Risk Management Exam 1 (Chapters 1-4) 100% Correct Answers

What is the definition of risk? - ANS No single definition of risk. Uncertainty concerning the occurrence of a loss. Any situation where there is uncertainty about what outcome will occur. Variation of outcomes. What is loss exposure? - ANS Any situation or circumstance in which a loss is possible, regardless of whether a loss occurs. What are the three different types of risk attitude? - ANS 1. Risk Averse 2. Risk Neutral 3. Risk Taker (Lover) What is a risk averse? - ANS Avoid risk if and when possible. (Will pay extra to remove risk from a set of outcomes.) What is a risk neutral? - ANS Will evaluate risk and will strive to "pay" no more or less than the expected loss to avoid the risk. What is a risk taker? - ANS Will "gamble" on a big payout and not take many precautions to avoid risk. What is an objective risk? - ANS Defined as the relative variation of actual loss from expected loss can be statistically calculated by some measure of dispersion. (Standard deviation) What is the law of large numbers? - ANS States that as the number of exposure units increases, the more closely the actual loss experience will approach the expected loss experience. What is a subjective risk? - ANS Defined as the uncertainty based on a person's mental condition or state of mind, varies by individual. (Cannot be measured) What is the chance of loss? - ANS Defined as the probability that an event will occur. What is a peril? - ANS Defined as the cause of the loss. Ex. Your house burns because of fire, the peril, or cause of loss, is the fire. What is a hazard? - ANS Cause of peril, a condition that creates or increase the frequency of severity of loss. Ex. Your house burns because of a fire because of wood, wood is the hazard. What are the four major types of hazards? - ANS 1. Physical hazard 2. Moral hazard 3. Attitudinal hazard (Morale hazard) 4. Legal hazard What is a physical hazard? - ANS A physical condition that increases the frequency or severity of loss. Ex. Icy road that increases the chance of an auto insurance. What is a moral hazard? - ANS Dishonesty or character defects in an individual that increase the frequency or severity of loss. Ex-post vs. Ex-ante Ex. Faking an accident to collect from insurers, intentional murder to collect life insurance. What is ex-post and ex-ante? - ANS Ex-post is when you exaggerate after a loss and ex-ante is when you lie that you don't have problems for health insurance. What is an attitudinal hazard (morale hazard)? - ANS Carelessness or indifference to a loss which increases the frequency or severity of a loss. Ex. Leaving car keys in an unlocked car. What is a legal hazard? - ANS Refers to characteristics of the legal system or regulatory environment that increase the frequency or severity of losses. What are the different kinds of risks? - ANS 1. Pure and speculative risk 2. Diversifiable risk and nondiversifiable risk 3. Enterprise risk What is a pure risk? - ANS Only the possibilities of loss or no loss. Ex. Premature death, Job-related accidents, Fire, lightening, flood What is a speculative risk? - ANS Possibilities of both loss or profit. Ex. Stock purchase, Gambling, Horse racing, Investing in real estate What is a diversifiable risk? - ANS A risk that affects only individuals or small groups and not entire economy. (Low correlation) What is a nondiversifiable risk? - ANS A risk that affects the entire economy or large numbers or persons or groups within the economy. It's a risk that cannot be eliminated or reduced through diversification. What is an enterprise risk? - ANS All major risks faced by a business. Pure risk, speculative risk, financial risk, operation risk, etc. What is a personal risk? - ANS Risk that directly affect an individual or family. Ex. Premature death, insufficient retirement income, poor health, and unemployement What is a property risk? - ANS The risk of having property damaged or lost from numerous causes. What are two major types of loss associated with property? - ANS Direct and indirect What is a direct loss? - ANS Defined as a financial loss that results from the physical damage, destruction, or theft of the property. What is an indirect loss? - ANS Defined as a financial loss the results indirectly from the occurrence of a direct physical damage or theft loss. It is also called consequential loss. What is a liability risk? - ANS A pure risk where you can be held legally liable if you do something that results in bodily injury or property damage to someone else. What are the different types of liability risk? - ANS 1. Property of ownership 2. Automobile 3. Products 4. Professional services What are the three major burdens on society? - ANS 1. The size of an emergency fund must be increased. 2. Society is deprived of certain goods and services. 3. Worry and fear are present. What is risk control? - ANS Techniques that reduce the frequency or severity of losses. What is risk financing? - ANS Techniques that provide for the funding of losses. What are major risk-control techniques? - ANS 1. Avoidance 2. Loss prevention 3. Loss reduction What is avoidance? - ANS Avoid the risk of something by not doing it. What is loss prevention? - ANS Certain activities that reduce the frequency or severity of losses. Ex. Heart attacks can be reduced if quit smoking. What is loss reduction? - ANS Reduce severity of loss. Ex. Sprinkler system What are major risk-financing techniques? - ANS 1. Retention 2. Noninsurance transfers 3. Insurance What is retention? - ANS Individuals and firms retain (assume) part or whole risk. Retention can either be _____ or _____. - ANS Active, passive What is active retention? - ANS Individual is consciously aware of the risk and deliberately plans to retain all or part of it. Ex. Small collison What is passive retention? - ANS Certain risks that is unknowingly retained because of ignorance, indifference, laziness, or failure to identify an important risk. Ex. Permanent disability What is self-insurance? - ANS A special form of planned retention by which part or all of a given loss exposure is retained by the firm. Ex. Workers compensation Risk management matrix - ANS Frequency, Severity Low, High (Insurance) Low, Low (Retain) High, High (Avoid) High, low (Loss control) How do you find expected value? - ANS Multiply each outcome by the probability of occurrence and then summing the resulting product.