1. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 1 Introduction to Risk Management and Insurance, 7E - Dorfman Chapter 1: Fundamentals and Terminology

2. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 2 OVERVIEW OF COURSE LIFE CONTINGENCIES CONTRACTS & PERSONAL INSURANCE SOCIAL PROGRAMS COMMERCIAL INS. & ADVANCED RISK MANAGEMENT TERMINOLOGYPRINCIPLES INSURANCE AND RISK MANAGEMENT COMPANIES (MACRO) COMPANIES OCCUPATIONS CONSUMERS Government

3. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 3

4. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 4 Insurance Benefits to Society Stability of families Aids planning ability to businesses Facilitates credit transactions Anti-monopoly device Reduces credit costs Increases efficiency of capital

5. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 5 Costs to Society The costs of operating the insurance mechanism Commissions Overhead of the company Exaggerated claims Intentional losses (moral) General indifference about the way we treat our property, etc. (morale) Does not include losses that would have occurred anyway

6. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 6 The Problem of Arson Illustration of Loss Costs What is Arson? What is Arson-for-Profit? What are the costs? Who really pays for Arson? Should insurance companies be substituted for the role of public law enforcement authorities?

7. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 7 INTRODUCTION Definitions and terms Insurance Two main elements 1) Financial intermediation 2) Contractual relationship Loss (definition of) Types of losses  Direct Loss  Indirect Loss Chance of Loss  Number expected / Total exposed = Fraction

8. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 8 INTRODUCTION Definitions and terms Peril - The cause of a loss or contingency that causes a loss “Named peril” or Specified peril contracts ”Open-peril" contracts  burden of proof Hazard Something that increases the probability of loss or increases the severity when a loss occurs  physical, moral, morale

9. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 9 INTRODUCTION Definitions and terms Proximate cause of the loss Also known as Doctrine of proximate cause First insured peril in an unbroken chain of events leading to the loss - all is paid.

10. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 10 INTRODUCTION Definitions and terms Risk - many definitions - the term is used in a variety of ways 1) To describe that there is a possibility of loss 2) To identify the probability of loss 3) To identify the cause of loss - peril 4) To identify conditions that increase frequency of severity of loss - hazard 5) To identify the property or person exposed 6) To identify the potential $ amount of loss 7) To describe the variation in potential losses – the ability to predict

11. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 11 Objective Risk - relative variation from expected Degree of risk – the ability to predict Not the same thing as probability of loss Law of large numbers Coefficient of variation = s/x = % of variation expected relative to the mean OBJECTIVE RISK V. THE PROBABILITY OF LOSS

12. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 12 OBJECTIVE RISK V. THE PROBABILITY OF LOSS

13. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 13 OBJECTIVE RISK V. THE PROBABILITY OF LOSS

14. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 14 OBJECTIVE RISK V. THE NUMBER OF EXPOSURES

15. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 15 OBJECTIVE RISK V. THE NUMBER OF EXPOSURES

16. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 16 Risk - types Subjective Risk - individual’s mental attitude concerning loss Pure Risk - exposure that can only result in a loss or no change (two possible outcomes) Speculative Risk - exposure that can only result in a loss, no change, or gain (three possible outcomes)

17. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 17 Risk Management Logical process used by firms and individuals to deal with exposures to loss. Involves pre-loss planning concerning the use of post-loss resources to minimize overall costs. Continuous process that identifies exposures and decides how to deal efficiently with them. Post-loss activities puts the plans into action.

18. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 18 Insurance works well when: Many individuals purchase Few people collect Keeps rates affordable

19. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 19 Mathematical Basis for insurance - Example Houses in pool 10,000 Avg. value of each $ 80,000 Total property value $ 800 million Predicted losses = 1.5% of value $12 million Predicted Loss per house $ 1,200 Rate per $100 of value $ 1.50

20. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 20 Mathematical Basis for insurance - Example continued Insurance Premium Cost of losses $ 1.50 Admin. costs.45 Reserves for unexpected losses.10 Investment Earnings (0.07) Rate per $100 value $ 1.98

21. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 21 Concepts: Cash flow underwriting Loss ratio Expense ratio Combined ratio Salvage

22. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 22 Insurance Benefits to Society Stability of families Aids planning ability to businesses Facilitates credit transactions Anti-monopoly device Reduces credit costs Increases efficiency of capital

23. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 23 Costs to Society The costs of operating the insurance mechanism Commissions Overhead of the company Exaggerated claims Intentional losses (moral) General indifference about the way we treat our property, etc. (morale) Does not include losses that would have occurred anyway

24. Instructor’s Manual with Transparency Masters to Accompany Introduction to Risk Management and Insurance, 7E - Dorfman © 2002 by Prentice Hall, Inc. A Simon & Schuster Company Upper Saddle, NJ 07458 24 The Problem of Arson Illustration of Loss Costs What is Arson? What is Arson-for-Profit? What are the costs? Who really pays for Arson? Should insurance companies be substituted for the role of public law enforcement authorities?