Environmental Risks and Disasters
Lecture Notes 3 (1/29/2008)
Adjusting to risk. Risk perception. The value of life.
Regardless of how the risk is expressed, the desire of most people (and societies)
is to reduce the risk that they are exposed to. Individuals respond to risk by
"adjusting" to it. Similarly governments and societies have "adjusted" or
"adapted" to various risks. The end result is usually that the risk is brought to a
lower level, which can be described as an "acceptable" risk or "safe enough". This
raises the question of what level of risk is acceptable.
A good example of this process may be society's response to the fire hazard. All
of us are aware of fire companies, fire drills, fire insurance, fire extinguishers, fire
retardant fabrics, and so on. A complex set of laws, codes and regulations have
been established to either reduce the hazard or the vulnerability associated with
One common adjustment to risk is insurance. Consider the situation where you
have finished school, you have a great job making lots of money, your spouse
makes hardly anything, and in addition you have the responsibility for your young
children. You worry about what would happen to them if you were to die. What
can you do? You can insure your life.
There are different types of life insurance. In particular, there is something called
"term insurance". This is the kind that often appears in movies. Basically, this is a
contract where the customer pays a premium to the insurance company, and if he
or she dies within a specified period of time (usually a year), a (sometimes large)
sum of money is given to the next of kin (or the villain).
Somebody gave me a flyer from a life insurance company with some premiums,
and I thought we could compare this company's assessment of risk with what we
have just examined using population data from the government. The flyer lists the
premium that should be paid for various amount of principal. For example, for
somebody 20 years old, the monthly premium for a $100,000 coverage is $12.50.
Is this reasonable, given the risk of dying?
We have earlier calculated the risk of dying at 20 to be about 0.001. The
insurance company therefore expects to pay out $100,000 to 0.001 x (number of
policies) each year. Let's say they write 1000 policies to 20-year-old customers.
Only one of these will, based on probabilities, have to be paid out, a cost of
$100,000. At the same time, the company will receive the premiums for 1000 x
12 x $12.50 = $150,000. This seems to suggest that they may make a profit of
$50,000 on these customers. Note that the premium for men and women is the
same up to the age of nearly 40. Does this seem fair (i.e., does it reflect the real