Risk Management Introduction to Risk and Insurance

Definitions Risk - Unpredictable Outcome In terms of insurance, risk is the chance of financial loss from perils (causes) to people or property. 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

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

Methods of Handling Pure Risk Avoidance Loss Control (reduce risk) ◦ Loss Prevention - Reduce Loss Frequency ◦ Loss Reduction - Lower Loss Severity Transfer ◦ Corporations ◦ Contractual Agreements Assumption – retention

Risk Management Process Identify Risks of Loss Assess Seriousness of Risks Handle Risks Serious Risks Nonserious Risks Shift Risk Avoid Risk Reduce Risk Assume Risk

Risk Management Plan Young, Single Adult Risk Seriousness of Financial Impact Method for Handling Auto AccidentsHigh *Collision and Liability Insurance *Driver Education Class *Safer Driving Practices Theft or damage to property in apartments Medium *Renter’s Insurance *Take security measures Theft or damage to property at work or in my car Medium *Renter’s Insurance *Floater policy *Take security measures Injury to apartment visitors Medium *Renter’s Insurance *Keep apartment safe Personal Illness and sports Injuries High *Health Insurance *Avoid Risk – stop skydiving, stop smoking *Wear a bike helmet *Get specialized training

Risk Management Plan Young, Single Adult Continued… Risk Seriousness of Financial Impact Method for Handling Vision & Dental NeedsLow *Dental Insurance *Assume Risk – Pay out of pocket for any expenses Income ProtectionLow/Medium *Life Insurance *Disability Insurance

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

Definitions (Cont.) Perils - Immediate Causes of Loss Hazards - Conditions Affecting Perils * Physical Hazards - Property Conditions * Intangible Hazards - Attitudes and Culture * Moral Hazard - Fraud

What is the Purpose of Insurance? Insurance is a social device in which a group of individuals (insured) 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. ** Basically it is a method for spreading individual risk among a large group of people to make losses more affordable for all.

Who can take out an insurance policy? An insurable interest is any financial interest in life or property such that, if the life or property were lost or harmed, the insured would suffer financially. Insurance is not a get rich quick scheme. ◦ Insurance is meant to only compensate for actual losses. This is called indemnification. It means putting the policyholder back in the same financial condition he/she was in before the loss occurred.

What Can Be Insured? 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 mental health insurance? ALarge Number of Similar Exposure Units BFortuitous Losses CCatastrophe Unlikely DDefinite Losses EDeterminable Probability Distribution

Types of Insurance - Examples Personal ◦ Homeowner’s ◦ Renter’s Life Health Commercial Property-Liability Professional Liability Medical Malpractice Disability