Objective risk: is defined as the relative variation of actual loss from expected loss.
Calculated using a measure of dispersion, such as the standard deviation. Declines with
increase in exposure units (law of large numbers).
Subjective risk: is defined as uncertainty based on a person’s mental condition or state of
mind
Two persons have different perceptions of risk (e.g.: Drinking and driving depending on
past experience)
Chance of Loss: The probability that an event will occur. Peril is defined as the cause of
the loss Hazard is a condit. tht increase the chance of loss
Pure risk is one in which there are only the possibilities of loss or no loss (earthquake)
Speculative risk is one in which both profit or loss are possible (gambling) Fundamental
(or non-diversifiable) risk affects the entire economy or large numbers of persons or
groups (hurricane)
Particular (or diversifiable) risk affects only the individual (car theft)
Adverse selection is the tendency of persons with a higher-than-average chance of loss to
seek insurance at standard rates
Private Insurance: Life and Health, Property and Liability Government Insurance: Social
Insurance Other Government Insurance
Risk Managers sources of information to identify loss exposures: Questionnaires Physical
inspection
Flowcharts Financial statements Historical loss data
Risk Control methods: Avoidance means a certain loss exposure is never acquired, or an
existing loss exposure is abandoned. Loss prevention refers to measures that reduce the
frequency of a particular loss. Loss reduction refers to measures that reduce the severity of
a loss after is occurs
Retention means that the firm retains part or all of the losses that can result from a given
loss
Current net income: losses are treated as current expenses Unfunded reserve: losses are
deducted from a bookkeeping account
Funded reserve: losses are deducted from a liquid fund Credit line: funds are borrowed to
pay losses as they occur
captive insurer is an insurer owned by a parent firm for the purpose of insuring the parent
firm’s loss exposures
Captives are formed for several reasons, including: -The parent firm may have difficulty
obtaining insurance -Costs may be lower than purchasing commercial insurance -A captive
insurer has easier access to a reinsurer -A captive insurer can become a source of profit
-Premiums paid to a captive may be tax-deductible under certain conditions
non-insurance transfer is a method non-insurance by which a pure risk and its potential
financial consequences are transferred to another party
Examples include: Contracts, leases, hold-harmless agreements
Principle of indemnity: The insurer agrees to pay no more than the actual amount of the
