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1 review
by: JKJ

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6

Exam 2 study guide RMI 2101

JKJ
Temple

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About this Document

topic 4,5, parts of 6
COURSE
INVESTING FOR THE FUTURE
PROF.
Diane Luedtke
TYPE
Study Guide
PAGES
6
WORDS
CONCEPTS
Risk Management, RMI 2101
KARMA
50 ?

1

1 review
"Amazing. Wouldn't have passed this test without these notes. Hoping this notetaker will be around for the final!"
Green Lesch

Popular in Risk Management And Insurance

This 6 page Study Guide was uploaded by JKJ on Saturday March 12, 2016. The Study Guide belongs to RMI 2101 at Temple University taught by Diane Luedtke in Spring 2016. Since its upload, it has received 130 views. For similar materials see INVESTING FOR THE FUTURE in Risk Management And Insurance at Temple University.

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Amazing. Wouldn't have passed this test without these notes. Hoping this notetaker will be around for the final!

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Date Created: 03/12/16
Topic 4 Probability Distributions Two types:  Discrete- finite number of possible outcomes o Frequency distributions  Continuous- Infinite number of possible outcomes o Severity distributions Two important measures for probability distributions: I. Central tendency: mean or expected value (EV) II. Dispersion: Variance, standard deviation and coefficient of variation (COV) - Measures variability among values in a distribution Mean- Weighted average of all possible outcomes for probability distribution μ=EV=Σx p  i i - The mean or expected loss for a loss distribution is designated EL Standard deviation ( σ¿ - Square root of variance ( √σ ¿  Higher standard deviation relative to mean has greater uncertainty of loss  Lower standard deviation relative to mean has lower uncertainty of loss Variance ( σ ¿ - Sum of squared differences between possible outcomes and the expected value, weighted by probability of outcomes 2 xi−EL¿  σ =Σ p ¿ i - If distributions have same mean, can look at variance of standard deviation Coefficient of variation - If two distributions have different means, use COV to measure risk σ  COV= El Expected Loss (EL)- Gross Premium= pure premium + risk charge + administrative costs - Should cover all costs, but insurer does not know all costs until last lost is settled \ Pure Premium- Portion of gross premium needed to pay losses = EL Risk Charge- Is a cushion, or extra amount charged by insures to represent the estimation risk Administration costs- “Expense loading”  Marketing, Advertising  Underwriting  Claim payment  Sales commissions  state premium tax - Admin costs may be anywhere from 10-30% of overall premium Law of large numbers (LLN)- -Used to predict losses for large groups of policyholders - In order to obtain accurate estimates of future events based on past information, a large amount of past info must be used - By using LLN, insurers reduce the risk of adverse outcomes - Does not tell which individual policyholder will suffer a loss To work properly, events should be Independent and Homogenous Homogenous- Exposure units are similar, but not necessarily identical  Face approximately the same expected frequency or severity of loss Ex: - Auto insurance: Location, age, gender, driving record Maximum possible loss- Is the “worst case scenario” and the most pessimistic view Ex: entire building and everything inside could be destroyed (such loss could be considered a “shock loss”). Maximum probable loss- Is inversely proportional to the size of a structure and the effectiveness of any protective safeguards. Ex: The larger the building, the less likely the entire property will be destroyed; The better the fire protection (sprinklers, alarms and public protection) the more likely a fire will be contained and extinguished before the entire building is destroyed. The occupancy and contents within the building also affect the amount of damage likely to occur. Topic 5 RISK CONTROL TECHNIQUES “Control” the risk or loss exposure Make the risk easier to live with I. AVOIDANCE (avoiding the risk all together) a. REACTIVE Stop engaging in the activity causing the loss For example: Company stops making drugs because there have been losses b. PROACTIVE Never engaging in the activity in the first place For example, other pharmacies decide to never manufacture a certain drug because they have seen other pharmacies suffer losses II. Loss Prevention Steps taken to reduce the Frequency of loss; this won’t eliminate it - Loss prevention could impact severity III. Loss Reduction - Reduce the severity of a loss  Pre-loss measures- Used before the loss occurs o Sprinklers o Fire extinguisher o Fire alarms  Post-loss measures- Used after a loss occurs o Rehabilitation of injured workers o Product recall o Salvage operations o Crisis management IV. Separation of exposure units - Breaks the assets/activities/responsibilities into smaller parts and separates them - May be done for business reasons other than loss control Ex: I. Two or more warehouses vs. one II. Two delivery trucks vs one - Limits the size of the loss from any single occurrence - Reduces the severity - Works well to decrease net income losses - Decreases overall risk as measured by variation (makes losses more predictable) - Increased frequency since more units are exposed to loss V. Duplication of exposure units - Key asset/activity/capability is replicated or duplicated and held in reserve I. Not used until needed Ex: II. Copies of records/computer backup III. Inventories/spare parts IV. Back up supplies - Decreases severity VI. Diversification - Spreads loss exposures over various products, markets or regions - Losses from one may be offset by gains from another - Used for business risks Ex: Diversified portfolio of investments I. Increase frequency II. Decreases severity III. Increases loss predictability Topic 6 Loss financing options - Risk financing deals with sources of funds to pay losses  External funds  Internal funds  Alternative risk financing arrangements Risk Financing Techniques I. Transfer - External funds from third parties to pay foir losses - Still have the asset/ activity exposed to loss - Transfer financial responsibility to pay for loss to third party, but the liability exposure is not transferred A. Insurance -Transfer financial responsibility to pay for loss to insurers, but not the asset or activity itself Ex: own car- buy insurance II. Retention - Internal funds to pay for losses - Firm or individual engaging in retention assumes financial responsibility for losses that occur - Retains exposure to loss  Not buying insurance  Underinsured  Insurance contract with a deductible in the contract Active vs. Passive Retention Active - Knowingly - Planned retention Passive - May be unaware - Usually results from underestimation or failure to properly identify loss expose Funded vs. Unfunded Retention Funded - Firm sets aside funds every period to pay for losses - In the event of loss, these funds are used to pay for losses - Better for losses that are high frequency and low severity Unfunded - Firm does not have a separate fund to pay for losses - Losses are paid from current revenue or borrowed funds Self –Insurance - Also called self-funding - Planned and funded retention - Retention program for firms with many loss exposures and potentially large losses Advantages of self-insurance Potentially less exposure - Gross premium = EL + risk charge + expenses - Loss cost savings - No risk charge - Expense savings Flexibility in their design of “insurance programs” Money may be invested internally at a higher rate of return than is credited by the insurer

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