Presentation on theme: "A Definition of Risk Risk is a condition in which there is a possibility of an adverse deviation from a desired outcome that is expected or hoped for."— Presentation transcript:
1A Definition of RiskRisk is a condition in which there is a possibility of an adverse deviation from a desired outcome that is expected or hoped for.1. Risk not subjective - a state of the real world2. Risk can exist whether or not it is perceived3. Risk can be imagined where possibility of loss does not exist (subjective)
2The Degree of Risk1. What is more risk or less risk?2. Varies with the probability of deviationfrom what is expected in case of aggregate datafrom what is hoped for (no loss) in case of individual
3Risk Distinguished From Peril and Hazard Peril: the cause of lossHazard: a condition that creates or increases the chance of loss
5Classifications of Risk Financial and non-financialStatic and dynamicFundamental and particular4. Pure and speculative
6Static and Dynamic Risks 1. Dynamic risks result from changes in the economy (e.g., changes in price levels, consumer taste, income, and output).benefit society in the long run, by adjusting misallocations of resources2. Static risks would exist even in the absence of economic change (from perils of nature or human dishonesty).not a source of gain to society
7Fundamental and Particular Risks 1. Fundamental risks are impersonal in origin and consequences. They are societal risks.It is held that society (rather than the individual) should deal with them.2. Particular risks involve losses that arise out of individual events and are felt by individuals rather than the entire group.Particular risks are considered the individual’s own responsibility that are properly addressed by the individual.
8Pure and Speculative Risks 1. Speculative risks involve the possibility of loss or gain. They are voluntarily accepted because of the possibility of gain.2. Pure risks involve the possibility of loss or no loss only.3. In general, insurance deals with pure risks only.
9Classifications of Pure Risk 1. Personal risks(premature death, retirement income, poor health,unemployment)2. Property risks3. Liability risks4. Risks arising out of failure of others
10The Burden of Risk1. Some losses will occur2. The cost of accumulated reserves3. Deterrent effect on capital accumulation4. Higher cost of capital5. Feeling of frustration and mental unrest
11Methods of Dealing With Risk 1. Avoidance2. Reduction(loss control)3. Retention (active or passive)4. TransferSharing
12Nature & Functions of Insurance In its simplest aspect, insurance has two fundamental characteristics:1. Transfer of risk from the individual to the group.Sharing of losses on some equitable basis.(unstated but important third characteristic is that of INDEMNIFICATION)
13Insurance Defined: Individual Perspective Insurance is an economic device whereby the individual substitutes a small certain cost (the premium) for a large uncertain financial loss (the contingency insured against) which would exist if it were not for the insurance.
14Risk Reduction Through Pooling 1. The risk an insurer faces is not merely a summation of risks transferred to it by individuals.2. Insurer can predict within narrow limits the amount of losses that will occur.3. If insurer could predict future losses with absolute precision, it would have no risk.4. Accuracy of insurer’s prediction is based on the law of large numbers.
15Probability Theory and Law of Large Numbers Probability theory is the body of knowledge concerned with measuring the likelihood that something will happen and making predictions based on this likelihood.
16Insurance Defined Social Perspective Insurance is an economic device for reducing and eliminating risk through the process of combining a sufficient number of homogeneous exposures to make the losses predictable for the group as a whole.
17Insurance: Transfer or Pooling? 1. The view that the essence of insurance is risk transfer emphasizes the individual’s substitution of a small small certain cost for large uncertain loss.2. Emphasis on pooling or risk sharing emphasizes the role of reducing risk in the aggregate.3. Insurance can exist without pooling, but not without transfer.
18Insurance and Gambling 1. In gambling, there is no chance of loss (and therefore no risk) prior to the wager.2. In the case of insurance, the chance of loss exists whether or not insurance is purchased.3. Gambling creates risk, while insurance provides for the transfer of existing risk.
19Economic Contribution of Insurance 1. Creates certainty about burden of loss2. Spreading losses that do occur3. Provides for an optimal utilization of capital
20Elements of an Insurable Risk 1. Large numbers of exposure units2. Definite and measurable loss3. The loss must be fortuitous4. The loss must not be catastrophic
21The Fields of Insurance 1. Private insurancevoluntary programs designed to protect individual against financial loss2. Social Insurancecompulsory insurance programs generally operated by government3. Public Benefit Guarantee Programsquasi-social coverages usually associated with regulation
22Private (Voluntary) Insurance 1. Usually (but not always) voluntary.2. Usually (but not always) offered by private insurers.
23Private (Voluntary) Insurance 1. Life insurance2. Accident and health insurance3. Property and liabilityfiremarinecasualtyfidelity and surety bonds
24Casualty Insuranceaccident and health insuranceautomobileliabilityworkers compensationboiler and machineryplate glassburglary, robbery, theftcredit insurancetitle insurance
25Social InsuranceBased on the notion that there are some people in society who face fundamental risks that they cannot deal with themselves.Social insurance programs rest on the premise that if an individual cannot provide for a reasonable standard of living through personal efforts, society should assist.
26Social Insurance Definition 1. Coverage is compulsory2. Eligibility derived from contributions: no requirement to demonstrate need3. Method of determining benefits prescribed by law4. Benefits not directly related to contributions
27Social Insurance Definition 5. Definite long-range plan for financing6. Cost borne primarily by contributions7. Plan administered or supervised by government8. Plan not established solely for government employees
28Social Insurance Programs in the U.S. 1. Old-Age, Survivors and Disability Insurance2. Railroad Retirement, Disability and Unemployment Insurance3. Unemployment Insurance4. Medicare5. State Compulsory Temporary Disability
29Public Guarantee Insurance Programs 1. Quasi social insurance programs, mainly in connection with financial institutions2. Public Guarantee Insurance Programs are usually allied with the function of regulation3. Insurance principle is used to protect lenders, depositors, or investors against loss resulting from failure of a financial institution
30Federal Public Guarantee Programs 1. Federal Deposit Insurance Corporation2. National Credit Union Administration3. Securities Investor Protection Corporation4. Pension Benefit Guarantee Corporation