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The Concept of Risk

1.

Basic problem with which insurance deals

2.

Insurance theorists have not been able to


agree on a definition

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Common Elements in Definitions of Risk


1.

Indeterminancy - at least two possible


outcomes

2.

Adversity - at least one of the outcomes is


undesirable

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The Texts 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.
1. Risk not subjective - a state of the real
world
2. Risk can exist whether or not it is
perceived
3. Risk can be imagined where possibility of
loss does not exist
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Uncertainty and its Relationship to Risk


1. The most widely held meaning of uncertainty
refers to a state of mind characterized by a
lack of knowledge or doubt about the future.
2. It is contrasted with certainty, as in
I am certain I will get an A in this course.
I am uncertain what grade I will get.

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The Degree of Risk


1.

What is more risk or less risk?

2.

Varies with the probability of deviation

from what is expected in case of


aggregate data

from what is hoped for (no loss) in case


of individual

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Risk Distinguished From Peril and Hazard


Peril:

the cause of loss

Hazard:

a condition that creates or


increases the chance of loss

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Classifications of Hazards
Physical
Moral
Morale

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Classifications of Risk
1.

Financial and non-financial

2.

Static and dynamic

3.

Fundamental and particular

4.

Pure and speculative

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Static 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 resources

2. 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


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Fundamental and Particular Risks


1.

Fundamental risks are impersonal in origin


and consequences. They are societal risks.

2.

It is held that society (rather than the


individual) should deal with them.

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


individuals own responsibility that are
properly addressed by the individual.
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Pure 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.

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Classifications of Pure Risk


1.

Personal risks

2.

Property risks

3.

Liability risks

4.

Risks arising out of failure of others

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The Burden of Risk


1.

Some losses will occur

2.

The cost of accumulated reserves

3.

Deterrent effect on capital accumulation

4.

Higher cost of capital

5.

Feeling of frustration and mental unrest

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Methods of Dealing With Risk


1. Avoidance
2. Reduction
3. Retention
4. Transfer
5. Sharing

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