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