3 Definitions of Risk
1. Uncertainty
2. The possibility of loss
3. The possibility of undesired outcome
Interest Rate Risk
The possibility of loss due to changes in the cost of borrowing money.
Product Acceptance Risk
The possibility of loss due to lower than expected or wear demand for a company's product.
Loss Exposure
a situation or action that creates the possibility of a loss; a loss enabler; a risk
Peril
a cause of loss
Hazard
a condition that makes losses more likely to occur and/or more severe (to a financial loss) if they occur.
Physical Hazard
location of building, type of material the building is made of
Moral Hazard
dishonest acts that 1) cause one to have a loss or 2) increase the probability and or severity of ones loss because insurance is involved.
Moral (attitudinal hazard)
carelessness or indifference to loss especially loss covered by insurance
Legal Hazard
legal or regulatory matters that each increase the probability or severity of loss
Direct Loss
financial loss due to physical damage to property
Indirect Loss
financial loss resulting from loss of use of the damaged property
Idemnify
to restore the position/condition that existed immediately before the loss
Chance of loss
the probability that a loss causing event will occur
objective probabiltiy
the long run statistical probability (infinite number of observations), assuming no change in conditions
law of large numbers
as N increases, actual losses approach expected losses
objective risk (degree of risk)
The probability of actual losses deviating from expected losses; an estimate of the range of deviation from the expected loss; uncertainty about whether actual loss will equal expected loss
Frequency of Loss
probability of loss during a given period
severity of loss
size of loss
risk avoidance
eliminating the possibility of loss
loss prevention
taking steps to reduce the probability of a loss
loss reduction
measures designed to lessen the severity of a loss if one occurs
loss control (risk control)
measures intended to reduce losses by reducing their frequency and/or severity; includes avoidance, reduction and prevention
Insurance
a contractual transfer of risk form the insured to the insurance company (carrier)
Deductable
first dollars of loss paid by the insured before the insurance company pays for the loss
Risk Retention
to hold onto risk
Risk Retention Level
maximum loss the firm is willing to retain/incur
Captive Insurer
carried formed by a company to insure its losses
Pure Captive
owned by just one parent company
group captive
owned by more than 1 parent company
parent company
company which owns another company
subsidiary company
a company which is owned by another company (the parent)
Passive Retention Risk
unknowingly retaining risk by failing to identify risk exposures and or failing to implement risk management techniques
Funded Reserve
firm sets aside money to cover losses as they arise
2 requirements for self insurance
1. setting aside funds in advance to cover losses
2. losses must be predictable and stable
Stop loss insurance
insurance that pays after the self insurer has reached a specific limit or loss
Insurance premium formula
Premium= expected losses+admin cost+ selling cost+ profit for insurer- investment income
LLC
limited liability company