greater is the degree of accuracy in

predicting the proportion of home that

will burn

CHAPTER 1 RISK & ITS

TREATMENT
Risk

Uncertainty concerning the occurrence

of a loss to be identified the property
or life being insured
Example : the risk of being killed in
an auto accident is present because
uncertainty is present

Chance of Loss

Objective Probability

Loss exposure

Any situation or circumstance in

which a loss is possible, regardless of
whether a loss occurs.
Example : manufacturing plants may
be damaged by an earthquake or flood

Objective Risk

The relative variation of actual loss

from expected loss
Example : 10000 houses are insured,
on average 100 houses burn each year.
There is a variation of 10 houses from
the expected number of 100, or
variation of 10%

Subjective Risk

Uncertainty based on a persons

mental condition or state of mind
Example : a drunk driver is
uncertainty whether he will arrive
home safely or being arrested for
drunk driving

Law of Large Numbers

As the number of exposure units
increases, the more closely the actual
loss experience will approach the
expected loss experience
Example : as the number of home
under observation increases, the

The probability that an event will

occur

The long-run relative frequency of

an event based on the assumption of
an infinite number of observation
and of no change in the underlying
condition
Can be determined by two way :
Deductive reasoning
Inductive reasoning

Subjective Probability

The individuals personal estimate of

the chances of loss
Factors affecting subjective
probability :
Age
Gender
Intelligence
Education
People who by lottery ticket on their
birthday believe it is their lucky day
and overestimate the small chance of
winning

Peril

Cause of loss
Example : if your house burn of fire,
then the peril is the fire

Hazard

Condition that creates or increases

the frequency or severity of loss

Physical Hazard

Physical Condition that creates or

increases the frequency or severity of
loss
Example : icy road that increases
than chance s of auto accident

Moral Hazard

Dishonesty or character detect in an

individual increases the frequency or
severity of loss
Can be control by :
Deductibles
Waiting periods
Exclusions
Riders
Example : Faking an accident to
collect insurance

Attitudinal Hazard (morale hazard)

Carelessness or indifference to a
loss, which increases the frequency
or severity of loss
Example : Leaving car keys in
unlocked car which increases the
chance of theft
Legal Hazard
Characteristics of the legal system or
regulatory environment that
increases the frequency or severity of
loss
Example : Adverse jury verdicts or
large damage awards in liability
lawsuits
Pure Hazard

A situation in which there are only

the possibilities of loss or no loss
Example : Job-related, damaged

A situation in which either profit or

loss is possible
Example : Betting on horse race,
investing real estate

Diversifiable Risk

Risk that affect only individual or

small groups and not the entire
economy
Example : Car theft, robberies

Non-diversifiable Risk

Risk that affect the entire economy or

large numbers of persons or groups
within the economy
Example : Natural disaster, cyclical
unemployment, rapid inflatio

Enterprise Risk

A term that encompasses all major

risks faced by a business including
pure risk, speculative risk, strategic
risk, operational risk and financial risk

Strategic Risk

Uncertainty regarding the firms

financial goal and objectives
Example : if a firm enters a new line
of business, the line may be
unprofitable

Operational Risk

Results from the firms business operation

Example : A bank that offers online
banking services may incur losses

Speculative hazard
Financial Risk

Uncertainty of loss because of adverse

change in community prices, interest
rates, foreign exchange rates and the
value of money
Example : A food company that agrees
to deliver cereal at fixed price to a
supermarket chain in six months may
lose money if grain prices the product

Avoidance

Shying away from potential loss

Example : risk divorce can be avoided
by not marrying
Loss Control
Consist of certain activities that
reduce the frequency or severity of
losses

Active retention

An individual is consciously aware of

the risk and deliberately plans retains
all or part of it
Use for two major reasons :
Can save money
Risk may be deliberately retained
A business firm may deliberately
retain the risk of petty thefts by
employees.
Passive retention

Loss Prevention

Reducing the probability of loss so

that the frequency of losses is reduce
Example : Auto-accidents can reduce
if motorists take a safe-driving course
and drive defensively

Loss Reduction

Reduce the severity of a loss after it

occur
Example : Fire doors and fire walls
can be used to prevent a fire from
spreading

Self-Insurance

An individual or business firm retains

part of all the financial consequences
of a given risk

A special from of planned retention by

which part or all of a given loss
exposure is retained by the firm
Example : A large corporation may
self-insure or fund part or all of the
group health insurance benefits paid to
employees

Retention Limits

Retention

Unknowingly retained because of

ignorance or laziness
Example : Workers with earned income
are not insured against the risk of total
and permanent disability.

The maximum amount of insurance

that insurer is willing to carry at its
own risk on any one life

Non-insurance Transfer

The risk is transferred to a party other

than life the insurance