Review Sheet for RMI 3011

Exam 1

Chapter 1

What is risk?

Risk is uncertainty about a chance or amount of loss

Uncertainty exists when the probability of an event is not 0 or 1

How can risk be classified?

1. Pure risk

a. Chance of loss or no loss

b. No chance of gain

c. Risk of premature death (life insurance), risk of insufficient income during retirement, risk of poor health (health insurance), risk of unemployment

2. Speculative Risk

a. Chance of loss, no loss or gain

i. Starting a business

ii. gambling

3. Fundamental Risk

a. Risk that affects a large number of individuals or the entire economy

i. Inflation, stock market, unemployment

4. Particular Risk

a. A risk that affects only individuals as individuals

i. Car accident

5. Static Risk

a. Doesn’t change over time

i. Fire probability

6. Dynamic Risk

a. Changes over time

i. Terrorism probability

7. Operational risk

a. Risks involved when starting or operating a business

8. Financial risk

a. Interest rate risk – might rise or fall

b. Credit risk – people might not pay

c. Commodity price risk – resources might increase in price

9. Strategic risk

a. Risk when a business strategy does not work as predicted

10. Liability risk

a. Responsibility for actions that cause injury or property damage to another

b. No maximum upper limit

c. Liens on future wages can be imposed

d. May result in legal defense costs, regardless of merit of claim

Insurance companies like to handle pure, particular, static risks

What is the difference between objective and subjective risk?

1. Objective risk – defined as the relative variation of actual results from expected results. Can be measured across time and individuals. Standard deviation is used.

2. Subjective risk – depends on individual’s state of mind. May differ across time and individuals

What is the difference between a peril and a hazard?

Peril – defined as the immediate cause of the loss

Fire, wind, hail

Hazard – a condition that increases the chance of a loss

Physical hazard – something tangible
Moral hazard – condition where the insured has an incentive to profit from a loss
Morale hazard - Carelessness or indifference caused by the presence of insurance
Political/legal hazard – government does something that unintentionally affects someone

What are some common perils?

1. Fire, wind, hail

What are the different types of hazards? How can you tell them apart? How do insurers reduce moral hazard?

a. Physical hazard – something tangible

b. Moral hazard – condition where the insured has an incentive to profit from a loss

c. Morale hazard - Carelessness or indifference caused by the presence of insurance

d. Political/legal hazard – government does something that unintentionally affects someone

What do insurers use to reduce moral hazard?

a. principle of indemnity

b. principle of underwriting

a. make sure people get a policy that fits their risks

c. imposing a deductible

d. claims adjusting

a. make sure that a covered loss happen

b. make sure that people are paid the right amount for their loss

How can you measure risk? If you had two company’s cash flows, how could you tell which one was riskier?

You can measure risk with standard deviation. The higher the standard deviation (variance) is the higher the risk.

The business that has a more fluctuating cash flow is riskier.

What is the difference between a direct and indirect loss?

Direct loss – financial loss from damage to property

Car accident, fire in the house

Indirect loss (or consequential loss) – losses arising from loss of use of property

What are some of the burdens of risk on society?

Requires emergency funding

Money to cover your ass in case you cant pay for it

Increased prices/loss of certain goods and services

Eg. There are only a few vaccines manufactures because they most of them could not pay insurance

Worry or Fear that something might happen



	What is risk Review Sheet for RMI 3011 Exam 1 Chapter 1 What is risk? Risk is uncertainty about a chance or amount of loss Uncertainty exists when the probability of an event is not 0 or 1 How can risk be classified? 1. Pure risk a. Chance of loss or no loss b. No chance of gain c. Risk of premature death (life insurance), risk of insufficient income during retirement, risk of poor health (health insurance), risk of unemployment 2. Speculative Risk a. Chance of loss, no loss or gain i. Starting a business ii. gambling 3. Fundamental Risk a. Risk that affects a large number of individuals or the entire economy i. Inflation, stock market, unemployment 4. Particular Risk a. A risk that affects only individuals as individuals i. Car accident 5. Static Risk a. Doesn’t change over time i. Fire probability 6. Dynamic Risk a. Changes over time i. Terrorism probability 7. Operational risk a. Risks involved when starting or operating a business 8. Financial risk a. Interest rate risk – might rise or fall b. Credit risk – people might not pay c. Commodity price risk – resources might increase in price 9. Strategic risk a. Risk when a business strategy does not work as predicted 10. Liability risk a. Responsibility for actions that cause injury or property damage to another b. No maximum upper limit c. Liens on future wages can be imposed d. May result in legal defense costs, regardless of merit of claim Insurance companies like to handle pure, particular, static risks What is the difference between objective and subjective risk? 1. Objective risk – defined as the relative variation of actual results from expected results. Can be measured across time and individuals. Standard deviation is used. 2. Subjective risk – depends on individual’s state of mind. May differ across time and individuals What is the difference between a peril and a hazard? Peril – defined as the immediate cause of the loss Fire, wind, hail Hazard – a condition that increases the chance of a loss Physical hazard – something tangible Moral hazard – condition where the insured has an incentive to profit from a loss Morale hazard - Carelessness or indifference caused by the presence of insurance Political/legal hazard – government does something that unintentionally affects someone What are some common perils? 1. Fire, wind, hail What are the different types of hazards? How can you tell them apart? How do insurers reduce moral hazard? a. Physical hazard – something tangible b. Moral hazard – condition where the insured has an incentive to profit from a loss c. Morale hazard - Carelessness or indifference caused by the presence of insurance d. Political/legal hazard – government does something that unintentionally affects someone What do insurers use to reduce moral hazard? a. principle of indemnity b. principle of underwriting a. make sure people get a policy that fits their risks c. imposing a deductible d. claims adjusting a. make sure that a covered loss happen b. make sure that people are paid the right amount for their loss How can you measure risk? If you had two company’s cash flows, how could you tell which one was riskier? You can measure risk with standard deviation. The higher the standard deviation (variance) is the higher the risk. The business that has a more fluctuating cash flow is riskier. What is the difference between a direct and indirect loss? Direct loss – financial loss from damage to property Car accident, fire in the house Indirect loss (or consequential loss) – losses arising from loss of use of property What are some of the burdens of risk on society? Requires emergency funding Money to cover your ass in case you cant pay for it Increased prices/loss of certain goods and services Eg. There are only a few vaccines manufactures because they most of them could not pay insurance Worry or Fear that something might happen