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4fundamentals of Risk

The document discusses the fundamentals of risk, including: 1. Risk refers to uncertainty about outcomes and the possibility of an unfavorable event occurring. 2. Risk can be classified as a cause, probability, object, or verb. It is also distinguished from chance, probability, and uncertainty. 3. Risks are classified as financial vs non-financial, pure vs speculative, and fundamental vs particular based on their causes and effects. 4. Perils refer to specific loss causes while hazards affect the likelihood and severity of losses from perils. Physical, moral, and morale hazards are described. 5. Insurable risks must meet requirements like involving large independent exposures, accidental

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36 views

4fundamentals of Risk

The document discusses the fundamentals of risk, including: 1. Risk refers to uncertainty about outcomes and the possibility of an unfavorable event occurring. 2. Risk can be classified as a cause, probability, object, or verb. It is also distinguished from chance, probability, and uncertainty. 3. Risks are classified as financial vs non-financial, pure vs speculative, and fundamental vs particular based on their causes and effects. 4. Perils refer to specific loss causes while hazards affect the likelihood and severity of losses from perils. Physical, moral, and morale hazards are described. 5. Insurable risks must meet requirements like involving large independent exposures, accidental

Uploaded by

tsioney70
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Fundamentals of Risk

Meaning of risk

• What exactly is mean by the word risk?


• The word risk is certainty used frequently in
everyday conversation and seems to be well
understood by those who are using it.
• To most people the word risk implies some form of
uncertainty about an outcome in a give situation. An
event might occur and the outcome is not favorable
to us, it is not an out come we look forward to.
• The word implies both doubt about the future, and
the fact that the outcome could leave us in a worse
position than we are in at the moment
• The word risk can be used in variety of ways in
insurance. For Example
• Risk as a cause
• Risk as probability
• Risk as object
• Risk as a verb
• Risk as a cause
• We use the word risk to rifer to the cause of an outcome. In this way we
speak about fire as risk, theft as risk, personal injury as risk. We may use
the phrase ' the risk of fire', meaning the risk of fire damage.
•
•
• Risk as probability
• We often talk the risk of something happening, meaning the probability
of it occurring.
• We sometimes modify this by referring to a high or law risk of some
event. Leaving the key in the car will result higher risk of theft, locking
the car in garage results lower risk of theft. The implication is that there
is level or degree of risk
Risk as object
• Taking a risk does not mean that we are going to take
fire or storm. What we mean in this case is that we place
ourselves in situation or position where there is some
doubt about the future outcome.
Risk as a verb
• We use the risk not only as a noun but also as a verb. We
might a risk crossing the road between traffic lights or
risk of investing some money in venture. This is the act
of positively placing one self in situation in where loss
could occur
Distinguishing Risk with the following words

• Risk Vs chance
• Risk Vs Probability
• Risk Vs Uncertainty
• Risk Vs chance
Chance refers favorable outcome
• Risk Vs Probability
Probability refers a chance of occurrence of
certain event
What happens if p=1
p=0
p>1 and <0
Risk Vs Uncertainty

• Uncertainty future alternative and their


associated chances are unknown
• Risk associated with possible alternative and their
associated chances are known
• Illustration in three condition
1. Risk absent Uncertainty Present
2. Risk Present Uncertainty absent
3. Uncertainty Present Risk Present
4. Uncertainty absent Risk absent
Classification of risk

• Financial and Non financial risk


• Pure and speculative risk
• Fundamental and particular risk
Financial and Non financial risk

Financial risk
• This is easy to see in the case of material damage to property, theft of property or
loss of business profit following by fire. In case of personal injury, it can also possible
to measure financial loss in terms of court award of damage or as a result of
negotiation between lawyers and insurer
• . In any of the above case the outcome of risky situation can be measured financially.
Non financial risk
• There are other situations where this kind of measurement is not possible. Take the
case of the choice of new car, the selection of an item from the restaurant menu.
These could be considered as a risky situation, not the outcome will cause financial
loss, but the outcome could be uncomfortable or disliked in some other way.
• the main the outcome is not measurable financially but by other, more human's
social criteria.
• In the world of business, insurers primarily concerned with risks which have
financially measurable outcomes.
Pure and speculative risks

Pure risk involves a chance of loss, at best, a break-even


situation. The outcome can only be unfavorable to us.
Example
• A material damage of property by fire, explosion
Speculative risk
• Speculative risk involves both a possibility of loss and gain.
• Investing money in share is a good example. The
investment may result loss or a possibility of break-even
situation, but the reason it was made was the prospect of
gain.
Fundamental and Particular risks

Fundamental risk
• This classification relates to both the cause and effect of risk.
Fundamental risks are those which arise from cause from
outside the control of any one individual or even a group of
individual. In addition, the effect of fundamental risk is felt by
large numbers of peoples. This includes earthquakes, floods,
volcanoes and other natural disasters.
Particular risk
• In contrast, particular risks are much more personal both in
there cause and effect. This would includes fire, theft, work
related injury and motor accidents. All of these risks arise from
individual and affects individual in there consequences.
Distinction between Peril, and Hazard

• Peril: - refers to the specific cause of loss.


Example; fire, windstorm, theft, explosion, flood, etc
• Hazard: - refers the condition that may create or in crease
the chance of loss arising from the given peril. Hazard
affects the magnitude and the frequency of loss. The more
hazardous conditions are, the higher the chance of loss.
There are three categories of hazard:
1. Physical Hazard
2. Moral Hazard
3. Morale Hazard
• Physical Hazard: - This is associated with the physical properties of the item
exposed to risk. Examples of physical hazard include the following:
– types of construction material
– Location of property such as near to flood area, near to earthquake
– Occupancy of building such as dry cleaning, chemicals
– Working condition such as machine for personal accident
• Moral Hazard;- this originates from evil tendencies in the character of the insured
person. It is associated with the human nature, qualities, reputations, attitude, etc.
Examples include the following:
– Dishonesty
– Fraudulent act
– Exaggeration of claim
• Morale hazard: - This originates from the act of carelessness leading to the
occurrence of the loss. It occurs due to the lack of concern for events. Example;
– Poor house keeping
– cigarette smoking around petrol station
Requirements of an Insurable Risk

1. The Large Number of Homogeneous


exposure units
2. Accidental and unintentional loss
3. Determinable and Measurable loss
4. Loss Not to be Subject to Catastrophic Hazard
5. Chance of loss must be calculable
6. Economically Feasible premium

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