Risk Managment

Pure risks ideally should have certain characteristics to be insurable by private insurers. List the six characteristics of an ideally insurable risk.

1) There must be a large number of exposure units 2) The loss must be accidental and unintentional 3) The loss must be determinable and measurable 4) The loss should not be catastrophic 5) The chance of loss must be calculable 6) The premium bus be economically feasible

Explain the difference between a direct loss and an indirect or consequential loss.

A direct loss is the financial loss from a damage or theft loss to a property. An indirect loss is the loss that results indirectly from the damage.

A. What is the Difference between a peril and a hazard? A 'peril' is defined as 'a cause of loss', whereas a hazard is a 'condition that creates or increases the frequency/severity of a loss'. To put this into perspective, if you have a house fire, and your house is blown to smithereens, then the 'peril' would be the fire in itself, whereas the 'hazard' could have been something that may have contributed towards the cause of the house fire. Maybe the stove was left on, or perhaps the wiring in a building was defective - these are examples of 'hazards'. B. Define physical hazard, moral hazard, attitudinal hazard and legal hazard.

A. A 'peril' is defined as 'a cause of loss', whereas a hazard is a 'condition that creates or increases the frequency/severity of a loss'. To put this into perspective, if you have a house fire, and your house is blown to smithereens, then the 'peril' would be the fire in itself, whereas the 'hazard' could have been something that may have contributed towards the cause of the house fire. Maybe the stove was left on, or perhaps the wiring in a building was defective - these are examples of 'hazards'. B. A physical hazard is 'a physical condition that increases the frequency or severity of a loss'. Referring back to part A of this question, we could say that defective wiring, leading to a burning house could be considered a 'physical hazard'. Another example could be an icy road leading to a car accident. -A moral hazard is a form of 'dishonesty or character defects in an individual that increase the frequency or severity of a loss'. Looking back at the example of a house fire, maybe an individual faked the accident by "accidently" burning the house down, giving him/her access to some form of insurance. This would be an example of a moral hazard, when someone is abusing the benefits given from insurance companies etc. -An attitudinal hazard is 'carelessness or indifference to a loss, which increases the frequency or severity of a loss'. This is also known as a 'morale' hazard. Examples of this would be leaving a door unlocked, which would lead to a theft or burglary. Or referring back to a house burning down, leaving the stove on would also be known as an 'attitudinal/morale hazard'.

A. What is the meaning of adverse selection? B. Identify some methods that insurers use to control for adverse selection.

A. Adverse selection is the tendency for 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. B. Adverse selection can be controlled by careful underwriting, by charging higher premiums to substandard applicants for insurance, and by certain policy provisions.

A. Define Chance of Loss B. What is the difference between objective probability and subjective probability?

A. Chance of loss is, simply put, the 'probability that an event will occur. B. 'Objective probability' is the 'long-run relative frequency of an event based on the assumptions of an infinite number of observations and of no change in underlying conditions. In other words, objective probability is probability that can be measured, and is based upon fact. 'Subjective probability' is the 'individual's personal estimate of the chance of loss' in other words, subjective probability is probability that is based on opinion.

A. Explain the meaning of enterprise risk. B. What is financial risk? C. What is systemic risk?

A. Enterprise risk is a term that encompasses all major risks faced by a business firm. Such risks include pure risk, speculative risk, strategic risk, operational risk, and financial risk. B. Financial risk refers to the uncertainty of loss because of adverse changes in commodity prices, interest rates, foreign exchange rates, and the value of money. C. Systematic risk is the risk of collapse of an entire system or entire market due to the failure or a single entity or group of entities that can result in the breakdown of the entire financial system.

A. What is enterprise risk managment? B. How does enterprise risk management differ from traditional risk managment?

A. Enterprise risk management in business includes the methods and processes used by organizations to manage risks and seize opportunities related to the achievement of their objectives. B. Enterprise risk management is a process with a goal to form a consistent understanding of an organization's goals and the risks that may stunt the organization's success. Whereas traditional risk management aims to deal with risks independent of each other as they arise, in order to mitigate damage to the organization.

Chapter 1 A. Explain the historical definition of risk. B. What is a loss exposure? C. How does objective risk differ from subjective risk?

A. Historically, risk is defined as uncertainty concerning the occurrence of a loss. B. A loss exposure is any situation or circumstance where a loss can happen, regardless of if that loss happens or not C. Objective risk is the relative variation of actual loss from expected loss, whereas subjective risk is uncertainty based on a person's mental condition or state of mind

Chapter 2 Explain each of the following characteristics of a typical insurance plan. A. Pooling of losses B. Payment of fortuitous losses C. Risk transfer D. Indemnification

A. Pooling is the spreading of losses incurred by the few over the entire group, so that in the process, average loss is substituted for actual loss. In addition pooling involves the grouping of a large number of exposure units so that the law of large numbers can operate to provide a substantially accurate prediction future losses. B. A second characteristic of private insurance is the payment of fortuitous losses. Most insurance policies exclude intentional losses. A fortuitous loss is one that is unforeseen and unexpected by the insured and occurs as a result of chance. C. Risk transfer means that 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. D. Indemnification means that the insured is restored to his or her approximate financial position prior to the occurrence of the loss.

A. Explain the basic characteristics of social insurance programs. B. Identify the major social insurance programs in the United States.

A. Social insurance programs are government insurance programs with certain characteristics. The programs are enacted into law to deal with social and economic problems. The programs generally are compulsory and financed by contributions from covered employers and employees; benefits are paid from specifically earmarked funds; benefits are skewed or weighted in favor of lower income groups; benefit amounts generally are related to the covered individual's earnings; and eligibility requirements and benefit rights are prescribed by statute B. Major social insurance programs are the following: Old-age, survivors, and disability insurance (Social Security) Medicare Unemployment insurance Workers compensation Compulsory temporary disability insurance Railroad Retirement Act.

A. Explain the difference between pure risk and speculative risk. B. How does diversifiable risk differ from non diversifiable risk?

A. The difference between pure risk and speculative risk is that pure risk is that there is either a loss or no loss and speculative risk is where either profit or loss is possible B. Diversifiable risk differs from non-diversifiable risk because diversifiable risk is a risk that only affects individuals or small groups and not the entire economy, while non diversifiable risk is a risk that affects the entire economy or a large number of people or groups.

A. Identify the major fields of private insurance. B. Identify several property and casualty insurance coverages.

A. The major fields of private insurance are life insurance, health insurance, and property and liability insurance (also called property and casualty insurance). B. Property and casualty coverages can be divided into personal lines and commercial lines. Personal lines include private passenger auto insurance, homeowners insurance, personal umbrella liability insurance, earthquake insurance, and flood insurance.Commercial lines include fire and allied lines insurance, commercial multiple peril insurance, general liability insurance, products liability insurance, workers compensation insurance, commercial auto insurance, accident and health insurance, inland marine and ocean marine insurance, professional liability insurance, directors and officers liability insurance, boiler and machinery insurance (also known as equipment breakdown insurance), fidelity and surety bonds, and crime insurance.

What are the two major differences between insurance and gabling?

Insurance differs from gambling in two ways. First, gambling creates a new speculative risk that did not exist before, while insurance is a technique for handling an already existing pure risk. Second, gambling is socially unproductive, since the winner's gain comes at the expense of the loser. Insurance is always socially productive, since both the insured and insurer win if the loss does not occur.

What are the two major differences between insurance and hedging?

Insurance differs from hedging. An insurance transaction usually involves the transfer of risks that are insurable, since the requirements of an insurable risk can generally be met. Hedging is a technique for handling risks that are typically uninsurable, such as protection against a substantial decline in the price of commodities. A second difference is that moral hazard and adverse selection are more severe problems for insurers than for speculators who buy or sell futures contracts.

Identify the approaches that insurers can use to deal with the problem of catastrophic loss exposures.

Insurers can deal with the problem of a catastrophe loss by (1) reinsurance, (2) avoiding the concentration of risk by dispersing coverage over a large geographical area, and (3) use of certain financial instruments in the capital markets, such as catastrophe bonds.

Identify the major risks faced by business firms.

Major risks faced by business firms include cyber security, bankruptcy, property risks, and liability risks.

List the major types of pure risk that are associated with economic insecurity.

Premature death, insufficient income during retirement, old age, poor health, and unemployment.

Describe the major social and economic burdens of risk on society.

The burdens of the risk on society can be emergency funds having to be increased. This means that the insurances would have to increase their funds to cover unexpected losses. Another burden can be society being deprived of their resources and goods. This means that some companies discontinue products because of liability lawsuits. Also a burden can be worry and fear. This is just about being uneasy or in fear because of the risk of something such as having a loved one drive on the roads during a snowstorm.

Explain the law of large numbers.

The law of large numbers states that the greater the number of exposures, the more closely the actual results will approach the probable results expected from an infinite number of exposures. As the number of exposures increases, the relative variation of actual loss from expected loss will decline. Thus, the insurer can predict future losses with a greater degree of accuracy as the number of exposures increases. This is important, since an actuary must charge a premium that is adequate for paying all losses and expenses during the policy period. The lower the degree of objective risk, the more confidence an insurer has that the actual premium charged will be sufficient to pay all claims and expenses and leave a margin for profit.

Why are most market risks, financial risks, production risks, and political risks considered difficult to insure by private insurers?

These risks are generally uninsurable for several reasons. First, many of these risks are speculative risks, which are difficult to insure privately. Second, the potential for a catastrophic loss is great; this is particularly true for political risks, such as the risk of war. Finally, calculation of the correct premium may be difficult because the chance of loss cannot be accurately estimated.