RISK AND RELATED

TOPICS

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 Objectives of the chapter
At the end of the chapter students are
expected to:
Define and know basic concepts of risk
Differentiate risk and uncertainty
Define and differentiate risk, peril and
hazard
Explain the basic classification of risk

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 Definitions:
Risk is: The variation in outcomes.
A chance of a loss, and this depends on three elements,
hazard, vulnerability and exposure.
The actual exposure of something of human value to a
hazard and is often regarded as the combination of
probability and loss
The objectified uncertainty as to occurrence of an
undesired event.
Expected losses due to a particular hazard for a given
area and reference period.
The possibility that actual results may differ from
predicted average results.

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 Definition conti…
Based on the above stated definition of risk, we
can conclude that risk is defined as the
uncertainty concerning the occurrence of a loss.
It is termed as a chance or loss or exposure to
danger, arising out of internal or external
factors, that can be minimised through
preventive measures
If a loss is certain to occur, it may be planned in
advance and treated as a definite.
If there is uncertainty about the occurrence of a
loss, then the risk becomes an important problem.
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 RISK Vs UNCERTAINTY
RISK UNCERTANITY
• Describes the possibility of • The state of being uncertain i.e.
meeting danger or suffering harm condition where you are not sure
or loss about the future outcomes.

• Can be removed or minimized • Can’t be minimized or removed

• Is a combination of hazards, • A state of mind characterized by

vulnerability and exposure doubt based on a lack of
knowledge about future event.

• Measurable uncertainty that can be • It is more of subjective belief i.e. it

determined by objective analysis is based on the knowledge and
based on prior experience. attitudes of the person

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 RISK, PERIL & HAZARD
Peril- is defined as the cause of loss.
If a house burns because of fire, the peril (the
cause of loss) is the fire.
 Some common perils that cause damage or loss
to the property include lightening, windstorm,
tornadoes, earthquakes, theft and burglary.

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 Hazard
Is a condition that may creates or increases the
chance of loss arising from a given peril.
Aren’t themselves the cause of the loss, but
they can increase the effect loss.
They affect the magnitude and frequency of a loss.
The more hazardous conditions are, the higher the
chance of loss.

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Types of hazards:
1. Physical hazard- is related with the physical
properties of the thing exposed to risk.
Examples:
Type of construction material such as wood,
bricks,
Location of property such as near to fuel station,
near to flood area, near to earthquake area, etc.

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 Cont…
2. Moral hazard-dishonesty or character defects in
an individual that increase the frequency or severity
of loss.
Example: The dishonest persons may fake an
accident to collect the insurance or they
intentionally burn unsold merchandise that is
insured.
3. Morale hazard- carelessness to a loss because of
the existence of insurance. Example
 Leaving a door unlocked that allows a burglar to
enter,
Rash driving without proper signaling.
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 CLASSIFICATION OF RISK
1. Pure risks and Speculative risks
2. Static risks and Dynamic risks
3. Fundamental risks and Particular risks

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 1. Pure Risk and Speculative risks

1. Pure risks: situation in which there are only the

possibilities of loss or no loss.
The only possible outcomes are adverse (loss) and
neutral (no loss).
The outcome can only be unfavourable to us or
leave us in the same position as we enjoyed
before the event occurred.
E.g. Premature death, job-related accidents,
lightning, flood, fire at a factory, theft of goods from a
store, or injury at work etc.

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 Types of Pure Risk
a) Property risks: losses associated with ownership of
property such as destruction of property by fire
stolen, damaged or destroyed by various causes.
 Natural disasters such as flood, earthquake, storm,
fire can bring about enormous property losses as
well as taking several human lives.
 There are two major types of loss associated
with the destruction or theft of property;
Direct loss: a financial loss resulting from physical
damage, destruction or theft of the property.
Example: Physical damage to Restaurant in which
the building was insured by property insurance
policy.
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Conti……..
Generally, property suffers a direct loss when the
property itself is directly damaged or destroyed or
disappears because of a contact with physical or social
peril.
Indirect or consequential loss: is a financial loss that
results indirectly from the occurrence of a direct physical
damage, destruction, or theft.
Example: profit loss in addition to the physical damage
loss, the restaurant.
Other examples the loss of the use of the building, the
loss of rents, and the loss of a market.
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 Pure risk classification conti….
b)Personal risk: is a risk that directly affect an individual.
Detrimentally affect the income earning power of an
individual.
Major personal risks:
A.Risk of premature death: the death of a family head with
unfulfilled financial obligations.
B.Risk of insufficient income during retirement: is a major
risk that associated with old age
C.Risk of poor health: includes both the payment of
catastrophic medical bills and the loss of earned income.
D.Risk of unemployment

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 Costs of premature death
1. The human life value of family need lost forever.
2. Additional expenses may be incurred b/c of
 Funeral expense
 Uninsured medical bills.
3. B/c of insufficient income, some families will experience
reduction in standard of living.
4. Certain non economic costs are also incurred such as:
 Emotional grief
 Loss of role model ,counseling ,and guidance for the
children

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Pure risk classification conti….
c) Liability risk: is the possibility of loss arising from
intentional or unintentional damage made to other
persons or to their property.
A person may be generally obligated to another,
because of moral or other reasons, to do or not to do
something; the law, however, does not recognize moral
responsibility alone as legally enforceable.
One would be legally obliged to pay for the damage
his/her infected upon other persons or their property.

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 2. Speculative risk-is a situation in which
either profit or loss is possible.
Thus, here there are possibilities of both profit and
loss.
Example:
Introduction of new product to the market, lottery, and
gambling.
If Mr.X purchases 100 shares of a company, he
would gain if the price of that share increases but
would lose if the price declines.

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2. Static and Dynamic risks
Static risks- associated with losses caused by the
irregular action of nature or by the mistakes &
misdeeds of human beings.
Are losses arising from causes other than changes in
the economy.
Involve losses brought about by acts of nature or by
malicious and criminal acts by another person.
Are generally considered predictable and are more
easily taken care of by insurance coverage because of
their relative predictability.
E.g. Earthquake, Fire, Flood….
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 Dynamic risk: originates from changes in the
overall economy such as price changes,
changes in consumer, income distribution,
technological changes, political changes and
other.
Results from changes in price level, income, tastes
of consumers, technology etc can bring about
financial losses to members of the economy.
They are less predictable and hence beyond
the control of risk managers some times.

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3.Fundamental Risk and Particular risks
Fundamental risks- is a risk that affects the
entire economy or large number of persons or
groups within the economy.
Affects the entire society or large group of the
population.
Are usually beyond the control of individuals.
The responsibility for controlling these risks is left
for the society itself
E.g. High inflation, Cyclical unemployment & War.

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 Particular Risk: affects only individuals and not
the entire community.
Only individual experiencing such losses are
affected by not the entire economy or large group of
people.
The responsibility of individuals, can control by
purchasing insurance policies and other risk
handling tools
Examples:
Property losses, death, disability and dwelling
fires car thefts, bank robberies, etc.

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 Objective Vs Subjective risk
 Objective: is the relative variation of actual loss from the
expected loss.

Example
Expectation, 10 houses to burn in 2002.

Actual loss, 8 or 12 houses were burnt in 2002

Objective risk, 2 houses (the difference b/n expected losses

and actual losses)

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Subjective risk: uncertainty based on a person’s
mental condition or state of mind.
For example, a person who has drunk more in the bar

may attempt to drive home on his own and he may

uncertain whether he or she will arrive home safely
without being arrested by the police for drunken
driving.

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 End of the first chapter!

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