Risk and Risk Management Vocabulary

Vocabulary flashcards covering key definitions, mathematical formulas, and concepts from Chapters 1 and 3 on Risk and Risk Management.

Risk

Uncertainty concerning the occurrence of a loss.

Objective Risk

The relative variation of actual loss from expected loss, measured by standard deviation.

Law of Large Numbers

A principle stating that as the number of exposure units increases, the actual loss experience will more closely approach the expected loss experience, causing objective risk to decrease.

Chance of Loss

The probability that an event that causes a loss will occur.

Objective Probability

The long-run relative frequency of an event based on the assumptions of an infinite number of observations and of no change in the underlying conditions.

Subjective Probability

An individual's personal estimate of the chance of loss.

Peril

The cause of loss.

Hazard

A condition that creates or increases the chance of loss.

Physical Hazard

A physical condition that increases the chance of loss.

Moral Hazard

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

Attitudinal Hazard

Carelessness or indifference to a loss because of the existence of insurance.

Legal Hazard

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

Pure Risk

A situation in which the only possibilities are loss or no loss.

Speculative Risk

A situation in which loss, no loss, or profit is possible.

Diversifiable Risk

A risk that affects individuals and not the entire community.

Non-Diversifiable Risk

A risk that affects the entire economy or large numbers of persons or groups within the economy.

Direct Loss

A financial loss that results from the physical damage, destruction, or theft of property.

Indirect Loss

A financial loss that results indirectly from the occurrence of a direct physical damage or theft loss; also known as consequential loss.

Risk Management

A process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating such exposures.

Loss Exposure

Any situation or circumstance in which a loss is possible, regardless of whether a loss occurs.

Form 10-K

An annual financial report filed by publicly-traded U.S. companies with the SEC.

Form 10-Q

A quarterly financial report filed by publicly-traded U.S. companies with the SEC.

Form 8-K

A "current report" filed by publicly-traded U.S. companies to communicate material information on an as-needed basis.

Loss Frequency

The probable number of losses that may occur during some given time period.

Loss Severity

The probable size of the losses that may occur.

Maximum Possible Loss

The worst loss that could happen to a firm during its lifetime.

Maximum Probable Loss

The worst loss that is likely to happen to a firm.

Expected Value

The sum of the products of outcome $X_i$ multiplied by the probability $P(X_i)$ of $X_i$, represented mathematically as $E(X) = \sum [X_i \times P(X_i)]$.

Sample Variance

A statistical measure of dispersion calculated as $Variance = \frac{1}{n-1}\sum (x_i - \bar{x})^2$.

Normal Distribution Rule

A statistical distribution rule where $68\%$ of values lie within $1$ standard deviation of the mean, $95\%$ lie within $2$ standard deviations, and $99\%$ lie within $3$ standard deviations.

Coefficient of Variation

A statistical measure used to evaluate the accuracy of predictions when standard deviations differ across distributions with different means.

Risk Control

Techniques that reduce the frequency or severity of loss, including avoidance, loss prevention, loss reduction, duplication, separation, and diversification.

Risk Financing

Techniques that provide for the funding of losses, including retention, noninsurance transfers, and commercial insurance.

Avoidance

A risk control technique with the goal of setting $P(\text{loss}) = 0$ and $\text{risk} = 0$.

Loss Prevention

Risk control measures designed to reduce the frequency of loss, such as car alarms, workforce training, passwords, and non-slip flooring.

Loss Reduction

Risk control measures designed to reduce the severity of loss, implemented through duplication, separation, and diversification.

Retention

A risk financing approach where a firm retains part or all of a given loss.

Active Retention

The conscious and deliberate assumption of risk by a firm.

Passive Retention

Risk assumption resulting from ignorance or the underestimation of maximum loss size.

Captive Insurance

An insurer owned by a parent firm for the purpose of insuring the parent firm's loss exposures.

Noninsurance Transfer

A risk financing method shifting risk to another party via contracts, incorporation, or pension plan restructuring (e.g., DB to DC plans).

Manuscript Policy

An insurance policy created or tailored specifically to meet the unique needs of a firm.

Deductible

A specified amount subtracted from the loss payment otherwise payable to the insured, representing a form of risk retention.

Excess Insurance

Insurance coverage under which the insurer pays only if the actual loss exceeds the amount the firm has chosen to retain.

Hard Market

An insurance market phase characterized by declining insurer profitability, tougher underwriting, reduced capacity, fewer competitors, higher premiums, and restricted coverage.

Soft Market

An insurance market phase characterized by improving insurer profitability, easier underwriting, increased capacity, more competitors, lower premiums, and broader coverage.

The Prouty Approach

A structured risk treatment matrix that categorizes loss severity (Severe, Significant, Slight) and loss frequency (Almost Nil, Slight, Moderate, Definite) to guide decision-making.

Frequency-Severity Risk Matrix

A matrix mapping frequency and severity combinations to recommended actions: Retain (Low/Low), Transfer (Low Freq / High Sev), Loss Control and Retain (High Freq / Low Sev), and Avoid (High/High).

Net Present Value

A financial technique used to evaluate loss control projects by calculating the present value of future cash flows minus initial investment, expressed as $NPV = \sum \frac{C_t}{(1+r)^t} - C_0$.

Total Cost of Risk

The total expenditures for risk management, equal to the sum of outlays to reduce risk, opportunity cost, expenses from financing potential losses, and cost of unreimbursed (retained) losses.

Risk Management Process

A four-step cycle comprising: 1. Identify loss exposures, 2. Measure and analyze loss exposures, 3. Select appropriate combination of techniques, and 4. Implement and monitor the risk management program.

Insurance Cycle

The ongoing macroeconomic market cycle alternating between hard and soft market states driven by underwriting profits, investment returns, rate changes, and loss realizations.