Risk and Insurance

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Important information from lecture 1 of risk and insurance
Bianca Davis
Flashcards by Bianca Davis, updated more than 1 year ago
Bianca Davis
Created by Bianca Davis over 7 years ago
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Question Answer
Definition of Risk a condition in which there is a possibility of an adverse deviation from a desired outcome that is expected or hoped for.
Definition of uncertainty (objective) variation between the present and the future outcome can be measured thus decision based on actual risk
Definition of uncertainty (subjective) lack of knowledge as to real facts at a particular point in time to make a decision. It is not measurable; involves feeling or state of mind
Degree of risk is measured by the likelihood or variation between the expected and the actual results
Frequency number of times that a risk occurs
Severity magnitude/financial implications of the risk
Risk combination Risk is a combination of the likelihood (frequency) of an event and the extent of financial loss (severity) should the event occur
Expected Value probability of the loss multiplied by the amount of the potential loss
Physical hazards physical characteristics or attributes that increase the chance of loss from the various perils
Moral hazards human aspects such as attitude or characters of the insured person, which may influence the outcome such as defrauding the insurer
Morale hazard results from the careless attitude on the part of an insured or uninsured person toward the occurrence of losses
Legal Hazard the increase in the frequency and severity of loss that arises from legal doctrines enacted by legislatures and created by the courts
Peril a cause of a loss
hazard a condition that may create or increase the chance of a loss arising from a given peril
Financial risks exposures whose outcome can be measure into monetary terms
Non-financial risks exposures whose measurement in monetary terms is not possible. (the risk has no financial consequences)
Dynamic risks resulting from the changes in the economy and normally benefit society in the long run since they are a result of adjustments to misallocation of resources
Static risks losses, which occur even if there are no changes in the economy. These losses are caused by perils such as dishonesty of individuals and nature
Fundamental risks involve losses that are impersonal in origin and with wide spread consequences
Particular risks arise out of individual events and that are felt by an individual rather than the entire group
Pure risks situations that involve only the chance of loss or no loss
Speculative risks situation where there is a possibility of loss as a gain or a break even
Systematic risk in economics, the term is often used where a shock, such as the failure of a single entity, could cause cascading effects and severely disrupt the financial system
Personal risks consists of the probability of loss of income or assets as a result of loss of ability to earn income
Property risk embrace two distinct types of loss, direct loss or indirect (consequential) loss.
Liabilty risks arises from the unintentional injury of other persons, or damage to their property through negligence or carelessness as well as from intentional injuries or damages
Risk arising from failure of others These risks are insurable. the risks arise out of non-performance of agreed contracts resulting in financial loss
Cost of losses problems - uncertainty about the cost of losses - human costs in terms of pain and suffering - monetary cost or financial severity
Burden of risk losses that naturally occur
Risk management identification, analysis and economic control of those risks which can threaten the assets or earning capacity of businesses
Risk management concept focuses on reducing the cost of safe guarding against insurable and non insurable risks by whatever means are most appropriate and cost effective
Market risk arising from adverse movements in market prices
Credit risk the potential that a borrower will fail to pay a debt
Liquidity risk risk that business will have insufficient liquid assets to meet obligations that come due
Operational risk risk of loss from inadequate or failed internal processes. E.g. failure in control and management, failure in it processes, human errors, fraud and jurisdictional and legal risk
Reputational risk the potential that negative publicity will cause a loss
Strategic risk failing to successfully implement the firms strategies
Compliance risk risk of failing to comply with laws and regulations
Risk control focuses on minimizing the risk of loss which the firm is exposed and includes the techniques of avoidance and reduction
Risk reduction designed to reduce the likelihood of loss or the potential severity of those losses that do occur through; loss prevention and loss control
Risk avoidance when decisions are made that prevent a risk from coming into existence
Risk financing guarantee the availability of funds to meet those losses which remain after the application of risk control techniques
Risk transfer a mechanism whereby in consideration of payment of a small certain amount (the premium) by the insured, the insurer contracts to indemnify the insured to a certain limit for the agreed losses, which may or may not occur
Risk retention or assumption where the person or organisation takes no positive action to reduce, avoid or transfer risk
Intentional retention a person recognises the existence of the risk but due to unattractive choices available he assumes the consequences impacted
Unintentional retention a person is open to the risk but does not identify its existence. E.g. the person takes out insurance to cover a risk but gets a policy which does not cover that risk
High Severity/High Frequency methods Avoidance and reduction Reduction may be used when it is possible to lower the potential severity or the probabiilty to a manageable level; otherwise the risk should be avoided
High severity/Low frequency methids Transfer - Insurance High severity implies some catastrophic impact if the loss should occur, and the low probability implies a lower expected value and hence the low cost of transfer, which makes insurance the most attractive option
Low severity/High frequency methods Retention and reduction Retention because the high frequency implies that transfer will be costly and reduction to minimise the aggregate amount of losses that must be borne possible
Low severity/Low Frequency Retention Risks seldom occur and when the occur their financial impact is inconsequential, hence can be retained, without any financial strain to the business
Six steps in the risk management process 1. Determination of objectives 2. Identification of risks 3. Analysing and evaluation of risks 4. Consideration of alternatives and selection of the risk treatment device 5. Implementation of the decision 6. Evaluation and review
Post-Loss Objectives Survival Continuity of operations Earning stability Continued growth Social responsibility
Pre-Loss objectives Economy Reduction in anxiety Meeting externally imposed Social responsibility
Objective-based risk identification Any event that may endanger achieving an objective partly or completely is identified as risks
Scenario-based risk identification Any event that triggers an undesired alternative scenario is identified as risk
Taxonomy-based risk identifcation a breakdown of possible risk sources based on the taxonomy and knowledge of best practices
Critical risks losses are of a magnitude that would result in bankruptcy
Important risks losses that would not lead to bankruptcy but would require the firm to borrow in order to continue operations
Unimportant risks losses that could be met out of the current income of the firm without imposing undue financial strain
Social benefits of Insurance Indemnification of loss Reduction of anxiety Source of investment funds Loss prevention Enhancement of Credit
Social Cost of Insurance Cost of doing business Fraudulent claims Inflated claims
Individual risk events should be _______ independent In practice we wont often get strict independence but a low correlation is desirable
Large numbers of similar risks should be _______ pooled This is in order to reduce the variance and hence achieve more certainty. They should still be independent.
The loss must be ______ accidental The probability of the event should be relatively small. In other words, an event that is nearly certain to occur is not conducive to insurance or may invite adverse selection behaviour.
Adverse Selection a person whose exposure to loss is higher than average to purchase or continue insurance to a greater extent than those whose exposure is less than average
There should be an ______ ______ on the liability undertaken by the insurer ultimate limit We must be able to tell when a loss has taken place and we must be able to set some value to the extent of it.
Moral hazards should be ______ eliminated as far as possible because they are difficult to quantify, result in selection against the insurer and lead to unfairness in treatment between one policyholder and another.
Indemnity the exact compensation required to restore the policyholder to the financial position they enjoyed immediately before a loss occurred.
Excess the initial amount of each and every claim that is supposed to be borne before any indemnification
Insurable Interest Where you have a valid reason to insure and stand to suffer a direct financial loss if the event insured against occurs. E.g. a person has an insurable interest in their own car but not their neighbours car
Utmost Good Faith Whereby both parties of the contract must disclose all the material facts truly and fully (whether requested or not).
Subrogation Subrogation allows the insurer to pursue any rights which the policyholder may possess, always in the name of the insured.
Proximate Cause An insurance policy will define the perils or insured events that cover is provided for.
Contribution An insured party may have policies with several insurers for the same risk. Contributions is the right of an insurer to call upon the other insurers to share the costs of such a claim payment.
Private Insurance Life Insurance Health Insurance Property and liability insurance
Social Insurance Compulsory protection for personal risks. E.g. ACC
Public Guarantee Insurance Government operated, compulsory, quasi social insurance programs. E.g. EQC
General Insurance Characteristics Cover is for a fixed period Claims are not of fixed amounts A claim occurring does not bring the policy to an end
General Insurance Products Liability Property Damage Financial Loss Fixed benefits
Liability Provide indemnity where the insured, owing to some form of negligence, is legally liable to pay compensation to a third party.
Employers Liability This insurance indemnifies the insured against legal liability to compensate an employee or his/her estate for bodily injury, disease or death suffered, owing to negligence of the employer in the course of employment.
Motor Third Party Liability This insurance indemnifies the owner of a motor vehicle against compensation payable to third parties for personal injury or damage to their property
Public Liability The insured is indemnified against legal liability for the death of or the bodily injury to a third party or for damage to property belonging to a third party.
Product Liability This insurance indemnifies the insured against legal liability for the death of or bodily injury to a third party or for damage to property belonging to a third party, that results from a product fault.
Professional Indemnity The insured is indemnified against the legal liability resulting from negligence in the provision of a service.
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