Insurance Chapter 1

Risk

Uncertainty concerning the occurrence of a loss

Uncertainty

Situation where probabilities cannot be estimated

Loss exposure

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

Objective risk

Relative variation of actual loss from expected loss

Subjective risk

uncertainty based on a person’s mental condition or state of mind

Chance of loss

The probability that an event will occur

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 the underlying conditions

Subjective probability

the individual’s personal estimate of the chance of loss

Peril

The cause of the loss

Hazard

a condition that increases the chance of loss

Pure risk

A situation in which there are only the possibilities of loss or no loss

Speculative risk

A situation in which either profit or loss is possible (gambling)

Diversifiable risk

Affects only individuals or small groups

Non-diversifiable risk

Affects the entire economy or large numbers of persons or groups within the economy

Enterprise risk

encompasses all major risks faced by a business firm

Strategic risk

refers to uncertainty regarding the firm’s financial goals and objectives

Operational risk

results from the firm’s business operations

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

Systematic risk

the risk of collapse of an entire system or entire market due to the failure of a single entity or group of entities that can result in the breakdown of the entire financial system

Personal risks

risks that directly affect an individual or family

Property risks

Involve the possibility or losses associated with the destruction or theft of property

Direct loss

a financial loss that results from the physical damage, destruction, or theft of property, such as fire damage to a house

Indirect or consequential loss

a financial loss that results indirectly from the occurrence of a direct physical damage or theft loss

Liability risks

involve the possibility of being held legally liable for bodily injury or property damage to someone else

Pure risks that firms face that can have serious financial consequences if a loss occurs

Property, liability, loss of business income, cybersecurity and identity theft

Risk control refers to techniques that reduce the frequency or severity of losses:

Avoidance and loss prevention

Loss reduction refers to activities to reduce the severity of losses

Duplication, separation, diversification

Retention

an individual or business firm retains part or all of the losses that can result from a given risk

Active retention

An individual is aware of the risk and deliberately plans to retain all or part of it

Passive retention

risks may be unknowingly retained because of ignorance, indifference, or laziness

Self insurance

Special form of planned retention by which part or all of a given loss exposure is retained by the firm

Hedging

a technique for transferring the risk of unfavorable price fluctuations to a speculator

Pooling technique

used to spread the losses of the few over the entire group