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FIL 250 Chapter 1
Introduction to Risk Management
| Question | Answer |
|---|---|
| What are the steps in the risk management process? | 1. risk identification 2. risk measurement 3. determining feasible techniques 4. choose optimal technique 5. implement selected technique 6. monitor outcomes and revise |
| chance of loss | The probability that a (loss) event will occur |
| Diversifiable risk | Also known as particular or specific risk. A risk that affects only individuals and not an entire community. This is no correlation among losses. |
| Nondiversifiable risk | Also know as fundamental or market risk. A risk that affects an entire community or large numbers of persons or groups within the economy. There is significant correlation among those experiencing losses. |
| Enterprise risk | A term that encompasses all major risks faced by a business, including pure (hazard) risks, speculative risks, business and financial risks, even strategic risks. |
| What are the four quadrants of risk often considered in enterprise risk management? | 1. hazard risk 2. financial risk 3. operational risk 4. strategic risk |
| hazard | conditions that increase the frequency or severity of losses. |
| Name four types of hazards. | 1. Physical hazard 2. Moral hazard 3. Morale hazard 4. Legal hazard |
| Financial risk | A risk that is faced by businesses due to adverse changes in commodity prices, interest rates, or foreign exchange rates |
| Moral hazard | The existence of insurance often provides some incentive to cause a loss or to inflate losses through dishonest acts such as fraud. |
| Morale hazard | Also called attitudinal hazard. Carelessness or indifference to a loss because of the existence of insurance. |
| Physical hazard | A physical condition that increases the frequency and/or severity of loss (example: icy roads) |
| Legal hazard | The possibility that a change in laws will ultimately increase losses (especially for insurers). |
| What are three financial consequences of risk? | 1. Expected cost of paying losses (offset by potential gains) 2. Expenditures on risk management (in an attempt to reduce losses) 3. Cost of residual uncertainty |
| Loss exposure | Any situation or circumstance in which a loss is possible, regardless of whether a loss occurs |
| Objective risk | Uncertainty that can be quantified. It is the relative variation of actual loss from what was expected. Often objective risk can be quantified using statistics and can agreed upon by all who understand the structure of the risk. |
| Subjective risk | uncertainty based on state of mind or opinions. Unlike objective risk, subjective risk is in the eye of the beholder. |
| Peril | a specific cause of loss (example: fire) |
| Risk | uncertainty regarding outcomes. Risk includes the uncertainty in the amount of the outcome and its timing. Also, one of the outcomes is negative |
| Pure risk | A situation in which there are only the possibilities of loss or no loss. That is, only bad outcomes are possible (downsided risk only) |
| Speculative risk | A situation in which either profit or loss are possible (two sided risk - win or lose) |
| What are the three elements of loss exposures? | 1. an asset is exposed to loss in value 2. a peril can impair the asset, as well as the hazards which increase the chance of loss 3. financial consequences of the loss |
| What are four types of loss exposure? | 1. property 2. liability 3. personnel (personal) 4. net income |
| Tangible vs. intangible property | Tangible property has a physical form and can be touched. Intangible property cannot be physically touched (e.g., goodwill or patents) |
| Property loss exposure | a property owner can sustain loss from damage, destruction, or theft in which the owner has financial interest |
| Liability loss exposure | the possibility that another party will make a claim that a person or business is responsible for their injuries or damages |
| Personnel loss exposures | possibility that the skills of a key employee will be lost due to injury, sickness, disability, or death |
| Net income exposure | Possibility that net income will decline. Often result |
| What are pre-loss goals of risk management? | 1. preparation for loss in the most cost effective manner 2. Keeps uncertainty at a tolerable level 3. Ensure legal obligations are satisfied 4. social responsibility |
| What are different levels of goals for risk management after a loss has occurred? | 1. ultimate survival 2. continuity of operations 3. any level of profitability 4. stable earnings (no loss in profit 5. social responsibility (to employees, suppliers, customers, and community) 6. continued growth |
| direct loss | Financial loss that results from (is speciafally caused by) an insured peril |
| indirect loss | Financial loss occurring as the result of some other loss (also called consequential loss). An example is business interruption where a business is closed following a direct loss. |
| objective probability | frequency of an event that can be estimated precisely, either by induction (such as mortality) or by the structure of the event (such as drawing an ace out of a standard deck of cards) |
| subjective probability | frequency that cannot be verified because it is based on the state of mind of the observer (such as the likelihood of a stock increasing in value) |
| law of large numbers | as the number of observations or trials increases, the amount of objective risk falls. important for insurers, it says that the experience of a group of policyholders becomes more predictable as the number of policies increases. |
| Risk map or risk matrix | A two-dimensional assessment of the risks faced by an organization which begins the process of selecting risk management tools. A risk map illustrates the frequency and the severity/impact of each risk. |
| Frequency | the probability of a loss occurring, or the number of losses occurring during a particular time period |
| Severity | the dollar impact of a loss if a business or individual becomes affected |
| What are the two major categories of risk management techniques that are available? | risk control and risk financing |
| Risk control | any technique that attempts to reduce the amount of losses experienced |
| risk financing | any technique that is used to pay for losses when they occur |
| What are the costs of risk to society? | reduction in productive capacity of economy (damaged factories don't produce), individuals would have larger emergency funds, discontinued goods/services, worry and fear |
| What are the benefits of risk management? | Fewer/smaller losses saving resources, reduced financing costs for businesses, no societal burden for unfortunate, reduced residual uncertainty |
| probability | a measure of the likelihood that some event or outcome might happen |
| risk management | an active decision made by businesses, and to a lesser extent by individuals, to attempt to minimize the effects of losses in order assist the organization in meeting its overall objectives |
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