FSU - RMI 2302 - Charles Nyce - Exam 1

What are the three sub-categories of Intangible hazards?

- Moral hazard - behavioral changes (driving faster because you have anti-lock brakes) - Morale hazard - indifference (I don't care if I get a fender bender because my car is insured) - Societal hazards - legal or cultural (the German autobahn has no speed limit, so I will drive as fast as I want)

What are the three "burdens of risk on society" described in module 1?

- Need for Larger Emergency Funds - Loss of Needed Goods and Services - Fear and Worry

What are the three attitudes toward risk and how do they differ from each other?

- Risk Neutral - indifferent toward risk, value of risky situation is expected loss - Risk Averse - Prefer to avoid risk, willing to pay more than expected loss to avoid risk - Risk Seeker - prefer risk, would pay more than expected return to engage in risky situation

What are three statistical methods of evaluating risk?

1. Central Tendency - mean, median, mode 2. Measures of Variation - standard deviation 3. Law of Large Numbers - large number of policy holders decreases the likelihood of an insurance company taking a loss

What are the six steps of the Risk Management process?

1. Determination of objectives 2. Identification of risks 3. Evaluation of risks 4. Consideration of alternatives - selection of the tool 5. Implementing the decision 6. Evaluation and review

What are the three basic rules of Risk Management discussed in module 1?

1. Don't risk more than you can afford to lose 2. Don't risk a lot for a little 3. Consider the odds

What are the pre-loss objectives listed in module 1?

1. Economy 2. Reduction in Anxiety 3. Meeting Externally imposed Obligations 4. Social Responsibility

What are the steps of the decision making process discussed in module 3?

1. Identification of various possible outcomes (no control over the outcomes). 2. Identification of all the courses of action (control over actions). 3. Determination of the pay-off function (combinations of the acts and outcomes). 4. Choosing from among various alternatives on the basis of some criterion.

What are the steps of a ONE-STAGE decision making cycle?

1. Identify courses of action in the face of possible events. 2. Develop pay-off and regret tables. 3. Choose a course of action in accordance with some principle.

What are the advantages of a corporation?

1. Most effective for raising money - For example, stocks (equity financing) and bonds (debt financing) 2. Limited liability - Owners/stockholders risk only what they paid for the stock. Personal assets are not at stake. 3. Expand easily due to attracting capital 4. Life independent of owners and officers - Long range planning and growth

What are the three ways in which households dispose of income?

1. Personal Taxes (U.S. households paid 12% of their income to taxes in 2005; only 3% in 1941) 2. Personal Saving 3. Personal Consumption Expenditures

The Evaluation and Review step generally involves:

1. Reevaluating the program's objectives 2. Repeating the identification process to assure that it was performed correctly 3. Evaluating the risks that have been identified 4. Verifying that the decision on how to address each risk was proper 5. Verifying that the decision was property executed

The Government's role in the private sector is to provide legal structure; this means that it:

1. Sets legal statuses of business enterprises 2. Ensures rights of private ownership 3. Allows making and enforcement of contracts 4. Establishes "rules of the game" controlling relationships between businesses, suppliers and consumers Note: Intervention of government is presumed to improve allocation of resources, but intervention may be too little or too much as measured by marginal cost and marginal benefit

What are the three legal forms of business?

1. Sole proprietorship (72% of U.S. firms) - Business is owned and operated by one person. 2. Partnership (8% of U.S. firms) - Business in which two or more partners agree to own and operate a business together, pooling financial resources and sharing risks of profits/losses. 3. Corporation (20% of U.S. firms) - Can acquire resources, own assets, produce/sell products, incur debts, extend credit, sue/be sued.

What are two reasons that potential severity must be measured?

1. Some notion of severity is necessary for classifying risks. Whether an exposure will be classed as critical, important, or unimportant depends on the potential severity of loss. 2. Severity must be measured to determine the amount of insurance that should be purchased when the decision is made to transfer the risk.

What are the post-loss objectives listed in module 1?

1. Survival 2. Continuity of Operations 3. Earnings Stability 4. Continued Growth 5. Social Responsibility

What are the three ways by which the Government redistributes income?

1. Transfer payments - Provide relief to the destitute, the dependent, disabled and older citizens. (welfare checks, food stamps, etc.) 2. Market intervention - Government modifies prices that are/would be established by the market. (paying above-market prices to farmers, requiring minimum wage, etc.) 3. Taxation - Government uses personal income tax to take larger portions from the rich than from the poor to narrow after-tax income differences.

Economic stability is achieved by addressing two problems; what are they?

1. Unemployment - occurs when private sector spending is too low, common actions taken are an increase in government spending or lowering taxes 2. Inflation - occurs when spenders try to buy more then the economy's capacity to produce, common actions taken are raising taxes or government reducing their total spending

U.S. households typically save about _____% of income.

3

A durable good has a life expectancy of _____ years or more, while a non-durable good lasts lest than _____ years.

3,3

What is the generally accepted/preferred approach to risk identification?

A "combination approach," in which all of the tools available are brought to bear on the problem.

What is a Multiplant firm?

A firm organized horizontally, with several plants performing much the same function.

What is an Excise tax levied on?

A small, select list of commodities.

What is the "Rollback Technique"?

A technique by which the solution to the problem is obtained by working backwards, from right to left, through the decision tree.

What is the "Decision Theory"?

A theory used to determine optimal strategies where a decision-maker is faced with several alternatives and an uncertain, or risky, pattern of future events.

How are Multi-Stage decision making problems solved?

By evaluating the decision proceeding in a backward manner by evaluating the best course of action at the later stages to decide the best action at the earlier stages.

The Government maintains _________________ by controlling supply and keeping the few monopolies that exist regulated.

Competition

What are the two forms of Internal Risk Reduction discussed in module 1?

Diversification and Investments in Information

How do you calculate the expected loss?

E(loss) = sum of [amount of loss * prob. of loss]

Most of Local government spending can be attributed to:

Education

The ____________ ______________ is the best method for making decisions.

Expectation Principle

A ___________ occurs when some of the cost or the benefits of a good are passed on to someone other than the immediate buyer or seller.

Externality

True or false: Between the Maximum Likelihood principle and the Expectation principle, the Maximum Likelihood principle uses more information.

False

True or false: Document analysis and interviews are not good strategies for identifying risk and should be avoided.

False

True or false: Organizations do not usually have a risk management program already in existence.

False

True or false: People always make decisions based on maximizing their expected monetary value.

False

True or false: Private goods are produced through a non-competitive market system and do not incorporate rivalry and excludability.

False

True or false: Uncertainty can NOT differ across individuals even when risk is the same.

False

True or false: Information alters both risk and uncertainty.

False, information can only alter uncertainty, not risk.

True or false: The "Payoff Matrix" can be used in situations that involve a sequence of decisions.

False, it must be a ONE-STAGE decision making cycle

A __________ is a business organization that owns and operates plants. (May be one plant or many).

Firm

What are Conglomerates?

Firms that have plants which produce products in several industries.

What are the four ways of ANALYZING OR MEASURING risk discussed in module 1?

Frequency/likelihood, Severity/impact, Expected value/loss, and the Risk profile

Quasi-Public goods are:

Goods provided by government that fit the definition of a public good, but can be delivered in such a way that exclusion is possible.

Public goods are provided by the ___________ and create the free-rider problem.

Government

What is a condition affecting the frequency or severity of loss called?

Hazard

What does variation/standard deviation mean when discussing risk?

How far is it from what we expected to happen to what actually happened?

The "Scientific View" of Risk requires you to put a value on ___________ __________.

Human Life

For Risk-seekers, the utility function rises at a ____________ rate.

Increasing

The Functional Distribution of Income:

Indicates how the nation's earned income is apportioned among wages, rents, interests, and profits according to the function performed by the income receiver.

The Personal Distribution of Income:

Indicates how the nation's money income is divided among individual households.

A _________ is a group of firms that produce the same or similar products.

Industry

What is the Laplace principle?

It is based on philosophy that if we are uncertain about the various events then we may treat them as equally probable. The expected mean value of pay-off for each strategy is determined and the strategy with the highest mean value is adopted, unless we are dealing with cost in which case the lowest average cost is adopted.

What are two ways of evaluating loss severity?

Maximum possible loss and probable maximum loss.

What are the two types of cost associated with Risk, according to "The Scientific View of Risk"?

Monetary and Non-Monetary

What are the two main types of Risk Transfers?

Noninsurance Transfers (Contracts, Hedging, and Incorporation) and Insurance

The vast majority of the Federal Government's tax revenues come from _______________ _______________ taxes and _________________ taxes.

Personal Income, Payroll

What are the four SOURCES of risk discussed in module 1?

Personal Risks, Property Risks, Liability Risks, and Financial Risks

What are the two main types of hazards?

Physical and Intangible

What are the two different types of Risk Retention?

Planned vs. Unplanned and Funded vs. Unfunded

A __________ is a physical establishment that performs one or more functions in fabricating and distributing goods and services.

Plant

The problem faced when owners want maximum company profit and stock price, but agents want power, high pay, etc. regardless of company performance is the:

Principal-Agent Problem (Principals are stockholders and Agents are hired by stockholders to run the business)

______________ are often used to evaluate loss frequency.

Probability distributions

Government _______________ are exhaustive (directly absorb resources and are part of the domestic output), while _____________ _________________ are non-exhaustive (don't directly absorb resources or create output).

Purchases, Transfer Payments

What are the four CATEGORIES of risk discussed in module 1?

Pure vs. Speculative Static vs. Dynamic Fundamental vs. Particular Core vs. Secondary

What are three "tools" for identifying risk discussed in module 1?

Questionnaires, checklists, and procedure guides.

What are the two forms of "loss control" discussed in module 1?

Reduced level of risky activity and Increased precautions.

What are the four categories of Funded Retention?

Reserves, Self-Insurance, Captive Insurance Companies, and Credit

What are the four forms of "loss financing" discussed in module 1?

Retention and Self-Insurance, Insurance, Hedging, and other Contractual Risk Transfers

People are usually ___________ ____________, meaning their utility functions rise at a decreasing rate; $100 to a college student vs. $100 to a billionaire.

Risk Averse

What was likely the first Risk Management technique?

Risk Control

How do organizations (i.e. entire industries) generally handle risk?

Risk Management practices

Risk control includes __________ and __________.

Risk Prevention and Risk Reduction

What is the definition of Risk Management?

Scientific approach to dealing with risk

What are the two reasons people save money?

Security and Speculation

Governments use _________ to decrease the private demand. This frees resources from production of private goods and makes them available for production of public and quasi-public goods.

Taxes

What two principles are employed by the more optimistic risk takers?

The Maximax (highest possible profit) and Minimin (smallest possible cost) principles.

What principles should be used if the probability of each possible outcome is known?

The Maximum Likelihood principle and the Expectation principle

What does it mean when a firm is vertically integrated?

The firm owns plants that perform different functions in the various stages of the production process.

According to the Scientific View of Risk, what is the definition of Risk?

The probability of a person suffering an adverse effect from some activity or exposure over a given period of time/involvement.

What element is added when considering the "Scientific View" of Risk?

The time element

True or false: A Positive Externality appears as a benefit to other producers/consumers, like immunizations or education and is corrected by subsidizing consumers (low interest student loans) and suppliers (public colleges) and by goods provided by the government (postal service).

True

True or false: Consumer purchases are divided between durable goods (12%), nondurable goods (29%), and services (59%).

True

True or false: Danger does NOT equal Risk

True

True or false: Exposure is when a person or property is facing risk of loss.

True

True or false: Inspection tours are a valuable tool for risk identification and will often bring attention to risks that might otherwise have been undetected.

True

True or false: More than 85% of total household income flows back into the business sector as money spent on consumer goods.

True

True or false: Risk Control encompasses all techniques aimed at reducing the number of risks facing the organization or the amount of loss that can arise from these exposures.

True

Risk has many definitions (individual, organizational, or societal), but what is the most common/broad one?

Uncertainty regarding loss

How do you calculate Variance and Standard Deviation?

Variance = [Loss Value - E(Loss)]2 * P(Loss) Standard Deviation = Square Root of Variance Coefficient of Variation = Standard Deviation / E(Loss)

______ _______________ and _________________ provide an alternate criterion for decision making; they say decisions are made so as to maximize expected utility rather than expected monetary value.

Von Neumann, Morgenstern

________ and ____________ make up 71% of all U.S. income.

Wages and Salaries

Utility functions are usually a function of what?

Wealth

What is the definition of "uncertainty" discussed in module 1?

doubt about our ability to predict future outcomes

Reduction in uncertainty can be a _____________ thing.

good

Using the Maximin principle, one would choose the ___________ _____________ profit.

maximum minimum

Using the Minimax principle would lead to choosing the _____________ ______________ cost.

minimum maximum

The Maximin and Minimax principles are adopted by ______________ decision makers who are conservative in their approach.

pessimistic

A Negative Externality is when _______________; this is corrected by the Government with legislation and specific taxes.

production or consumption costs inflicted on a third party without compensation

What is the definition of "peril" discussed in module 1?

the immediate cause of loss