Principles of Risk & Insurance

Uncertainty concerning the occurrence of a loss

Objective risk and subjective risk

Defined as the relative variation of actual loss from expected loss.

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

Refers to the long-run relative frequency of an event assuming an infinite number of observations and no change in the underlying conditions.

Is the individual’s personal estimate of the chance of loss.

• Is defined as the cause of the loss.
• In an auto accident, the collision is the peril

Is a condition that increases the chance of loss.

Conditions that increase the chance of loss (icy roads, defective wiring).

Dishonesty or character defects in an individual, that increase the chance of loss (faking accidents, inflating claim amounts).

Is carelessness or indifference to a loss because of the existence f insurance (leaving keys in an unlocked car).

Refers to characteristics of the legal system or regulatory environment that increase the chance of loss (large damage awards in liability lawsuits).

• • Pure and Speculative Risk
• • Fundamental and Particular Risk
• • Enterprise Risk

Is one in which there are only the possibilities of loss or no loss (earthquake).

Is one in which both profit or loss are possible (gambling).

Affects the entire economy or large numbers of persons or groups (hurricane)

A risk that affects only the individual (car theft)

Encompasses all major risks faced by a business firm, which include: pure risk, speculative risk, strategic risk, operational risk, and financial risk

• 1. Personal risk
• 2. Property risk
• 3. Direct loss vs. indirect loss
• 4. Liability risks

Involve the possibility of a loss or reduction in income, extra expenses or depletion of financial assets.

• Involves the possibility of losses associated with the destruction or theft of property:
• Physical damage to home and personal property from fire, tornado, vandalism, or other causes.

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

Results indirectly from the occurrence of a direct physical damage or theft loss, such as lost profits due to inability to operate after a fire.

Involves the possibility of being held liable for bodily injury or property damage to someone else.

In the absence of insurance, individuals would have to maintain large emergency funds

The risk of a liability lawsuit may discourage innovation, depriving society of certain goods and services

Risk causes worry and fear

• Avoidance
• Loss control
• Rentention
• Noninsurance transfers
• Insurance