Module 1- Basics of Risk
Cost Benefit Analysis
"Should I do X to protect Y?" If the expected gain is higher than alternatives, then yes do the activity.
Severity/Impact
"how bad is it when it happens?" Severity is often measured in terms of financial loss. We often measure the expected severity, or what we expect the loss to be when it occurs.
Risk Measurement Questions
"how does this relate to tomorrow's exposures?"
Frequency/Likelihood
"how often is something to occur?", "over what time frame?" How often something happens is usually compared to how many times it could have happened. Think probability.
Static Risk
"is the risk changing through time?" These risks do not change through time.
Pure Risk
"will there be a loss or no loss?" There are clear expectations. These risks only involve two possible outcomes.
Speculative Risk
"will there be a loss, no loss, or a gain?"
Loss control
-Reduce the level of risky activity -increase precaution
Uncertainity
-When you do not know the outcome. -It is doubt about our ability to predict future outcomes. -Subjective -Can be altered through information
Loss financing
-retention and self-insurance (you pay for it) -Insurance (someone else pays for it) -Hedging -Other contractual risk transfers
Moral Hazard
-type of intangible hazard -behavioral changes- effects the frequency/ severity of loss
Morale Hazard
-type of intangible hazard -indifference - effects the frequency / severity of loss
Societal Hazard
-type of intangible hazard -legal or cultural attitude - effects the frequency / severity of loss
Hazard
Condition of affecting the frequency or severity of loss. They affect perils.
Yes. It requires putting a value on human life. Consider how to balance risk/reward of how much it is worth spending to saving one life. What is the quality of life they would have if you did save them?
Do risk reduction methods have costs that are both monetary and nonmonetary?
Risk Financing
Either you pay for the adverse outcomes that may occur (risk retention) or you get someone else to pay for it (risk transfer).
Risk Likelihood
Frequency - the probability that a loss can occur. This can be described as high, medium, or low
Consider relative variation of actual from expected loss (aka variation aka standard deviation). "How far is it from what we expected to happen from what actually happened?"
How do you figure out what is riskier?
Green = Good, Red = Bad
On the risk profile table, what is the color green considered? What is the color red considered?
Frequency of losses
Risk prevention methods are best applied to what?
Severity of losses
Risk reduction methods are best applied to what?
Risk Impact
Severity - the potential effect that a loss could have if it arises. The magnitude can also be described as high, medium, or low.
Standard Deviation
Square Root of Variance
Coefficient of Variation
Standard Deviation/ E(Loss)
Risk Control
The first risk management technique that involves avoiding losses. Aimed at reducing the number of risks facing the organization or the amount of loss that can arise from these exposures. It includes risk prevention (frequency) and risk reduction (severity). Consider cost benefit analysis. This refers to the group of risk management techniques that are designed to reduce either the frequency of potential losses or the severity of potential losses or a combination of the two.
(.25 x $10,000) + (.50 x $10,000) + (.25 x $10,000) = $20,000
The frequency states that there is a 25% chance of 1 accident, a 50% chance of 2 accidents, and a 25% chance of 3 accidents. The severity states that it costs $10,000 per accident. What is the expected loss?
Risk
Uncertainty regarding loss.
Dun and Bradstreet (credit reports), SEC 10-K report, annual report, balance sheet (point in time), and income statement (period of time).
What are examples of financial statements?
Pure, speculative, static, dynamic, fundamental, particular, core, and secondary risk
What are the eight categories of risk?
Personal, property, liability, and financial risk
What are the four sources of risk?
Risk Neutral, Risk Averse, and Risk Seeker
What are the three attitudes towards risk?
(1) A 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 also be measured to determine the amount of insurance that should be purchased when the decision is made to transfer the risk
What are the two reasons that potential severity must be measured for?
Physical (tangible) and intangible hazards
What are the two types of hazards?
Moral, Morale, and Societal Hazards
What are the types of intangible hazards?
the steps it takes to go from raw materials to finished products
What do flow charts depict about a company?
The layout hierarchy of the organization. "Who reports to whom?" and "what are they responsible for?"
What do organizational charts depict?
Uncertainty regarding loss
What is the definition of risk on the individual level?
Uncertainty regarding loss and things that prevent the organization from reaching their objectives. It adversely affects the achievements of an organization's objectives. Note - risk management in organizations applies to the entire industry.
What is the definition of risk on the organizational level?
Uncertainty regarding loss and things that effect society as a whole. It has to effect a large portion of its constituents.
What is the definition of risk on the society level?
Review and Evaluate. The risk management process never stops; it is an ongoing practice among individuals and organizations.
What is the last step in the risk management process that is often done first?
Adverse Risk
What type of attitude is willing to pay more to avoid risk?
Variance
[Loss Value - E (Loss)]2 x P (Loss)
Exposure
a person or property facing risk of loss
Intangible Hazards
attitidues or culture
Liability Risks
having to take responsibility for your actions / inactions
Expected Value/Loss
how often it occurs multiplied by how bad it is when it occurs.
Risk
is a probability and is expressed as a fraction, or ratio, of the number of people who experienced the adverse effect divided by the number of people who engaged in the activity.
Core Risk
organizational level risk - these are directly associated with what an organization or business does.
Secondary Risk
organizational level risk - these have nothing to do with what an organization or business does.
Loss Distribution
outline, chart, or graph that lists all of the possible losses and their probabilities.
Risk Neutral
people who are indifferent towards risks. The value of risky situations is the expected loss or expected outcome.
Risk Seeker
people who prefer risk. Willing to pay more than expected return/gain to engage in risky situations. Willing to gamble or take on risk at values below the expected value.
Physical Hazards
property/tangible conditions
Personal Risks
related to life, health, and safety on the individual level
Property Risks
related to the potential damage to physical property / material things / stuff
Fundamental Risk
risks that effect everyone / a large portion of the population at the same time.
Particular Risk
risks that effect individuals / a small group of people at a given time.
Financial Risks
savings and investments
Dynamic Risk
the chances of something happening now and happening later are different. They change through time.
Risk Averse
the general population is this - people who prefer to avoid risk. Willing to pay more than the expected loss to avoid the risk.
Peril
the immediate cause of loss
The Scientific View of Risk
the probability of a person suffering an adverse effect from some activity or exposure over a given period of time
Risk Managment
the scientific approach to dealing with risks
Law of Large Number
these work well for independent losses that have no correlation to others. Insurance companies have thousands of independent losses. As policies increase, total standard deviation increases. This enables insurance companies to substitute certainty for uncertainty and to be in the skinny tall curve. This law narrows the range of outcomes.
Risk Profile
way of prioritizing risks
Loss
what you could have had, but don't
