# Study Guide RMIN 4000 Exam 1.docx - RMIN 4000 Chapter 1...

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RMIN 4000 Chapter 1: What is Risk? Textbook definition – Uncertainty concerning the occurrence of a loss Better definition – A calculated possibility of a negative outcome Calculated Possibility A probabilistic outcome that is known or estimated Ranged 0 to 1 50% is the highest risk Negative outcome Loss Must be Quantifiable (\$) Frequency & Severity Frequency o How often does a loss occur? o The number of losses that occur within a specific time period o Probability of a loss o Freq = Number of losses/Number of exposures Severity o How much does it cost when a loss occurs? o The dollar amount of loss for a specific peril o Severity = Total Losses (\$)/Number of losses Peril vs. Hazard Peril o Cause of Loss o Fire, Tornado, burglary Hazard o Condition that creates or increases the frequency and/or severity of a loss o Does not cause loss o Four types – physical, moral, morale (attitudinal), legal Physical Hazard o A physical condition that increases the frequency and/or severity of a loss o Rusty pipes Moral Hazard o Book Definition Dishonesty or character defects in an individual that increase the frequency and/or severity o Better Definition
The presence of insurance changes the behavior of the insured o Examples Using a hammer to create “hail” damage to a roof Exaggerating the value of insured property Morale (Attitudinal) Hazard o Carelessness or indifference to a loss, which increases the frequency and/or severity of a loss o Examples Leaving car keys in an unlocked car Neglecting a tree limb growing over your reef Legal Hazard o Characteristics of legal system or regulatory environment that increase the frequency and/or severity of a loss o Examples Juries in some areas are most sympathetic than other areas (meaning larger damage awards in liability lawsuits) Georgia now requires Diminution in Value to be paid on property losses (meaning increased severity in Georgia) Risk Classifications o Pure vs. Speculative Risk o Diversifiable Risk o Non-diversifiable Risk o Enterprise Risk o Systemic Risk Pure vs Speculative o Pure Loss or no loss Fire, Cancer o Speculative Loss or Gain, or neither Ex. Sports betting, Drinking Diversifiable Risk o Affects only individuals or small groups, not entire economy o Can be reduced/eliminated through diversification o Risk are not correlated between individuals (fire, theft, collision) Non-diversifiable Risk o Affects the entire economy or large numbers of groups within the economy o CANNOT be reduced/eliminated through diversification o Government assistance may be needed to insure o Risks are correlated (inflation, unemployment) o Ex. Floods Enterprise Risk o Encompasses all major risks by a business firm:
Pure Risk Speculative Strategic (CH. 3) Operational (CH. 3) Financial (CH. 3) Systemic Risk o Financial Markets o Risk of collapse of an entire system or entire market due to the failure of a single entity or group of entities that can result in the breakdown of the entire financial system o