640 Class 10 - Class 10 Insurance and Risk Management...

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Class 10 Insurance and Risk Management George D. Krempley Bus. Fin. 640 Winter Quarter 2008
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Definition of Risk Risk is defined as uncertainty concerning the occurrence of a loss
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Implication Risk is present: Whenever circumstances give rise to an outcome that cannot be predicted with certainty “Not knowing” the future creates risk.
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Objective Vs. Subjective Risk Risk : Uncertainty concerning the occurrence of a loss Objective Risk vs. Subjective Risk Objective risk is defined as the relative variation of actual loss from expected loss It can be statistically calculated using a measure of dispersion, such as the standard deviation Subjective risk is defined as uncertainty based on a person’s mental condition or state of mind Two persons in the same situation may have different perceptions of risk High subjective risk often results in conservative behavior
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Chance of Loss Chance of loss : The probability that an event will occur Objective Probability vs. Subjective Probability Objective probability refers to the long-run relative frequency of an event assuming an infinite number of observations and no change in the underlying conditions It can be determined by deductive or inductive reasoning Subjective probability is the individual’s personal estimate of the chance of loss A person’s perception of the chance of loss may differ from the objective probability
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Chance of Loss Vs. Objective Risk Key Distinction Chance of loss: Probability that a loss will occur Chance involves probability Risk involves variation
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Peril and Hazard A peril is defined as the cause of the loss In an auto accident, the collision is the peril A hazard is a condition that increases the chance of loss Physical hazards are physical conditions that increase the chance of loss (icy roads, defective wiring) Moral hazard is dishonesty or character defects in an individual, that increase the chance of loss (faking accidents, inflating claim amounts) Morale Hazard is carelessness or indifference to a loss because of the existence of insurance (leaving keys in an unlocked car) Legal Hazard refers to characteristics of the legal system or regulatory environment that increase the chance of loss (large damage awards in liability lawsuits)
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Basic Categories of Risk Pure and Speculative Risk A pure risk is one in which there are only the possibilities of loss or no loss (earthquake) A speculative risk is one in which both profit or loss are possible (gambling) Fundamental and Particular Risk A fundamental risk affects the entire economy or large numbers of persons or groups (hurricane) A particular risk affects only the individual (car theft) Enterprise Risk Enterprise risk encompasses all major risks faced by a business firm, which include: pure risk, speculative risk, strategic risk, operational risk, and financial risk
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This note was uploaded on 07/17/2008 for the course BUSFIN 640 taught by Professor Krempley during the Winter '08 term at Ohio State.

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640 Class 10 - Class 10 Insurance and Risk Management...

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