Review test 1
Review test 1 FIRE 375
Popular in Risk management and insurance
Popular in Human Development
Adonis Schinner DVM
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This 6 page Bundle was uploaded by Matheus Aching on Sunday September 20, 2015. The Bundle belongs to FIRE 375 at St. Cloud State University taught by Dr. Haley in Summer 2015. Since its upload, it has received 21 views. For similar materials see Risk management and insurance in Human Development at St. Cloud State University.
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Date Created: 09/20/15
CHAPTER 1 THE MEANING OF RISK Risk Item circumstances which are subject to uncertain outcomes Risk exists when the outcome of a set of circumstances or event is uncertain Risk is costly when 0 Expected loss is greater 0 Uncertainty is greater Chance of loss and uncertainty are different Attitudes toward risk Risk Adverse shying away from risk Preferring to have as much security and certainty as is reasonably possible Risk Seeker someone entering into an endeavor as long as a positive gain is possible Risk Neutral when one s risk preference is somewhere between risk adverse and risk seeking Diversification of risk Engaging in many activities so that the results of nay single activity does not overwhelm the results of the rest Types of Risk Risk Exposures Pure risk outcome ofloss or no loss 95 no loss 5 loss Speculative risk outcomes of loss or gain expect a gain Systematic risk risk that affects everything Personal Risk exposures Earnings unemployment poor health death old age Medical expenses health insurance Liability 3rd party claim law suit Property can come and goes Longevity out living our assets Financial Assets speculative Enterprise Risk Exposures Asset risk assets could disappear Product risk nobody wants it anymore Operational risk supply chain may not function right Perils amp Hazards Peril cause ofloss 0 Natural windstorm lighting 0 Human caused by human 0 Economic bad economy Hazard increase the chance of loss 0 Physical tangible environmental condition 0 Moral human behavior increases the chance of loss I Moral hazard is used to describe dishonest behavior I Morale hazard is used to describe behavior that is simply carless Role of risk in Decision Making Measuring and managing risk aids a business firm in its efforts to maximize its value Flipside is minimizing the probability of bankruptcy Duality is minimizing risk and maximizing the value of the firm CHAPTER 2 RISK MEASURMENT amp METRICS Frequency the number of losses per unit of time Severity the total amount of losses per unit of time divided by the number 3511 mre gt of losses average size of loss Probability of loss the frequency divided by the total number of exposures during the unit of time Expected loss per exposure the probability of loss multiplied by the severity Insurance Probabilities are based on Relative Frequency Insurance probabilities are based on historical relative frequency historical data Historical data has to be relevant Lots of data are gather for computing and predicting loss probabilities Large number of data is needed Can group different observation as long as everything is constant other wise 2 different observations Central Tendency and Dispersion Central tendency measures the mean or value with the highest probability of occurrence Dispersion measures the standard deviation how the data is spread out ValueatRisk or maximum probable loss The worst case scenario method for predicting the maximum loss that can reasonably be expected Risk Premium The dollar amount a person is willing to pay over and above the actuarially fair premium to transfer the risk to someone else CHAPTER 3 Information asymmetry problems Occurs when the party on one side of a contract has more knowledge than the party on the other side Principle agent problem occurs when the principle is unable to observe the agent An agent is expected to function in the best interest of the principle Example you travel hire a kid to mow the loan pays every week but the kid only mows the loan one day before you get back so you hire another kid to watch over Can limit the effectiveness of risk pooling via insurance contracts 2 problems 0 Adverse Selection occurs when a risk pool ends up with more above average risks than below average risk 0 Moral Hazard the existence of insurance coverage alters the insured s behavior Concerns Considerations Crosssubsidization Classification cost underwriting costs Efficient pricing of risky activity 0 Total premium expected losses risk loading expense loading CHAPTER 4 Risk Management Steps 1 Identify all risks 2 Assess the risk 3 Find a risk management solution for each risk 4 Evaluate the results A rule of thumb Exposure 1 Exposure 2 Exposure 3 Exposure 4 Frequency Low Low High High Severity Low High Low High Rule of thumb Retain Insure Retain Avoid Other in uences consideration Financial condition Nature risk External market Size of firm conditions Sensitivity to cash Catastrophic Volatility of Self insure ow interruptions insurance prices Investment needs Moral hazard Residual markets Correlation of cash ow Finance leverage Premium loadings Foreign exchange Noninsurance solutions Hedging Catastrophe bonds Hold harmless agreements Identifying and Assessing Risk Risk profiling 0 Process to evaluate all of the risks of an organization and measure their frequency and severity Risk mapping 0 Charting the entire spectrum of risk not individual risk silos from each separate business unit 0 Insurance contracts tend to be written in a way that separates risk Risk Management Alternatives Risk transfer insurance contracts 0 Risk can be transferred to an insurance company via contract 0 Terms of the contract determine covered items or activities covered perils deductibles coinsurance and coverage limits Limited liability corporations 0 Incorporating a business forms a separate entity insurance company with separates assets 0 Owners personal assets are separate from business assets Risk transfer noninsurance contracts 0 Examples warranties leases and rental agreements hold harmless clauses and surety bonds Risk Assumption Retention 0 Loss exposures are retained they are paid as it occurs 0 Risk retention groups allow multiple business firms to band together for a self insurance 0 Common in workersquot compensation Risk Reduction loss control 0 Efforts to alter the character of a loss exposure 0 Lower either frequency severity or both 0 Loss prevention attempts to lower frequency 0 Loss reduction attempts to lower severity Risk avoidance 0 Simply avoiding loss exposure cannot be used for all exposures CHAPTER 6 Nature of insurance Individuals transferring risk to a risk pool risk pool allows for the losses of the few to be average across a group Insurer the entity who form the risk pool Insured an individual who transfers his risk to the risk pool Law of Large Numbers As a sample of observation is increased in size the relative variation about the mean declines The standard deviation of expected losses decreases as the size of the risk pool increases As the number of loss exposures increase the more closely the actual results will approach the expected results Standard deviation reduced Skewness declines as the number of exposure increase becoming more normal distribution standard deviation declines reducing the uncertainty Correlation amp Risk Pooling If 2 loss exposures are perfectly positively correlated there will be nothing gained through the use of pooling 0 When one suffers a loss the other exposure will suffer an identical loss If 2 loss exposures have zero correlation there will be much to gain from risk pooling Discrimination in Insurance Underwriters form risk pools by classifying exposures according to expected loss Accurate discrimination of this type is very important to efficient risk pooling Requirements of an Insurable Risk The number of similar exposure unit is large A catastrophe cannot occur Losses are definite The probability distribution of losses can be determined The cost of coverage is economically feasible Types of Insurance Policies Personal group or commercial Life health or property casualty Private insurer or government agency Voluntary or mandatory coverage Industry Corporate Structure Stock insures Mutual insurers Lloyd s of London Banks amp Insurance Captive insures Risk retention groups Government quasigovernment insurance programs
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