When faced with the possibility of a loss, it is important to begin by understanding exactly what risk exposures are involved how the losses might occur, and how these losses might be prevented or reduced before deciding to insure against them
First Principle: Law of Large Numbers explains how insurers can figure out how much to charge different classes of insureds.
Second Principle: AN insurance policy is a contract. The insurance industry holds 7.5% of the assets of the 22 industries in Canada while having some 14% of the operating profit margin. It employs more than 230,000 people.
Risk
Risk Management is the process of dealing with the consequences of being wrong and it should concentrate on either limiting the size of the bet or on finding ways to hedge the bet so you are not wiped out if you take the wrong side
Risk is defined as an uncertainty about the occurrence of a loss – if there is uncertainty about a loss, there is a risk and, conversely, if a loss in a given situation is a certainty, then there is no risk sine the loss is a sure thing
Exclusion – If the insured has diabetes, a life insurance policy might be prepared to excluded complication arising from this disease
Premature death – A smoker’s policy may be declined life insurance or will charge a higher premium to reflect the increase risk for early demise
Exogenous and Endogenous Risks
Exogenous Risks are risks over which we have no control and which are not affected by our actions – example: earthquakes or hurricanes
Endogenous Risks are risks that are dependent on our actions. Example: Smoking in bed, not studying for an exam.
Combination of both: A car accident – While a drive has no control over other drivers (the exogenous portion), the probability of an accident happening is strongly influenced by the driver’s behaviour and ability (endogenous)
Objective and Subjective Risks
An objective risk is a risk that is determined by analyzing past experiences and calculating the mean (average) of the losses and the standard deviation (the average difference of each loss from this average) of the actual losses from the expected losses for a particular risk exposure
Insurers can calculate the objective probability of a loss by tracking various classes of drivers over several years
However, in terms of stocks vs. T-bills, a long term (15 to 20 year look) may be required to find the real average (compared to short term – less than 10 years)
A subjective risk means the uncertainty is based on a person’s mental condition or state of mind and the resulting subjective probability is based on an individual’s personal estimate of a chance of loss.
Example: Some drivers cannot accurately assess safe driving speeds in bad weather
Insurance companies use inductive reasoning to come to conclusions about objective risks – they analyse past data to predict future losses
Deductive reasoning can be used with probabilities where the probability is obvious from the nature of the event
Example: Probability of pulling a red card from a deck of cards is 50%
Pure and Speculative Risks
Pure Risk refers to risks where there is a chance of a loss or no loss, but no chance of a gain – these risks are generally insurable.
Example: Your house burns or it doesn’t; you die in an airplane crash or not
Speculative Risk describes situations where there is the possibility of a loss but also the possibility of a gain
For example: An investment in common stock can either return a profit or sustain a loss
Pure Risk for Individuals
Individuals are exposed to three broad categories of pure rise:
Property risk is the risk of damage to or loss of one’s auto, home, and personal belongings as a result of a fire, an accident, an earthquake, theft, etc.
Direct loss is the damage to or loss of property
Indirect loses – example: the need to rent another space while there
Related Documents: Risk Management - Chapter 1 Essay
FI 623: Chapter 1 FI 623: Chapter 1 The Investment Environment FI 623: Chapter 1 1 Investments in General FI 623: Chapter 1 Real Investments - physical, tangible assets that are acquired in order to generate future cash flows. Capital budgeting, a topic in Corporate finance, is focused on the decision to make real investments. Example: A factory is a real asset and the decision to build a new one would be studied in corporate finance. Financial Investments - Contracts that provide a claim…
Supplemental Reading Discussion Question Application 1 Company Background Vision Mission Leadership Team Whittington, J. L., & Evans, B. (2005). General issues in management: The enduring impact of great ideas. Problems & Perspectives in Management, (2), 114–122. Organization Culture Chapter 10, "Motivation and Coaching Skills" (pp. 289–305) How Do Organizations Motivate and Engage Employees or Members? Week 1 Team Assignment Ethics & Legal Weber, J…
INTERNATIONAL FINANCIAL MANAGEMENT FALL 2013 Tue&Thu, 4:25PM- 5:40PM Room: BA 351 Instructor: Office: Office Hours: Email: He Wang 5th Floor Ph.D. Cubicles Tuesday & Thursday: 10:00AM- 11:30AM he.wang@grad.moore.sc.edu COURSE DESCRIPTION This course aims at acquainting students with international aspects of corporate finance. The ultimate objective of the course is to develop your ability to understand and analyze major problems of financial management in an international context…
Michael Sherman Unit 1 Lab Chapter 1 dealt with the basic fundamentals of risk management. It defined risk, threat vulnerability, and loss and their relationship to one another. Risk is how likely a loss will occur. A threat is anything that can cause possible damage. Vulnerabilities are weaknesses. When business functions or assests are compromised, they are losses. This chapter also covered the seven domains of a typical IT infrastructure. These include the User domain (the people, including…
i 8/8/13 10:53 AM f-500 Project Management The Managerial Process /204/MH01987/Lar96596_disk1of1/0078096596/Lar96596_pagefiles Lar96596_fm_i-xviii_1.indd Page ii 8/8/13 10:53 AM f-500 /204/MH01987/Lar96596_disk1of1/0078096596/Lar96596_pagefiles The McGraw-Hill Series Operations and Decision Sciences OPERATIONS MANAGEMENT Beckman and Rosenfield, Operations, Strategy: Competing in the 21st Century, First Edition Benton, Purchasing and Supply Chain Management, Second Edition Bowersox, Closs,…
A Business Framework for the Governance and Management of Enterprise IT PREVIEW VERSION These following pages provide a preview of the information contained in COBIT 5. The COBIT 5 framework is available as a complimentary PDF (www.isaca.org/cobit) and for purchase in hard copy (www.isaca.org/bookstore). It provides an overview of the COBIT 5 guidance, its five principles and seven enablers. We encourage you to share this document with your enterprise leaders, team members, clients…
Chapter 14 Interest Rate Risk Measurement Copyright 2003 McGraw-Hill Australia Pty Ltd Copyright 2003 McGraw-Hill Australia PtyViney Ltd PPT Slides t/a Financial Institutions, Instruments and Markets 4/e by Christopher Slides prepared by Anthony Stanger 1 Learning Objectives • Describe interest rate risk and its forms • Identify the components of an interest rate risk exposure management system • Explain the interest rate risk management principle of asset repricing before liabilities •…
PROJECT MANAGEMENT What is a Project? A project is a temporary endeavor undertaken to create a unique product, service, or result. The temporary nature of projects indicates a definite beginning and end. The end is reached when the project’s objectives have been achieved or when the project is terminated because its objectives will not or cannot be met, or when the need for the project no longer exists. Temporary does not necessarily mean short in duration. Temporary does not generally apply to the…
Pacing Guide: Community Health and PopulationFocused Nursing Week 1–3 4 5 Topic Summary of Resources and Activities Preparing for Success 1. Read Introduction 2. Review Learning Resources 3. Review California Student Additional Requirements for this course Epidemiology 1. Read specified pages of chapter 9 and complete the activity “What Would you Do?” 2. Watch “Determinants of Health” 3. Complete Lesson 1, Lesson 4, Lesson 6, Lesson 7, and Lesson 8 in Course Connect 4. Read Morbidity and…