RMI 2101 Quiz Topic 1 - McCloskey

True or False: Risk can yield both positive and negative outcomes.

True - opportunities cannot be pursued, and reward cannot be obtained without incurring some risk.

The most widely known risk management technique used by individuals is...

risk financing by purchasing insurance

_________________ helps individuals to and organizations to avoid, prevent, reduce, or pay for the negative outcomes of risk so that opportunities for reward can be pursued.

Risk Management

True or False: Risk can have many different meanings, so it is often hard to define.

True

Risk is defined as...

the uncertainty about outcomes, with the possibility that some of the outcomes can be negative.

Risk can be quantified by knowing the _____________ of the possible outcomes

probability

The two elements within the definition of risk are these:

- uncertainty of outcome

- Possibility of a negative outcome

Risk involves uncertainty regarding the_________ and ___________ of the outcome, or both.

Type and timing.

Unlike possibility, __________________ is measurable and has a value between zero and one.

probability

Probability is defined as...

The likelihood that an outcome or event will occur.

These classifications of risk are some of the most commonly used:

- Pure and speculative risk

- subjective and objective risk

- diversifiable and non-diversifaible risk

- static and dynamic risk

Pure risk

A chance of loss or no loss, but no chance of gain.

An example of pure risk would be...

A building owners risk of possible fire loss - the building will either burn or not burn.

Speculative risk

A chance of loss, no loss, or gain.

An example of speculative risk would be...

an investor who purchases an apartment building to rent to tenants expects to profit from this investment, so its a desirable speculative risk. However, the venture could be unprofitable if rental controls limit the amount of rent that can be charged.

Some speculative risks in investments would be...

- market risk

- inflation risk

- interest rate risk

- liquidity risk

Credit Risk

the risk that customers or other creditors will fail to make promised payments as they come due.

True or false: insurance deals primarily with risk of loss, not risk of gain (aka pure risk rather than speculative risks)

True

Subjective Risk

The perceived amount of risk based on an individual's or organization's opinion.

Objective Risk

The measurable variation in uncertain outcomes based on facts and data.

Example of objective risk...

Assume that a property insurer has 10,000 houses insured over a long period. On average, 1 percent, or 100 houses, burn each year. However, it would be rare for exactly 100 houses to burn each year.

- The variation of actual loss from expected loss is the objective risk

True or false: Subjective risk can exist even when objective risk does not

True

diversifiable risk

A risk that affects only some individuals, businesses, or small groups.

Example of diversifiable risk...

a fire, which is likely to affect only one or a small number of businesses. An insurer can diversify the risks associated with fire insurance by insuring many buildings in several different locations.

nondiversifiable risk

A risk that affects a large segment of society at the same time.

systemic risk

The potential for a major disruption in the function of an entire market or financial system.

Static Risk

risk that is always present for an organization

Examples of static risk include...

the potential for loss from natural disasters, fire, theft, or employee injury.

Dynamic risk results from________ and ___________.

economic change and emerging risks

Examples of economic risks include...

- financial crises, recessions, regulatory changes, increased competition, changes in fuel prices, & changes in consumer habits.

Examples of emerging risks include...

climate change, internet privacy, terrorism, new technology, and innovations in energy.

Losses result from _________.

hazards

ex: the hazard of ice on a highway leading to accidents.

A hazard is...

A condition that increases the frequency or severity of a loss.

Insurers typically define hazards according to these four classifications:

- moral

-morale

- physical

- legal

Moral Hazard

A condition that increases the likelihood that a person will intentionally cause or exaggerate a loss.

One moral hazard incentive is _____________.

financial difficulty

Morale hazard (attitudinal hazard)

A condition of carelessness or indifference that increases the frequency or severity of loss.

Examples of Morale hazards include...

driving carelessly and failing to lock an unattended building.

Both ____________ and _____________ are behavior problems that can increase the frequency and/or severity of losses.

moral and morale hazards

a ____________ hazard results from a deliberate act; a ___________________ results from carelessness or indifference

moral;morale

Physical Hazard

A tangible characteristic of property, persons, or operations that tends to increase the frequency or severity of loss.

- EX: a slip-and-fall accident is more likely to occur on an icy sidewalk

Legal Hazard

A condition of the legal environment that increases loss frequency or severity.

EX: courts in some geographic areas are much more likely to find in favor of the plaintiff or to grant large damages awards in liability cases than are courts in other areas.

The financial consequences of risk by individuals or organizations can be broken into three components:

- expected cost of loses or gains

- expenditures on risk management

- cost of residual uncertainty

Herbert Heinrich observed that industrial accidents include the cost of the compensation paid to the injured employee as well as other hidden costs including:

- time lost by the injured employee

__________ is the immediate cause of the loss.

EX: fire, flood, theft, injury, death

Peril