Today’s Lecture Introduction to Risk and Insurance Definitions Methods of handling risk Insurance vs. gambling Ideal requisites for insurability Types of Insurance

Definitions Risk - Unpredictable Outcome Pure Risk Loss No Loss Speculative Risk Loss No Loss Gain

Type of Risk - Example Which of the following risks represents Speculative Risk? AYour car being stolen BYour mutual fund going down in value CFlunking a course DGetting a speeding ticket ENone of the above

Definitions (Cont.) Risk Neutral - Indifferent Toward Risk Value of Risky Situation is Expected Loss Risk Averse - Prefer to Avoid Risk Willing to Pay More than Expected Loss to Avoid Risk Risk Seeker - Prefer Risk Would Pay More than Expected Return to Engage in Risky Situation

Risk Attitudes - Example Engaging in a wager when the odds are in your favor is something that which of the following risk types would do? IRisk Neutral IIRisk Averse IIIRisk Seeker AI onlyBII only CIII onlyDI and III ENone of the above

Definitions (Cont.) Exposures - Person or Property Facing Pure Risk Personal Loss Exposures - Affect Life, Health or Income of an Individual Property Loss Exposure - Damage to Items Direct Loss - Cost of Repair (Replacement) Consequential Loss - Additional Costs Liability Loss Exposure - Responsible for Damages to Others

Loss Exposure Example The State Farm Car policy used in this class protects against which of the following exposures? IPersonal Loss IIProperty Loss IIILiability Loss AI and II onlyBI and III only BII and III onlyC I, II and III ENone of the above

Definitions (Cont.) Perils - Immediate Causes of Loss Hazards - Conditions Affecting Perils Physical Hazards - Property Conditions Intangible Hazards - Attitudes and Culture Moral Hazard - Fraud Morale Hazard - Indifference Societal Hazards - Legal and Cultural

Hazards Example Exaggerating the value of your property when submitting an insurance theft claim represents which of the following type of hazard? APhysical BMoral CMorale DSocietal ENone of the above

Methods of Handling Pure Risk Avoidance Loss Control –Loss Prevention - Reduce Loss Frequency –Loss Reduction - Lower Loss Severity Retention Transfer –Corporations –Contractual Agreements

Definition of Insurance (Page 52 of text) Insurance is a social device in which a group of individuals (insureds) transfer risk to another party (insurer) in order to combine loss experience, which permits statistical prediction of losses and provides for payment of losses from funds contributed (premiums) by all members who transferred risk.

Insurance Versus Gambling Gambling Creates Risk Insurance Transfers Existing Risk Gambling is Speculative Risk Insurance Deals with Pure Risk

Ideal Requisites for Insurability 1Large Number of Similar Exposure Units 2Fortuitous Losses 3Catastrophe Unlikely 4Definite Losses 5Determinable Probability Distribution 6Economic Feasibility

Ideal Requisites Example 1 Which, if any, of the ideal requisites for insurability are violated by flood insurance? ALarge Number of Similar Exposure Units BFortuitous Losses CCatastrophe Unlikely DDefinite Losses EDeterminable Probability Distribution

Ideal Requisites Example 2 Which, if any, of the ideal requisites for insurability are violated by divorce insurance? ALarge Number of Similar Exposure Units BFortuitous Losses CCatastrophe Unlikely DDefinite Losses EDeterminable Probability Distribution

Ideal Requisites Example 3 Which, if any, of the ideal requisites for insurability are violated by mental health insurance? ALarge Number of Similar Exposure Units BFortuitous Losses CCatastrophe Unlikely DDefinite Losses EDeterminable Probability Distribution

Types of Insurance Personal or Commercial Life-Health or Property-Liability Private or Government Voluntary or Involuntary

Types of Insurance - Examples Social Security Personal Life-Health Government Involuntary Medical Malpractice Commercial Property-Liability Private Voluntary