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115 Cards in this Set
- Front
- Back
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What is Uncertainty?
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The state of not knowing regarding a loss or events which might produce a loss
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All losses are in _________ terms
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financial
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When a known loss occurs, how much risk is there?
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none
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Probability of a loss
0 % = _________ Event 100% = _______ Event |
Probability of a loss
0 % = Impossible Event 100% = Certain Event |
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Both Pure and Speculative risk involve __________
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uncertainty
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Pure Risk provides for two possible states of the world, ____ and _____
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Loss and no loss
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Speculative risk provides for three possible states of the world, ____, ____, and _____
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Loss, No Loss/Gain, and Gain
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What are some examples of Speculative Risk?
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Stock Market, Investment, Starting a Business, Gambling
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What is static risk?
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Risk that does not significantly change over time and is always present
i.e. natural disasters, fire, theft, death |
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What are dynamic risks?
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“new/emerging risks” as a result of changing circumstances, laws, or conditions
Examples: Terrorism, tax laws, compliance risk, internet/privacy risk, pandemics |
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What are the three major types of pure risk?
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Personal Pure Risk
Property Pure Risk Liability Pure Risk |
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What is the source of Personal Pure Risk?
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Human Capital
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What is Human Capital
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The ability to generate income
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What makes human capital risky?
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Subject to “life and health exposures to loss." Ex: illness/sickness/injury/death. or Unemployment/Retirement. This creates an economic loss.
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What is the economic loss regarding human capital?
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Loss of income + medical expenses
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Why does everyone face personal pure risk?
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Everyone faces personal pure risk because everyone has the ability to generate capital
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What is the source of property pure risk?
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Ownership of Financial or Physical Assets
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What is the risk of owning Financial or Physical Assets?
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Theft/Damage
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Explain the losses incurred by Theft/Damage of Financial or Physical Assets
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Direct Losses
Example: Cost of repair and Cost of replacement Indirect Losses Example: Loss of income, Extra expenses, Business interruption, etc. |
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Why does everyone face property pure risk?
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Everyone faces Property Pure Risk because everyone owns property
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Where does Liability Exposure arise from?
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Negligent Acts
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Explain the losses incurred by Liability exposure
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Legal fees
Judgement (if any) Reputation Risk |
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When do people face liability pure risk?
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When they are negligent
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What are the 5 factors affecting risk
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Peril
Frequency Severity Hazards Burden or Cost of Risk |
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What is Peril?
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The immediate cause of the loss.
Ex: Random event that causes the loss to occur |
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Explain Frequency of a loss
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# of loss in a given time period
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What is frequency of a loss measured in?
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Positive whole numbers
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Low frequency losses = ____________________________
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Low Probability Events
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High frequency losses = ___________________________
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High Probability Events
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Explain the severity of the loss
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Given that a loss has occurred, how much in $ terms will it be
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What is severity measured in?
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Measured in positive, non-zero $ terms
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What is severity conditional upon?
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Conditional upon frequency being positive
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If frequency is _, then severity is not an issue
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0
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What is a hazard?
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A condition which lies behind the occurrence of a loss
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What are the three functions of hazards? Hazards will do one of these three things
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Increase the frequency of the loss
Increase the severity of the loss Increase both the frequency and severity of the loss |
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What are the three kinds of Hazards?
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Physical, Moral, Morale
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What are three examples of Physical Hazard?
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Location, Construction, Use
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What is Moral Hazard?
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Moral Hazard exists when the presence of insurance changes the behavior of the insured so as to increase the frequency and/or severity of the losses
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What are four classic examples of Moral Hazard
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Arson, Arranged Theft, Murder, Insurance Fraud
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What is a common trigger of Moral Hazard?
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Presence of insurance resulting in change in behavior
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What is morale hazard?
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Carelessness concerning losses
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Firms who face ____ risk are more valuable
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less
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What are examples of the costs of risk faced by the burden of Medical Malpractice?
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Financial Losses
-Legal Fees -Judgement (Damages) Loss of “goodwill” -Reputation loss -Loss of Revenue Cost of Risk Management -Loss mitigation tools or techniques to finance the losses -Loss of goods and services judged to be “too risky” Cost of residual uncertainty |
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What are the two ways to measure risk
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Subjectively and Objectively
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What is subjective measurement of risk?
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An individual’s perception on an uncertain situation
No “scale," instead the individual has different attitudes toward risk |
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What are the 3 attitudes toward risk?
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Risk Averse
Risk Lovers Risk Neutral |
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Explain the objective measurement of risk
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Risk is a variability concept
Variation of actual outcomes around or about expected outcomes Variation of Actual Losses (AL) from Expected Losses (EL) When AL = EL, no risk is present When AL < EL, The risk is managed When AL > EL, There is more risk than anticipated One way to measure the uncertainty objectively AL-EL |
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What is the Risk Management Process?
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Decision making process to manage pure risk events or activities facing firms and individuals
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Which kind(s) of risk are focused on by Traditional Risk Management?
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Pure Risk only
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Which kind(s) of risk are focused on by Enterprise Risk Management?
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Pure and Speculative Risk
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What are risk managers?
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Specialized branch of financial management
Uses the Risk Management decision process |
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What is the Temple University connection to Risk Management as a concept
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Responsible for the evolution of Risk Management as a concept.
1960’s - Insurance Management Narrow Non-Strategic Present - Managing Risk Add Value - Crisis Management |
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What is the main benefit of risk management
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Preventing business failures
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What are the four attributes of the cost of risk?
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Costs of accidental losses not reimbursed by insurance or outside sources
Insurance premiums or expenses incurred for noninsurance indemnity Costs of risk control techniques to prevent or reduce the size of accidental losses Costs of administering risk management activities |
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The reduction in overall cost of risk can increase _______
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profits
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How does Risk Management Reduce Deterrence Effects of Hazard Risks
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Alleviates management’s fears about potential losses, thereby increasing the feasibility of ventures that once appeared too risky
Increases profit potential by greater participation in investment or production activities Makes the organization a safer investment to suppliers of investment capital |
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How does Risk Management reduce downside risk?
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Include delays, errors, cost increases, and the failure of any aspect of the operation
Organizations use stop-loss limits, which are triggers to stop operation when stop-loss limit is surpassed |
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What is a technique used to manage downside risk?
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Hedging funds
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What is intelligent risk taking?
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Decisions regarding new opportunities should be based on the organization’s risk appetite
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What is a risk appetite?
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The events or perils and levels of impact an organization intends to retain, treat, and monitor
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How does Risk Management maximize profitability?
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Risk management helps to advise firms how to manage their business activities based on provided information to evaluate the potential risk-adjusted return on capital.
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What is Holistic Risk Management?
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A fragmented, departmentalized approach to risk management can miss critical risks to the organization
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What is the Sarbanes-Oxley Act of 2002?
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Sarbanes-Oxley Act of 2002 requires both the management of public companies and their auditors to assess and report on financial risk and controls
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What is the Dodd-Frank Act of 2010
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The Dodd-Frank Act of 2010 requires that financial bank holding companies and certain other public companies have a risk committee, one of the persons on the committee must be a risk-management expert
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What are the benefits for the economy put forth by Risk Management?
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Economy’s cost of risk management includes the resources consumed by or devoted to combating losses
Risk management benefits the entire economy by reducing waste of resources, improving allocation of productive resources, and reducing systemic risk |
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How does Risk Management improve the allocation of productive resources?
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Risk Management makes those who own or run an organization more willing to undertake formerly risky activities because they are better protected against the downside of risk
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What are the five steps of the risk management process?
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1. The Identification Step
2. Evaluate Risk Management Options 3. Select a Risk Management Option 4. Implement the Chosen/more likely option 5. Periodically evaluate chosen strategies |
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What are some loss exposure identification methods?
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Document Analysis, Compliance Reviews, Inspections, Expertise within and beyond the organization
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What are two elements of evaluating risk control?
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Safety options and financing options
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What are the factors affecting a decision regarding a risk management option?
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Attitudes toward risk of key decisions
Subjective Risk |
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How does one implement a chosen risk management option?
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Examples: begin safety program, purchase insurance, set up self insurance fund
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How does one evaluate chosen RM options?
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Cost-Benefit Analysis
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What is an example of Property Loss Exposure?
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Legal interest in property
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What does interest mean?
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Financial stake in the property
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What are the 5 sources of legal interest?
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Ownership interest, lease agreement, Insurance, Buyers and sellers, and Bailee Interest
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What are the two kinds of Ownership interest?
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Present Ownership Interest
- Most common type of legal interest Future Ownership Interest |
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What is FOB (Point)
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FOB (Point) - Indicates the point at which the financial responsibility shifts from the seller to the buyer.
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Explain the interest of bailee
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Limited to the repair/replacement
Bailee can often limit liability |
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What is a secondary loss?
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A loss a firm also suffers as a result of the primary loss
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How does a firm have personnel loss exposure?
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Firm has key employee - loss of income and or medical expenses
Creates loss of revenue and increased expenses Personnel loss exposures are a special case of Net Income Loss Exposures |
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Property and Liability Loss Exposures usually result in what additional kind of Loss Exposure?
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Net Income
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Net income loss exposures are also known as...
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Business Interruption Losses
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Management and Evaluation evaluates what kind of risk?
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Objective
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How do you find expected losses
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Weighted average of loss amount * probability of loss
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What is an exposure unit?
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Item, person, or thing of value exposed to the loss
Example: Property (car, building), Driver, Life, Reputation of a firm |
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_____ Serves as a basis for insurance adjustments
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P*
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What is the gross premium
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Premium paid per unit of coverage to insure a particular risk
Price should be sufficient to at least cover all costs of insurance contract The insurer does not know the actual gross premium until the last claim is settled |
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What is the Equation for Gross Premium?
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Gross Premium = Pure Premium + Risk Charge + Administrative Expenses
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What is the pure premium?
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Amount or portion of gross premium which is calculated or estimated as being sufficient to pay for the losses only (P*)
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AL = EL - _________
AL<EL - _________ AL>EL - _________ |
AL = EL - Break Even
AL<EL - Profit AL>EL - Loss |
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What is a risk charge?
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Extra amount charged by the insurer to estimate and insure risk
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What influences the size or magnitude of the risk charge?
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The accuracy of the estimate of P*
The level of confidence in the estimate of P* Past information is used to estimate P* |
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The more past information a firm has, the _____ the risk charge will be
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lower
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What is a state premium tax?
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Sales tax on an insurance contract
Usually 15-30% of the overall premium |
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How do you find the probability of two events happening (AND)
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[Probability of A happening]*[Probability of B happening]
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2 or more events are said to be ________ _________ if they cannot occur at the same time
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2 or more events are said to be mutually exclusive if they cannot occur at the same time
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How do you find the probability of one of two events happening?
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Probability of Event A OR Event B happening
([Probability of A happening]+[Probability of B happening])-[Probability of A AND B happening] |
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What is a random variable?
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A variable who’s outcome depends on some chance event
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What is a probability distribution?
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Table/graph that indicates for each possible outcome of random variable/the probability of obtaining that particular outcome
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How do you find the variance?
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6 column chart
Outcomes (Rolling a 1 on a die, 2 on a die, etc.) Mean - Weighted average of the probability of events (Outcome 1*Probability of event)+(Outcome 2*Probability of event)...etc. Outcome - Mean (Outcome - Mean)^2 Probability of event Column 4 * Column 5 Variance = Sum of column 6 |
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How do you find the standard deviation?
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√Variance
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How do you find the coefficient of variation?
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Standard Deviation/Mean
Units of measurement = Expected event/time frame Example: Expected Robberies/Month |
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Firm with the higher coefficient of variation is the _______ firm
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riskier
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What are the three possible goals of Risk Control?
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Decrease the frequency of the loss
Decrease the severity of the loss Improve the predictability of losses - Decrease variability of losses - Decrease the coefficient of variation |
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What is Reactive Avoidance?
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Stop engaging in an activity causing the loss
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What is proactive avoidance?
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Never engage in the activity causing the loss
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When should avoidance be considered as a RM option?
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When cost>benefit
When risk is high in frequency and high in severity |
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What are the two types of Loss Control?
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Loss Prevention and Loss Reduction
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What is Loss Prevention?
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Attempts to reduce the frequency or the probability of the loss
Interrupt or break the chain of events that take place prior to a loss Ex: Heinrich’s Domino Theory |
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What is Loss Reduction?
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Assume a loss has occurred, what could have been done before/after to reduce the severity of the loss
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What is Separation of Exposure Units?
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Break items/activities/assets/responsibilities down into smaller parts and separate them
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What are the benefits of separating exposure units?
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Decrease the coefficient of variation
Limit the size of the loss from any single occurrence Works well with net income losses |
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What is Duplication of Exposure Units?
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Key asset/activity/responsibility is replicated or duplicated and held in reserve
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What is a soft market?
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a market in which more people want to sell than want to buy
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What is a hard market?
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That part of the insurance sales cycle in which competitive pricing is at a minimum as companies charge the premiums necessary to meet their underwriting losses in order to avoid insolvency and boost capacity;
High Demand, low supply |
