Math 3620 Exam 1

Traditional Definition of Risk

uncertainty concerning the occurence of a loss

DHS Definition of Risk Management

Risk management is the process for identifying, analyzing and communicating risk while accepting, avoiding, transferring, or controlling it to an acceptable level considering associated costs and benefits of any actions taken

Physical Hazard

a physical condition that increases the frequency or severity of a loss

Moral Hazard

Dishonesty or character defects in an individual that can increase the frequency or severity of loss

Attitudinal Hazard

Attitude of carelessness or indifference to a loss which can increase the frequency or severity of a loss

Legal Hazard

Characteristics of the legal system or regulatory environment that increases the frequency or severity of losses

Pure Risk

A situation where there can only be loss or no loss at all. There is no profit to be made

Speculative Risk

A situation where either profit or loss is possible

Diversifiable Risk

Risk that only affects individuals or small groups. They can be eliminated by diversification

Non Diversifiable Risk

Risk that can affect the entire economy or large amounts of people in the economy

Direct Loss

Loss that results from physical damage, destruction, or theft of property

Indirect Loss

Financial loss that results indirectly from the occurence of direct physical damage or theft loss

Avoidance

This refers to eliminating, instead of reducing, an activity that creates the risk

Loss Prevention

This refers to things you do to reduce the frequency of losses

Loss Reduction

This refers to techniques that reduce the severity of losses

Risk Financing

This refers to the payment of losses AFTER they occur

Definition of Insurance

This is an agreement where insureds agree to pay insurers premiums so that if a risk occurs, the insurer can help cover the losses

Insurance: Pooling of Losses

This refers to spreading the impact of losses incurred by a few over the entire group so that losses can be paid off

Insurance: Fortuitous Losses

Losses must be random and happen by chance. Losses can't be expected or intentional and expect to be covered

Insurance: Risk Transfer

The risk of loss is passed on to the insurer in exchange for premium payments to the insurer.

Insurance: Indemnification

The person who has the insurance is restored to the same financial position as before the loss

Law of Large Numbers

As the sample size increases, the sample mean approaches the true mean of the distribution.

As sample sizes increases, there is less deviation in the average payout so insurance companies can have a more accurate picture of the price of a loss

Large number of exposures

Accidental and unintentional loss

Determinable and Measurable loss

No catastrophic loss

Calculable chance of loss

Economically feasible premium

6 Characteristics of Ideally Insurable Risk

Premiums may not match Losses

Insurance companies may also fail

Risk of Fixed Premiums

Pooling

This is the spreading of losses incurred by the few over the entire group so the actual loss is substituted for the average loss

Adverse Selection

This is the tendency of people with higher-than-average chance of loss to seek insurance at standard rates. This can be controlled by underwriting

Risk Management Process

Identify, Measure & Analyze, Select Techniques for Managing Risks, Implement and Monitor

Risk Management Process: Measure and Identify

Estimate loss frequency and loss severity. Loss severity is more important

Risk Financing: Retention

This means that the firm retains part of or all the losses that can result from a given loss. This is effective when no other method of treatment is available and the worst possible loss is not serious

Active Retention

This occurs when a firm identifies the risk in advance and agrees to retain part of or all the losses that can result from a given loss

Passive retention

This occurs when a firm does not identify the risk in advance, and the firm agrees to retain part of or all the given losses.

Captive Insurer

Members in a parent company of a firm each pool in money to share the risk of losses with other members. Ex: Property Risk, Liability Risk, Workers Compensation Risk

Non-insurance Transfers

This is a method where pure risk and its potential financial consequences are transferred to another party. EX: contracts, leases, hold-harmless agreements

Commercial Insurance

Insurance for low probability, high severity losses

Reinsurance

Insurance for insurance companies when the risk the original insurance company takes is too big

Retrocession Risk

Risk a reinsurer passes off to another reinsurer when the risk it takes is too big

Enterprise Risk Management

This is a business strategy that addresses all possible risks from large to small and manages all the possible risk as one big risk portfolio

Chief Risk Officer

Individual in a company that oversees all aspects of ERM in an organization

ERM: Risk Appetite

This is the total exposure that an organization is willing to accept given the risk and return trade-off

Risk Tolerance

This is the amount of uncertainty that an organization is willing to accept

ERM Process

This is similar to the risk management process, but it also considers the internal and external environments

Stock insurers, Mutual Insurers, Lloyd's of London, Reciprocal Exchanges, Blue Cross and Blue Shield Plans, Managed Care Plans, and Captive Insurance Companies

Types of Insurers

Private Insurers: Stock Insurer

This is a corporation owned by stockholders that aims to earn profit for stockholders by increasing the value of stock and paying dividends. Capital can be raised by selling more stock shares

Private Insurers: Mutual Insurer

This is a corporation owned entirely by the policy owners. Policy owners elect a board of directors who have effective management. Profits are returned to policyholders. No stock shares can be sold

Lloyd's of London

This is to cover unusual risks. Firms go to a society of members and get many members to insure a percentage of the risk so that the intended insurance level is reached. This is rare

Reciprocal Exchange

This is when different firms pool in money to cover risks of each other. Like captive insurance but for firms instead of workers.

Blue Cross and Blue Shield Plans

Non-profit community oriented insurance. These plans cover hospital services, and doctor fees

Managed Care Plan

Health insurance plan where doctors and hospitals are chosen in a network and prices are negotiated with providers to keep costs lower

Insurance Agent

This is someone who legally represents the insurance company and is responsible for acting within the company's guidelines

Binder

Temporary insurance that an insurer provides before the policy is actually written. Life insurance agents do not have the authority to do this

Broker

This is someone who legally represents the insured and aims to match the insured with the best insurer. They usually get commission after doing this.

Avoidance, Loss Prevention, Loss Reduction, Duplication, Separation, Diversification

Risk Control Techniques

Pooling of losses, fortuitous losses, risk transfer, indemnification

Four Keys to the Definition of Insurance

Avoidance, Loss Prevention, Loss Reduction, Duplication, Separation, Diversification

Techniques for Managing Risk

Duplication

This refers to having back-ups or copies of important property in case a loss occurs

Separation

This refers to dividing the assets exposed to loss to minimize the harm from a single event

Diversification

This refers to spreading the loss exposure across different parties, securities, or transactions to reduce the chance of loss

Retention, Non-insurance Transfers, and Commercial Insurance

Risk Financing Methods

Risk Control and Risk Financing

Techniques for Managing Risk

Risk Control

This is a strategy to reduce the risk as much as possible

Risk Financing

This is the strategy to pay for losses after they occur

Health Maintenance Organizations, Point of Service Plans, and Preferred Provider Organizations

Managed Care Plans Examples

Easier to raise new capital, greater flexibility (can offer employee stock options), but increased SEC requirements and management gets more stock than policyholders

Pros and Cons of Demutualization

Demutualization

A mutual insurer is converted into a stock insurer

Risk Identification, Risk Analysis, Selection of Risk Treatment Measures, Monitoring & Correcting

ERM Process

Hazard Risk, Financial Risk, Operational Risk, Strategic Risk, and Governance/Compliance Risk

Types of ERM Risk

Avoidance, Loss Prevention, Loss Reduction, Duplication, Separation, and Diversification

Types of Risk Control

Property damage

Hazard Risk Example

Financial Assets, or interest rates

Financial Risk Example

Human Interaction Risk

Operational Risk Example

Demographic changes

Example of Strategic Risk

compliance with accounting rules

Governance/Compliance Risk examples

Reputational Risk, Increase in crime

Other Risk Examples

prepare for losses in an economical way, reduce anxiety about losses, follow government requirements

3 pre loss objectives

survival of the firm, continue operations, stability of earnings, continued growth, and social responsability.

post loss objctives