Risk Management

&
Insurance

AAU
School of Commerce
Department of Accounting
Introduction
 CHAPTERS
3

1. Introduction to RISK

2. Risk Management

3. INSURANCE: An introductory aspects

4. INSURANCE: Fundamentals of insurance

contract

5. INSURANCE: Analysis of insurance contract

6. TYPES of insurance: Life and health insurance

7. TYPES of insurance: None life insurance

8. The insurance business in ETHIOPIA

RISK MANAGEMENT &
INSURANCE

CHAPTER – ONE
NATURE OF RISK AND RELATED
CONCEPTS
 Agenda
9

1.1. Definitions of Risk

1.2. Risk Vs Uncertainty, and chance of loss

1.3. Risk, peril and hazard

1.4. Classes of Risk

1.5. Types of pure risk

1.5.1. Personal pure risks

1.5.2. Property pure risks

1.5.3. Liability pure risks

 Learning Objectives
10

After studying this chapter you should be able to:

Define the term risk
1.

Distinguish risk from uncertainty .

2.

Distinguish risk from Chance of Loss.

3.

Discuss on the difference between risk, hazard and peril.

4.

Recognize the different classes of hazard

5.

Classify risk in to different class.

6.

Describe the category in to which pure risk may be

7.

subdivided
 1.1. Meaning of Risk
11

 There is no single and commonly agreed

definition for the term risk
 But there are common elements in all the

definitions: Indeterminacy and Loss.

The issue of Indeterminacy
 When risk is said to exist, there must
always be at least two possible outcomes
 The outcome must be in question.
question
The issue of Loss.
 of the possible outcomes one must be
undesirable.
 This may be a loss or it may be a gain
smaller than the gain that was possible.
 1.1. Meaning of Risk (Cont…)
12

Based on the above concepts risk can be defined

as:

 “acondition of the real world in which

there is an exposure to adversity”

 “Uncertainty Concerning the Occurrence of

Loss”

 “acondition in which there is possibility

of an adverse devotion from a desired
outcome that is expected or hoped for”
 1.1. Meaning of Risk (Cont…)
13

Example:

1. Starting a business venture

2. Gambling

3. .

4. .
 1.2. RISK, UNCERTAINITY AND CHANCE OF LOSS
14

UNCERTAINTY AND ITS RELATION WITH RISK

 “uncertainty refers to a state of mind

characterized by doubt, based on lack of
knowledge about what will or will not
happen in the future. ”
 We don’t even know weather loss exists or
not
RISK AND CHANCE OF LOSS
 “Chance of loss is the percentage expression
of only the loss part of a risky situation”
 “Chance of loss is the probability that an
event which will cause a loss will happen.”
 1.3. DISTINCTION BETWEEN RISK, PERIL AND
HAZARD
15

Peril: peril is defined as the cause of loss

 Any activity or material or condition that cause a loss is
considered as peril.

EXAMPLES
 If your home is damaged by fire the peril or cause of loss is fire
 If your property is lost because of theft the cause of loss, peril, is
theft.
 Fire
Earthquake


The
Tornado
following are the common perils that may cause property
  Flood
 Theft & burglary
damage:
 War
 Lightening  Hail e.t.c.
 Wind storm
 1.3. DISTINCTION BETWEEN RISK, PERIL AND
HAZARD
16

Hazard:
 Is a condition that increase or stimulates the
chance of loss arising out from a give peril.
 Physical hazards
 Moral hazard
 Morale Hazard/ Attitudinal Hazard
 Legal Hazard
 Types of hazard
17

 Physical hazards:
 are physical conditions that increase the chance of loss
( Eg. icy roads, defective wiring, defective locking)
 Moral hazard:
 is dishonesty or character defects or evil tendency of
an individual, that increase the chance of loss (Eg.
intentional firing of property, faking accidents, inflating
claim amounts)
 Morale Hazard:
 is carelessness or indifference to a loss because of the
existence of insurance (Eg. leaving keys in an unlocked car)
 Legal Hazard
 refers to characteristics of the legal system or regulatory
environment that increase the frequency or severity of
losses
 Agenda
18

1.1. Definitions of Risk

1.2. Risk Vs Uncertainty, and chance of loss

1.3. Risk, peril and HAZARD

1. Physical hazards
2. Moral hazard
3. Morale Hazard/ Attitudinal Hazard
4. Legal Hazard
 Agenda
19

1.4. Classes of Risk

1.4.1. Financial and non- financial
1.4.2. Objective and subjective
1.4.3. Static and dynamic risk
1.4.4. Fundamental and particular risk
1.4.5. PURE and speculative risks
1.5. Types of pure risk
1.5.1. Personal pure risk
1.5.2. Property pure risk and
1.5.3. Liability pure risk
 1.4. Classes of risk
20

1.4.1. Financial and non- financial

1.4.2. Objective and subjective

1.4.3. Static and dynamic risk

1.4.4. Fundamental and particular risk

1.4.5. Pure and speculative risks

 1.4.1. Financial and non- financial
21

Financial risks Non-financial risks

 These are those losses which
 Adversity that involves
did not have a financial loss.
financial/ monetary expanse.
expanse
 It may be moral or
Example: In the risk of psychological losses.

premature death the ff are Example: In the risk of

financial risk. premature death.

 Loss of emotional grief of the
 Loss of salary of the diseased.
diseased
 Additional expense made for  Loss of deceased's guidance
/counselling.
funeral and the like expanses. 21
 1.4.2. Objective and subjective
22

Objective Risks Subjective risks

 The relative variation  uncertainty based on a
of actual loss from the person’s mental
expected loss. condition or state of
mind.
 Impact of subjective
OR=AL – EL risk varies depending
Example: on the individual.
 It differs from one to
another person based
on experience,
culture, education
e.t.c
 1.4.3. Fundamental and particular
23
risk
Fundamental risk particular risk
 A risk that affects the entire  A risk that effects only
economy or large number of persons the individuals not the
/ groups within the economy. entire community.
 Involves those losses that are  Involves those losses
impersonal in origin and
whose origin and
consequence.
consequence is personal.
 Examples:
 Examples:
High inflation, cyclical
unemployment , car theft, bank robberies

War, drought, Earthquake, flood and

E.T.C fire to a dwelling.

 1.4.4. Static and dynamic risk
24

Dynamic risks Static risks

 Those risks that may
 Dynamic risks are those risk
occur even if there was no
that results from changes in change in the economy.
the economy.
 Causes by:
 irregular natural changes
 Causes by: ∆ in economy:
 mistakes of human being,
 Change in price level
 Consumer test
 mistakes of human being.
 Income and output, and
 Technology  Do not benefits the
 Normally benefits the society over society
the long run.  Example:
 Example:

24
 1.4.5. Pure and speculative risks
25

Speculative risks Pure risks

 A situation where there is  pure risk is defined
a possibility of loss and as a situation in
also a possibility of gain or which there are
profit. only the possibilities
of loss or no loss

Examples:
 Purchasing a share Examples:
 Doing a business for our  Death
own  Flood
 Gambling  Earth quacks

E.T.C
 Theft, e.T.C
25
 1.5. Types of pure risk
26

1.5. Types of pure risk

The major types of pure risk
include:

1. Personal risks

2. Property risks and

3. Liability risks.
 1.5.1. Personal pure risks
27


Risks that directly affect an individual.
 Involve the possibility of:
 Complete loss or reduction of earned income
 Extra expenses, and
 Depletion of financial assets.
 There are four major typical personal risks:
 Risk of premature death
 Risk of insufficient income during retirement
 Risk of poor health
 Risk of unemployment
 1. Premature Death:
28

Premature Death:
It is defined as the death of family head with
outstanding unfulfilled financial obligation.
Financial obligation::
Financial obligation
1.Dependents
1.Dependentstotosupport.
support.
2.Children
2.Childrento
toeducate
educate. .
3.A
3.Amortgage
mortgageto
topay
payoff.
off.
Costs of Premature Death:
Death
1.
1. loss
lossof
of the
thediseased
diseasedearnings
earnings
2.Additional
2.Additionalcost;
cost;like
likefuneral
funeralexp.
exp.
3.Reduction
3.Reductionof
ofstandard
standardof
ofliving
living. .
4.Other
4.Othernon-economic
non-economiccosts
costs. .
 B. Risk of insufficient income during
29 retirement
Also known as the risk of old age.
Unless we have:

1. Sufficient financial assets to be

withdrawn
2. Social security schemes or a
3. Private pension plan

We will suffer a financial insecurity

during retirement
 C. Risk of poor health
30

It includes both:
 payment for medical bills &
 loss of total or partial income.
Example: A disease that causes
heart surgery
 D. Risk of unemployment
31

 It is another major threat to financial security

 It can cause financial insecurity in three ways:
1. Total loss of income as a result of total unemployment

2. Partial loss of income as a result of partial unemployment

3. Exhaustion of past savings after a long period of

withdrawal.
Example: If a person have regular salary of Br 10,
000 monthly.
 Case one :
 Case two :
 Case three:
 1.5.2. Property pure risks
32
 It is the risk of having property damaged or lost.
 Property risks are of two types:
 Direct loss:
 It is a financial loss that results from the physical
damage, destruction or theft of the property.
 Indirect loss /Consequential
/ Loss :
 It is the financial loss that results indirectly from the
occurrence of the direct physical damage or theft.
 Example:
 A fire accident to a big “Manfg Firm”
 Damage to a hotel
 Damage to a residential dwelling {home}
 1.5.3. Liability pure risks
33

 One will be held legally liable if he/she, or he’s/her

property say car, do something that result in bodily
injury or property damage to someone else.
 This may held you to pay damage in to three ways:
1. Monetary damage payment

2. Imprisonment

3. Death penalty
 Uncertainty concerning the occurrence of such a
liability loss is termed as liability pure risk or third
party risk
 Example.
 Learning Objectives
34

After studying this chapter you should be able to:

Define the term risk
1.

Distinguish risk from uncertainty .

2.

Distinguish risk from Chance of Loss.

3.

Discuss on the difference between risk, hazard and peril.

4.

Recognize the different classes of hazard

5.

Classify risk in to different class.

6.

Describe the category in to which pure risk may be

7.

subdivided
35

End!