TOPIC 1

NATURE OF RISK
 LEARNING OBJECTIVES

Upon completion of this chapter, you

should be able to :

 Define some common terminology

 Describe the concept of risk, perils,hazard and loss
 Explain different types of probabilities theories
 Discuss classification risk
 Distinguish different types of pure risk
 Overview

 Concept Of Risk
 Concepts Of Peril, Hazards And Loss
 Probability Theories
 Classifications Of Risks
 Types Of Pure Risks
CONCEPT OF RISK

 Life is full of risks.

– Name the risks faced by you once you decided to
pursue Bachelor Degree? Risks facing you when
you are driving car?

 Risk is inherent in all aspects of our lives.

 Risk creates both problems and opportunities

– Name the bright and dark side of risks-
Computer failures
Definition of risk

 A condition in which there is a possibility of

adverse deviation from a desire outcome that is
expected or hoped for.

 Implies some form of uncertainty about an

outcome in each situation.

 It contrast with chance. Though chance implies

some doubt, but the outcome is normally a
favorable outcome.
  Risks implies;

• Some form of
Uncertainty about an
outcome in each
situation.
Possibility of an
unfortunate • Both doubt about future
occurrence

• Outcome will leave us in

a worse position

Possibility of
Unpredictable
Loss

Definition
of risks

Combination of Uncertainty of
Hazards loss
 Risk & Chance

Risk
 Uncertainty about an outcome of an event.
 The outcome normally NEGATIVE
 Example: Smoker & drug addict
Chance
 Some doubt or uncertainty about the outcome of an event
 The outcome normally a POSITIVE.
 Example: winning a bet, passing an examination
Concept of RISK
 Risk is a situation in which some kind of loss is
possible and part of life.
 Insurance protect risk, where it those who
purchase insurance are financially compensated
in case of loss.
 Although we are uncertain as to when the future
losses will take place, it is possible to estimate
the probability of loss by applying the
probability theories if there is a large number of
exposures.
CONCEPTS OF PERIL, HAZARD AND LOSS
Hazard – is anything that either causes
or increases the likelihood of a loss. Perils – is the direct cause of
the loss. Ex: Motor accident
Physical hazard – a physical condition
that increases the possibility of a loss.
Ex: Poor wiring system/wet floor Perils

Moral hazard – losses that results from

dishonesty – character defect in an
individual that increases the chance of
loss. Ex: setting fire to one’s own
premises/faking an accident
Ris
Morale hazard – closely related to
k
Hazard Loss
moral hazard, similarly, means a
character defect in an individual that
increases the chance of loss with the
knowledge that insurance exists. Ex:
Loss – is reduction/
When someone knowing that he has
disappearance of
motor insurance, carelessly leaves the
economic value
car keys in an unlocked car.
 Example
Hazard Peril Loss

Explosive Explosion Property damage

Loss of income
Additional income

Poor brake Motor accident Property damage

Loss of use
Loss of income

Poor health Illness Medical expenses

Loss of income

Carelessness Negligence Courts awards

Legal expenses
 Probability theories

Priori

Types of
probability

Judgmental Empirical
 PROBABILITY THEORIES
1. Priori Probability

 Determined when the total number of possible

events are known.
 Example: the probability of getting a six on a
roll of dice is 1/6.
 This concept has a limited practical
application in the study of risk because
situations where a number of possible
outcome are known are very rare.
 2. Empirical Probability
 Determined based on historical data
 Example: road accidents.
 The underlying concept that makes it possible for
empirical probability to be measured accurately is that
as the number of observations increases, the predicted
loss tends to approach the actual loss (the law of large
numbers)

 Law of large numbers is a concept with the following

requirements:
 Large number of similar loss exposures
 Loss exposures must be independent
 Random occurrence of losses.
 3. Judgmental Probability
 Determined based on the judgment of the person predicting the
outcome.
 It is used when there is lack of historical data or credible statistics.
 Example: Astronaut program by Malaysia. The insurance company in
Malaysia uses judgmental probability due to lack of credible statistics.
 Classification of risks

Fundamental vs
Particular risks
Financial
Pure
vs
vs Speculative
risks Non-Financial
risks

Classification
of risk
 CLASSIFICATIONS OF RISKS
 Fundamental and Particular Risks
 Fundamental risk
 Affects the entire economy or large number of persons/groups
within the economy
 Affects the society in general and cannot be controlled
 Example: Tsunami, earthquake

 Particular risk
 Those future outcomes that we can partially control
 Arises from individual decisions
 Example: to further study or to drive a car
 CLASSIFICATIONS OF RISKS
 Pure and Speculative Risks
 Pure Risk
 There are possibility of loss or no loss
 Insurable
 Example: probability of injuries in road accident

 Speculative Risk
 Possibility of loss, no loss or profit
 Most are uninsurable, because they are undertaken
willingly for the hope of profit.
 Example: investment
CLASSIFICATIONS OF RISKS

 Financial and Non-Financial Risks

• Financial Risks
 Outcome can be measured by monetary terms
 Example; Property damages can be measured in terms of loss of
profit
• Non-Financial Risks
 Outcome cannot be measured by monetary terms
 Example: Choice of career will affect one's quality of life & choice
of spouse.
TYPES OF PURE RISKS

Personal
risks

Types of
pure
risks

Liability Property
risks risks
 Personal Risks

 Risks that affect someone directly, such as illness, disability or death.

4 major types of personal risks:
 Risk of premature death
 Significant losses: loss of human value and additional expenses
 Risk of old age
 Significant loss: insufficient income during retirement
 Risk of poor health
 Significant losses: Expensive medical charges and loss of earned
income
 Risk of unemployment
 Significant losses: loss of earned income and depletion of
accumulation financial assets.
 Property Risk

 Affects either personal or real property.

3 main types of loss:
 Direct Loss
• Damage to property by a peril.
• Example: house destroyed by fire
 Indirect loss
• Loss in consequence of a direct loss
• Example: loss of profit
 Extra expenses
• Extra costs incurred as a result of the loss
• Example: owner have to rent another building to
continue operation/ living.
 Liability risks

 Also known as legal risk.

 Risks of being sued because of neglect,

malpractice, or causing willful injury either to
another person or to someone else's property.

 Possibility of financial loss if you are found

liable, or the financial loss incurred just
defending yourself, even if you are not found
liable.
Any question?
 Tutorial – Topic 1
1. Discuss three (3) types of hazard. (10 marks)
2. Explain the types of probability theories. (5 marks)
3. Differentiate between moral and morale hazard. (5
marks)
4. Differentiate with an example between fundamental
and particular risks. (5 marks)
5. Explain “property risk” in relation to pure risk. (5
marks)
NOW YOUR ALREADY
KNOW ABOUT RISKS,
LETS MOVE TO THE
TOPIC 2 – RISK
MANAGEMENT