer
Liability Risks
Legally liable if you do something that results in bodily injury or property damage to someone else
Unilateral Contract
Only one party makes a legally enforceable promise
Risk Management Policy Statement
Outlines the risk management objectives of the firm, as well as company policy with respect to treatment of loss exposures
Life Insurance
Pays death benefits to designated beneficiaries which the insured dies
Physical Hazard
Physical condition that increases the frequency or severity of loss
Manuscript Policy
Policy designed for a firm's specific needs and requirements
Commercial Lines
Property and casualty coverages for business firms, nonprofit organizations, and government agencies
Conditions
Provisions inserted in the policy that qualify or place limitations on the insurer's promise to perform
Personal Risks
Risks that directly affect an individual or family
Representations
Statements made by the applicant for insurance, such as the applicant's occupation, state of health, and family history
Subrogation
Substitution of the insurer on place of the insured for the purpose of claiming indemnity from a third party for a loss covered by insurance; the insurer is entitled to recover from a negligent third party any loss payments made to the insured
Hedging
Technique for transferring the risk of unfavorable price fluctuations to a speculator by purchasing and selling future contracts on an organized exchange
Risk Financing
Techniques that provide for the funding of losses after they occur, such as retention, non insurance transfers, and commercial insurance
Risk Control
Techniques that reduce the frequency or severity of losses, such as avoidance, loss prevention, and loss reduction
Binder
Temporary contract for insurance and can be either written or oral
Legal Purpose
That is, it must not be for the performance of an activity prohibited by law; else it is unenforceable.
Expense Loading
The amount needed to pay all expenses
Peril
The cause of loss
Premature Death
The death of a family head with unfulfilled financial obligations
Broad Evidence Rule
The determination of actual cash value should include all relevant factors an expert would use to determine the value of the property
Retention Level
The dollar amount of losses that the firm with retain
Personal Risk Management
The identification and analysis of pure ricks faced by an individual or family, and to the selection and implementation of the most appropriate technique(s) for treating such risks
Subjective Probability
The individual's personal estimate of the chance of loss
Pecuniary Interest
The insurable interest requirement in life insurance can be met
Principle of Insurable Interest
The insured must be in a position to lose financially if a covered loss occurs
Principle of Indemnity
The insurer agrees to pay no more than the actual amount of the loss; the insured should not profit from a loss
Conditional Contract
The insurer's obligation to pay a claim depends on whether the insured or the beneficiary has complied with all the conditions
Objective Probability
The long-run relative frequency of an event based on the assumptions of an infinite number of observations and of no change in the underlying conditions
Legally Competent
The parties must have legal capacity to enter into a binding contract
Insurance
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 occurrence, or to render services connected with the risk
Human Life Value
The present value of the family's share of the deceased breadwinner's future earnings
Fair Market Value
The price a willing buyer would pay a willing seller in a free market
Chance of Loss
The probability that an event will occur
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
Underwriting
The process of selecting and classifying applicants for insurance through a clearly stated company policy consistent with company objectives
Non insurance Transfers
The risk is transferred to a part other than an insurance company
Property Risks
The risk of having property damaged or lost from numerous causes
Pooling
The spreading of losses incurred by the few over the entire group, so that in the process average loss is substituted for actual loss
Adverse Selection
The tendency of persons with a higher-than-average chance of loss to seek insurance at standard (average) rates, which if not controlled by underwriting, results in higher-than-expected loss levels
Financial Risk
The uncertainty of loss because of adverse changes in commodity prices, interest rates, foreign exchange rates, and the value of money
Consideration
The value that each party gives to the other
Maximum Possible Loss
The worst loss that could happen to the firm during its lifetime
Probable Maximum Los
The worst loss that is likely to happen
Replacement Cost Insurance
There is no deduction for physical depreciation in determining the amount paid for a loss
Subjective Risk
Uncertainty based on a person's mental condition or state of mind
Risk
Uncertainty containing the occurrence of a loss
Innocent Misrepresentation
Unintentional misrepresentation
Passive Risk Retention
Unknowingly retained because of ignorance, indifference, laziness, or failure to identify an important risk
Actual Cash Value
Value of property at the time of its damage or loss, determined by subtracting depreciation of the item from its replacement cost