FBLA Insurance & Risk Management

Risk

Uncertainty of something, concerns a loss

Risk refers to ___ and ___ being injured

Property & Life

Objective Risk

Defined as relative variation of actual loss from expected loss

Objective Risk varies inversely with

square root of # of cases under observation

EX: 10,000 houses were insured

Objective Risk is 10/100 or 10%

The Law of Large Numbers

states that if the # of exposure units increases, the more closely the actual loss experience will approach the expected loss experience

Subjective Risk

defined as uncertainty based on a person's mental condition or state of mind

Chance of Loss

probability that an event will occur

Probability has both ___ and ___ aspects

objective and subjective

Objective Probability

refers to 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

Peril

defined as the cause of loss

Hazard

condition that creates or increases chance of loss

Four Types of Hazards

physical, legal, moral, morale

Subjective Probability

A probability derived from an individual's personal judgment about whether a specific outcome is likely to occur. Subjective probabilities contain no formal calculations and only reflect the subject's opinions and past experience.

Physical Hazard

a physical condition that increases the chance of loss

EX: icy roads, chance of fire, defective lock on a door

Moral Hazard

dishonesty or character defects in an individual that increases severity of loss

EX: faking an accident to collect money from insurer, fraudulent claims, murdering insured to collect life insurance

Morale Hazard

carelessness or indifference to a loss because of the existence of insurance

EX: leaving doors unlocked, leaving car keys in unlocked car

Legal Hazard

refers to the characteristics of the legal system or regulatory environment that increase the frequency or severity of losses

EX: large jury verdicts, large damage awards in liability lawsuits, coverage for alcoholism, etc.

Risk Categories

Pure and Speculative

Fundamental Risk and Partial Risk

Enterprise Risk

Pure Risk

situation where there are only possiblities of loss or no loss

EX: premature death, job accidents, medical expenses, damage to property from fire, lightning, flood, or earthquake

Speculative Risk

only profit or loss possible

Fundamental Risk

affects entire economy or large numbers of people

EX: war, inflation, terrorist attack

Particular Risk

affects only individuals and not entire community

EX: car theft, bank robbery, house fire

Enterprise Risk

encompasses all major risks faced by business firms

EX: pure risk, speculative risk, strategic risk, operation risk, financial risk

Strategic Risk

uncertainty regarding the firm's financial goals and objectives

Operational Risk

results from firm's business operations

EX: if hackers hack an online bank

Financial Risk

refers to unceratinty of loss because of adverse changes in commoditity prices, interest rates, foreign exhance rates, value of money

EX: if food prices raise, school can lose money in lunch department

Enterprise Risk Management

single treatment program that has all major risks faced by firm

Major Types of Pure Risk

personal risks, property risks, liability risks

Premature Death

death of a family head with unfulfilled financial obligations, surviving members have to deal with

Life Value

present value of the family's share of deceased breadwinner's future earnings

Other things that need tended to after premature death

funeral expenses, medical bills, estate settlement costs, taxes on large estates

Non-Monetary Things that come with Premature Death

grief, loss of role model, counseling and guidance for children

Risk of Insufficient Income During Retirement

major risk associated with old age is not enough money during retirement, US citizens retire before 65 usually

money goes down when someone retires unless people save enough money for retirement

Risk of Poor Health

includes both payment of medical bills and loss of earned income, major surgery, etc.

Health insurance helps, planning for future

Risk of Unemployment

major threat to financial security, comes from business cycle downswings, structural changes in economy, seasonal factos, imperfections in labor market

Downsizing

a way to hold down labor costs, reducing # of workers

Property Risks

risk of having property damaged or lost from numerous cases

EX: tornadoes, windstorms, theft

Direct Loss

financial loss from the physical damage, destruction, theft of property

Indirect Loss

financial loss from the occurrence of direct physical damage or theft loss

Consequential Loss

loss of profits

EX: loss of rents, loss of use of building, loss of a local market

Liability Risks

important type of pure risk that most people face, there is no limit of $ that can be asked for, can be very costly

EX: vehicle accidents

Methods of Handling Risk

avoidance, loss control, retention, non insurance transfers, insurance

Avoidance

avoiding the risk

ex: stay out of high crime areas, avoid driving, etc.

Loss Control

reduces frequency and severity of losses

Loss Prevention

aims to reduce probability of loss

EX: not smoking, safe driving

Loss Reducation

reduce frequency of loss

EX: sprinklers so that business doesn't stay on fire as long

Retention

business firm or individual retains all or part of a given risk

Active Retntion

individual is consciously aware of the risk and plans to retain all or part of it, it can save money

Passive Retention

certain risks are unkowningly retained because of ignorance, indifference, laziness, very dangerous