Risk and Insurance Test 1 notes

# Risk and Insurance Test 1 notes - Test 1 Notes Risk is the...

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Test 1 Notes Risk is the u ncertainty concerning the occurrence of a loss Peril – the cause of a loss Hazard – a condition that increases the probability or severity of a loss Physical Hazard is a physical condition that increases the chance of loss (icy road, defective wiring, weak door jam or broken lock) Moral Hazard is dishonesty or character defects in an individual that increase the frequency or severity of loss (faking an accident report, submitting a fraudulent claim (or padding -- “the insurer has plenty of money”) Morale Hazard = carelessness or indifference to loss because of the existence of insurance (leaving keys in parked car, leaving stock outside store overnight) Legal Hazard = characteristics of legal system that may increase the frequency or severity of loss. (Insurance regs that force a company to cover a specific risk, such as: coverage for alcoholism in a health insurance plan) Two Important Concepts in Estimating Risk Objective Risk is the relative variation of actual loss from expected loss. Objective Risk varies inversely with the square root of the number of cases under observation. A convenient way to summarize losses is a probability distribution Coefficient of Variation is a relative measure of risk Subjective Risk is based on a person’s mental condition or state of mind. Outcome is “Loss,” “Break Even or “Profit” Impact of Subjective Risk Varies from person to person High Subjective Risk = conservative/prudent behavior Low Subjective Risk = less conservative/prudent behavior Measurement of Risk- Frequency: number of losses per time period OR Severity : dollar amount per loss Chance of Loss is the probability that an event will occur. Probability: Objective Probability = long-term relative frequency of an event based on the assumptions of an infinite number of observations and of no change the underlying conditions. (actuarial tables, time to failure studies, etc.) Subjective Probability = the individual’s personal estimate of the chance of loss. (Buying a ‘lucky lottery ticket’ on your birthday) Categories of Risk Pure Risk there is only the possibilities of loss or no loss. Pure Risk is calculated by outcome “Loss” or “No Loss” (premature death, work accident, fire, lightning, flood, or earthquake damage) Insurers typically insure only pure risks Personal Risks directly affect an individual (premature death = death of a household head with unfulfilled financial obligations, insufficient retirement income, poor health (nursing home cost = >\$40,000 year; medical bills), unemployment) Property Risks damage or loss from numerous causes Direct Loss = a financial loss resulting from physical damage, destruction or theft of property Indirect or Consequential Loss

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Risk and Insurance Test 1 notes - Test 1 Notes Risk is the...

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