RMIN 4000 EXAM 1 LATEST 2024 GRADED A

Textbook definition of RISK Ans✔- Uncertainty concerning the occurrence of a loss

Better definition of RISK Ans✔- A calculated possibility of a negative outcome

Calculated Possibility Ans✔- 0 = Impossible event (NO RISK)

0.5 = Highest Risk (Most Uncertainty)

1 = 100% Certain Event (NO RISK

Negative Outcome Ans✔- Loss

Losses must be ? Ans✔- Quantifiable

Pure Risk States Ans✔- Loss

or

No Loss

Examples of Pure Risks Ans✔- Fire, Cancer, Dog bites a visitor

Speculative Risk States Ans✔- Loss

No Loss/No Gain
Gain

Examples of speculative risks Ans✔- Investment, Gambling, Drinking

Frequency answers what question? Ans✔- How often does a loss occur

The number of losses that occur in a specified time period

Probability of a loss Ans✔- Frequency

Severity answers what question? Ans✔- How much does it cost when a loss does
occur?

The dollar amount for a loss of a specific peril

Peril Ans✔- Cause of a loss

Hazard Ans✔- Condition that creates or increases the frequency and/or severity of
a loss

DOES NOT CAUSE A LOSS

Examples of Peril Ans✔- Fire, Tornado, Collision, Burglary

Types of Hazard Ans✔-

Physical Moral

Morale
(Attitudinal)

Legal

Physical Hazard Ans✔- A physical condition that increases the frequency and/or
severity of a loss
Book Definition of Moral Hazard Ans✔- Dishonesty or character defects in an
individual that increase the frequency and/or severity of a loss

Better Definition of Moral Hazard Ans✔- The presence of insurance changes the
behavior of the insured

Examples of Moral Hazard Ans✔- Using a hammer to create "hail" damage to a

roof

Exaggerating the value of insured property

Morale (Attitudinal) Hazard Ans✔- Carelessness or indifference to a loss, which

increases increases the frequency and/or severity of a loss

Examples of Morale Hazard Ans✔- Leaving car keys in an unlocked car

Neglecting a tree limb growing over your roof

Legal Hazard Ans✔- Characteristics of a legal system or regulatory environment

that increase the frequency and/or severity of a loss

Examples of a Legal Hazard Ans✔- Juries in some areas are more sympathetic than
in other areas

Georgia now requiring Diminution in Value to be paid on property losses

Diversifiable Risk Ans✔- Affects only individuals or small groups, not the entire
economy
Can be reduced/eliminated through diversification

Risks not correlated

Nonsystematic Risk or Particular Risk Ans✔- Diversifiable Risk

Nondiversifiable Risk Ans✔- affects the entire economy or large numbers of

groups/persons within the economy

CANNOT be reduced/eliminated through diversification

Gov. assistance may be needed

Risks are correlated

Fundamental Risk Ans✔- Nondiversifiable Risk

Major types of pure risks Ans✔- Personal risk

Property risk

Liability risk

Personal risk Ans✔- Directly affects an individual or family

Involves the possibility of loss of income, extra expenses, depletion of financial

assets

What perils are involved in personal risk? Ans✔- Death

Unemployment
Disability/Injury/Poor Health
Inadequate Retirement Income

Has to do with direct and indirect losses Ans✔- Property Risk

Direct Loss Ans✔- Cost to repair or replace property damaged by a peril

Indirect Loss Ans✔- Financial loss resulting as a consequence of a direct loss

Examples of an indirect loss Ans✔- Fire damages home; must live somewhere else
while its repaired

Business interruption, loss of income

Liability Risk Ans✔- Legal liability (financial consequences) resulting from injuries
or damages caused

No upper limit

Liens can be placed on income, assets seized

Defense costs - Lawyers

Techniques for managing risks Ans✔- Risk control

Risk financing

Risk Control Ans✔- Techniques to reduce the frequency or or severity of losses

Risk financing Ans✔- Techniques for funding losses

loss prevention, loss reduction, and avoidance are aspects of ? Ans✔- risk control
Loss prevention Ans✔- reduces frequency

Ex - airport security, safety training programs

loss reduction Ans✔- reduces severity

Ex - fire sprinklers

can occur pre or post loss

Duplication, Separation, Diversification

Avoidance Ans✔- a certain loss exposure is never acquired (proactive)

An existing loss exposure is abandoned (reactive)

Retention and non-insurance transfer are aspects of ? Ans✔- risk financing

Retention Ans✔- Retaining part or all of losses that can occur from a given risk

Active retention Ans✔- Deliberately retaining risk

choosing a high deductible

Passive retention Ans✔- unknowingly retaining risk

(not purchasing disability insurance)

Noninsurance transfer Ans✔- By contract
Ex - hedging, derivatives, incorporation

Definition of Insurance Ans✔- the pooling of fortuitous

losses by transfer of such risks to insurers, who agree to

indemnify insureds for such losses, to

provide other pecuniary benefits on

their occurrence, or to render

services connected with the risk.

Law of large numbers Ans✔- The greater the number of

exposures, the more closely will actual results approach

the

probable results expected from

an infinite number of exposures.

Coin flip - the more times you flip it, the closer you get to 50%

Pooling of losses Ans✔- The spreading of losses

incurred by a few over the entire group.

Reduces variation, which reduces uncertainty (risk)

Fortuitous Ans✔- Unforeseen and unexpected by the insured and occurs as a

result of chance
Risk Transfer Ans✔- A pure risk is transferred from

the insured to the insurer, who typically is in a

stronger

financial position.

Indemnification Ans✔- The insured is restored to its

approximate financial position prior to the occurrence of

the
loss.

Characteristic of an Ideally insurable risk Ans✔- Large number of exposure units

Loss must be accidental and unintentional

Loss must be determinable and measurable

Loss should not be catastrophic

chance of loss must be calculable

Premium must be economically feasible

Large number of exposure units Ans✔- Enables the insurer to

predict average loss based on the Law of Large Numbers

similar exposure units

Loss must be accidental and unintentional Ans✔- Loss should be outside of

insured's control bc Law of Large Numbers is based on randomness

Loss must be determinable and measurable Ans✔- Determine if a loss occurred

Measure the amount of the loss

Loss should not be catastrophic to the insurer Ans✔- Allows pooling technique to
work

Solutions are reinsurance and diversification

Chance of loss must be calculable Ans✔- must calculate avg frequency and avg
severity

Premium must be economically feasible Ans✔- insured must be able to afford it

not feasible for a 90 yr old looking for life insurance

Adverse Selection Ans✔- Tendency of persons with a higher than avg chance of
loss to seek insurance at standard (avg) rates, which, if not controlled by
underwriting, results in higher than expected loss levels

results from asymmetric information

Asymmetric Information Ans✔- Occurs when one party has information that is
relevant to a transaction that the other party does not have

Credit Based Insurance Score Ans✔- Utilizes a consumer's credit history to

predict the likelihood of future insurance losses

introduced in early 1990's

Not the same as credit score

AIC led to Ans✔- deterioration bc of low premiums and high number of losses

Types of private insurance Ans✔- Life insurance

Health Insurance

Property Insurance
Liability Insurance

Casualty Insurance

Life Insurance Ans✔- pays death benefits to beneficiaries when the insured dies

Health Insurance Ans✔- covers medical expenses because of sickness and injury

Property Insurance Ans✔- indemnifies property owners against the loss or

damage of real or personal property

Liability insurance Ans✔- covers the insured's legal liability arising out of
property damage or bodily injury to others

Casualty Insurance Ans✔- refers to insurance that covers whatever is not

covered by fire, marine, and life insurance

Social insurance groups Ans✔- Financed entirely or in large part by

contributions from employers and/or employees

Benefits are heavily weighted in favor of low income groups

Eligibility and benefits are prescribed by statute

Found at both federal and state level

Social benefits of insurance Ans✔- Indemnification for loss

Reduction of worry and fear
Source of investment funds

Loss prevention

Enhancement of credit

Social costs of insurance Ans✔- cost of doing business

Fraudulent claims

Inflated claims

Risk Management Ans✔- Process that identifies loss

exposures faced by an organization and selects the most

appropriate techniques for

treating such exposures.

Loss Exposure Ans✔- Any situation or circumstance in

which a loss is possible, regardless of whether a loss

actually

occurs.

Steps in Risk Management Process Ans✔- 1. Identify loss exposures

2. Measure and analyze the loss exposures

3. Consider and select the appropriate risk management techniques

4. Implement and monitor the chosen techniques

1. Identify loss exposures Ans✔- What assets need to be protected?

What perils are those assets exposed to?

Most important step

2. Measure and analyze the loss exposures Ans✔- Estimate the frequency

and severity of loss exposures.

Rank loss exposures according

to relative importance.
Severity is more important.
Maximum possible loss & Probable maximum loss

Maximum possible loss (MPL) Ans✔- The worst loss that could happen to the firm
during its lifetime

Probable maximum loss (PML) Ans✔- the worst loss that is likely to happen

3. Consider and select the appropriate risk management techniques Ans✔- Risk
control or risk financing

Risk control - Duplication Ans✔- Having back ups or copies of important

documents or property available in case a loss occurs

Risk control - separation Ans✔- Dividing the assets exposed to loss to minimize
the harm from a single event.

Firewalls or multiple company warehouses

Risk control - Diversification Ans✔- Reducing the chance of loss by spreading the
loss exposure across different parties (customers, suppliers), securities (stocks,
bonds), or transactions.

Risk financing - retention - captive insurer Ans✔- A captive insurer is an insurer

owned by a
parent firm for the purpose of

insuring the parent firm's loss

exposures.

Single-parent captive is owned by

only one parent.

Association or group captive is

an insurer owned by several

parents.

Captive advantages Ans✔- Can help a firm when

insurance is expensive or difficult to obtain.

Lower Costs

Easier access to reinsurance market.

Possibility of lower tax rate.

Possibility of favorable

regulatory environment.

Risk financing - retention - self insurance Ans✔- a special form of planned

retention by which part or all of a given loss exposure is retained by the firm.

Risk retention group Ans✔- Group captive that can write any type
of liability coverage except employers' liability, workers

compensation, and personal lines.

Exempt from many state insurance laws.

Risk financing - non insurance transfer Ans✔- Methods other than insurance by
which a pure risk and its potential financial consequences are transferred to
another party.

Ex - contracts, leases, hold harmless agreements

Risk financing - commercial insurance Ans✔- Appropriate for low-

probability, high-severity loss exposures.

Deductible

Excess Insurance

Manuscript policy

Deductible Ans✔- a specified amount subtracted from the loss payment

otherwise payable to the insured.

Excess Insurance Ans✔- a plan in which the insurer pays only if the actual loss
exceeds the amount a firm has decided to retain.

Manuscript Policy Ans✔- a policy specially tailored for the firm.

Underwriting cycles Ans✔- Hard Market

Soft Market

Hard Market Ans✔- insurer profitability is declining, underwriting standards are

tightened, premiums increase, and insurance is hard to obtain
Soft Market Ans✔- profitability is improving, standards are loosened, premiums
decline, and insurance become easier to obtain.

Step 4: Implement and monitor the chosen techniques Ans✔- Risk Management
Policy Statement

Provides standards for

judging the risk manager's

performance

Benefits of risk management Ans✔- Enables a firm to attain its

pre-loss and postloss objectives more easily

Society benefits because both

direct and indirect losses are

reduced

Can reduce a firm's cost of risk.

Cost of risk Ans✔- Measures the cost associated with

treating the organization's loss exposures.

Traditional Risk Management Ans✔- Limited in scope to pure loss

exposures - property, liability, and personnel-related

risks.
Enterprise Risk Management (ERM) Ans✔- Comprehensive risk

management program that addresses all risks faced by an organization -

pure risks, speculative risks,

strategic risks, and operational

risks.

Strategic Risk Ans✔- Uncertainty regarding an organization's goals

and objectives, and the

organization's strengths,

weaknesses, opportunities, and

threats (SWOT).

Operational Risks Ans✔- Develop out of business

operations, including the supply chain, the manufacture

and

distribution of products, providing

services to customers, and

cybersecurity.

Enterprise Risk Management Program Ans✔- Organizational risk

management program with an interconnected view of risk.

Headed by Chief Risk Officer

May consider regulatory,

reputational, and compliance

risks.

Why should an organization use ERM Ans✔- By combining all risks

into a single risk management program, the organization may

be able to offset one risk against

another, and reduce its overall risk.