CHAPTER 1 RISK AND ITS TREATMENT

Risk – define as uncertainty concerning the occurrence of a loss

Loss Exposure – is any situation or circumstance in which a loss is possible, regardless of
whether a loss occurs
Objective Risks – is defined as the relative variation of actual loss from expected loss, and
declines as the number of exposures increases
Objective risk varies inversely with the square root of the number of cases under observation
THE LAW OF LARGE NUMBER – states that as the number of exposure units increase, 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 – is defined as the probability that an event will occur
Objective Probability – refers to the long run relative frequency of an event based on the
assumption of an infinite number of observations and of no change in the underlying conditions
- Priori probability
Subjective Probability – is the individual’s personal estimate of the chance of loss
CHANCE OF LOSS VS OBJECTIVE RISK
Chance of Loss – is the probability that an event that cause a loss will occur
Objective Risk – relative variation of actual loss from expected loss
PERIL AND HAZARD
Peril – defined as the cause of loss
Hazard – is a condition that creates or increases the frequency or severity of loss
Four (4) types of Hazard
1. Physical Hazard - is the physical condition that increases the frequency or severity of
loss
2. Moral Hazard – is a dishonesty or character defect of an individual that increases the
frequency and severity of loss
3. Attitudinal Hazard (Morale Hazard) – is carelessness or indifference to a loss, which
increases the frequency and severity of a loss
4. Legal Hazard – refers to characteristics of the legal system or regulatory environment
that increase the frequency or severity of losses
CLASSIFICATION OF RISK
1. Pure and Speculative Risk
Pure Risk – defined as a situation in which there are only the possibilities of loss or
no loss
Speculative Risk – is define a situation which either profit or loss is possible
2. Diversifiable and Non diversifiable Risk
Diversifiable Risk (nonsystematic risk or particular risk) – is a risk that affects
only individuals or small groups and not the entire economy
Non Diversifiable Risk (systematic risk or fundamental risk) – is a risk that
affects the entire economy or large number of persons or groups within the economy
3. Enterprise Risk – is a term that encompasses all major risk faced by a business
firm. Such risk include pure risk, speculative risks, strategic risk, operational risk and
financial risk
Strategic Risk – refers to uncertainty regarding the firm’s financial goals and objectives
Operational Risk – results from the firm’s business operation
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.
MAJOR PERSONAL RISKS AND COMMERCIAL RISKS
1. Personal Risks – are risk that directly affect an individual or family
 Premature Death –death of a family head with unfulfilled financial obligations
Human Life Value – defined as the present value of the family’s share of the
deceased breadwinner’s future earnings.
 Insufficient income during retirement
 Poor health
 Unemployment
2. Property Risks
 Direct Loss – defined as financial loss that results from the physical damage,
destruction or theft of the property
 Indirect or Consequential Loss – is a financial loss that result indirectly from
the occurrence of a direct physical damage or theft loss
 Liability Risks – legally liable if you do something that results in a bodily injury
or property damage to someone else
 Commercial Risk
 Property Risk
 Liability Risk
 Loss of Business Income
 Other Risk
 Other Risks
 Crime Exposure
 Human Resource Exposure
 Foreign Loss Exposure
 Intangible Property Exposure
 Government Exposure
THE BURDEN OF RISK ON SOCIETY
 Larger Emergency Fund
 Loss of Certain Goods and Service
 Worry and Fear
TECHNIQUES FOR MANAGING RISK
 Risk Control – refers to the technique that reduce the frequency and severity of
losses
 Avoidance
 Loss Prevention
 Loss Reduction
 Risk Financing – refers to the techniques that provide for the funding of losses
 Retention – means that an individual or a business firms retains part of the
losses that can result from a given risk
SELF INSURANCE – is a special form of planned retention by which part or all of a given loss
exposure is retained by the firm
 Non Insurance Transfer – the risk is transfer other than an insurance
company
Hedging – is a technique for transferring the risk of unfavorable price
fluctuations to a spectator by purchasing and selling future contracts on an
organized exchange
 Insurance -