Risk

defined as uncertainty concerning the occurrence of a loss.

Loss Exposure
any situation or circumstance in which a loss is possible, regardless of whether a loss occurs.

Objective Risk
defined as the relative variation of actual loss from expected loss. For example of the 10,000
houses there is an expected loss of 100 (1%), but actually between 90-110 burn, thus a variation
of 10.

Subjective Risk
defined as uncertainty based on a person's mental condition or state of mind. For example a
person who has been heavily drinking may attempt to drive home even though he is not sure
whether he will be able to drive safely or get arrested.

Chance of Loss
defined as the probability that an event will occur.

Objective Probability
refers to the long-run relative frequency of an event based on the assumptions of an infinite
number of observations and of no change in the underlying conditions. For example the
probability of rolling a six on a six sided die is 1/6th.

Subjective Probability
the individual's personal estimate of the chance of loss. For example people who buy a lottery
ticket on their birthday think its their lucky day and will overcome the odds.

Peril
defined as the cause of loss

Hazard
a condition that creates or increases the frequency or severity of loss, there are four major types
which include Physical Hazard (icy roads), Moral Hazard (fraudulent claims), Attitudinal Hazard
(carelessness/indifference) & Legal Hazard.

Pure Risk
defined as a situation in which there are only the possibilities of loss or no loss.

Speculative Risk
defined as a situation in which either profit or loss is possible.

Diversifiable Risk (Particular Risk)

a risk that affects only individuals or small groups and not the entire economy.

Nondiversifiable Risk (Fundamental Risk)

is a risk that affects the entire economy or large number of persons or groups within the
economy.

Enterprise Risk
is a term that encompasses all major risks faced by a business firm. Such risks include pure risk,
speculative risk, strategic risk, operational risk and financial risk.

Enterprise Risk Management

combines all major risks faced by a business into a single unified treatment program all major
risks faced by the firm.

Personal Risk
are risks that directly affect an individual. They include premature death, insufficient retirement
income, injury or illness and unemployment.

Premature Death
is defined as the death of a family head with unfulfilled financial obligations.

Property Risk
the risk of having property damaged or lost from numerous causes. Having property destroyed
due to lighting, flood or fire are all examples of property risks which fall into two major types:
direct or indirect (consequential) loss.

Direct Loss

defined as a financial loss that results from the physical damage, destruction or theft of the
property. For example, if you own a home that is damaged by a fire.

Indirect or Consequential Loss

financial loss that results indirectly from the occurrence of a direct physical damage or theft loss.
For example because of the fire to your home you have to pay for additional living expenses
while the home is being rebuilt.

Liability Risk
are an important type of pure risk that most persons face.

Avoidance
technique for managing risk. For example you can avoid the risk of being mugged in a highcrime area by staying out of the area.

Loss Control
another important technique for managing risk. It consists of certain activities that reduce the
frequency or severity of losses. Two major objectives: loss prevention and loss reduction.

Loss Prevention
aims at reducing the probability of loss so that the frequency of losses is reduced. For example, if
drivers take safe-driving courses and drive defensively to reduce the risk of accident.

Loss Reduction
strict loss prevention efforts can reduce the frequency of losses, yet some losses will inevitably
occur. Loss control is to reduce the severity of a loss after it occurs. For example a department
store can install a sprinkler system so that a fire will be promptly extinguished, thereby reducing
the severity of loss.

Retention
is a technique for managing risk where an individual or business firm retains part of all of the
financial consequences of a given risk. It can be active or passive. It should only be used for
high-frequency low-severity risks where potential losses are relatively small.

Active Retention

means that an individual is consciously aware of the risk and deliberately plans to retain all or
part of it. For example, a motorist may wish to retain the risk of a small collision loss by
purchasing a policy with a $500 or higher deductible.

Passive Retention
risks can be retained passively. Certain risks may be unknowingly retained because of ignorance,
indifference or laziness. For example, many workers with earned incomes are not insured against
the risk of total and permanent disability.

Self-Insurance
a special form of planned retention by which part of all of a given loss exposure is retained by
the firm. For example, a large corporation may self-insure or fund part or all of the group health
insurance benefits paid to employees.

Noninsurance Transfers
technique for managing risk where risk is transferred to a party other than an insurance company.
These techniques include contracts, hedging or incorporation.

Contracts
used for transferring unwanted risk. For example, the risk of a defective television or stereo set
can be transferred to the retailer by purchasing a service contract, which makes the retailer
responsible for all repairs after the warrant expires.

Hedging
a technique for transferring the risk of unfavorable price fluctuations to a speculator by
purchasing and selling futures contracts on an organized exchange, such as the New York Stock
Exchange. For example, the portfolio manager of a pension fund may hold a substantial position
in a long-term U.S. Treasury bonds. If interest rates rise, the value of the Treasury bonds will
decline. To hedge that risk, the portfolio manager can sell U.S. Treasury bond futures. This will
allow the manager to offset the loss of declining stock price.

Incorporation
a risk transfer. If a firm is a sole proprietorship, the owner's personal assets can be attached by
creditors for satisfaction of debts. However, if a firm incorporates, personal assets cannot be
attached by creditors for payment of the firm's debt. This shifts the responsibility of debts from
shareholders and owners pockets to that of creditors.
Insurance

is the pooling of fortuitous losses by transfer of such risks to insurers, who agree to indemnify
insured's for such losses, to provide other pecuniary benefits on their occurrence, or to render
services connected with the risk.

Pooling
the spreading of losses incurred by the few over the entire group, so that in the process, average
loss is substituted for actual loss. Pooling not only shares the losses of the entire group but also
predicts future losses with some accuracy based on the law of large numbers.

Law of Large Numbers

states that the greater the number of exposures the more closely will the actual results approach
the probably results that are expected from an infinite number of exposures.

Fortuitous Losses
a loss that is unforeseen and unexpected by the insured and occurs as a result of chance. In other
words accidental. For example, a person may slip on an icy sidewalk and break a leg. Insurance
companies do not cover intentional losses.

Risk Transfer
means that a pure risk is transferred from the insured to the insurer, who typically is in a stronger
financial position to pay the loss than the insured. For example, premature death, disability and
personal liability lawsuits.

Indemnification
means that the insured is restored to his or her approximate financial position prior to the
occurrence of the loss. For example if your house that is insured burns in a fire your insurance
company will restore your house to its former glory.

Characteristics of Insurable Risk

(1) There must be a large number of exposure units.
(2) The loss must be accidental or unintentional.
(3) The loss must be determinable and measurable.
(4) The loss should not be catastrophic.
(5) The chance of loss must be calculable.
(6) The premium must be economically feasible.

Adverse Selection
is the tendency of persons with a higher-than-average chance of loss to seek insurance at
standard (average) rates, which if not controlled by underwriting, results in higher-than-expected
loss levels. If not controlled it can results in higher-than-expected losses to the insurer. For
example, when a high-risk driver seeks auto insurance at standard rates, if not controlled by
underwriting it can be bad for the insurer.

Underwriting
refers to the process of selecting and classifying applicants for insurance. Applicants that meet
their standards are insured at standard or preferred rates, if their standards are not met the
insurance is denied or an extra premium is paid or coverage offered may be more limited. The
problem of adverse selection arises when applicants with a higher-than-average chance of loss
succeed in obtaining coverage at normal rates.

Benefits of Insurance to Society

(1) Reduce opportunity costs.
(2) Lessen emotional burden.
(3) Loss indemnification.
(4) Increased loss prevention.
(5) Immense source of economic capital.
(6) Decrease policy holder's credit risk.

Cost of Insurance to Society

(1) Cost of doing business.
(2) Fraudulent Claims.
(3) Inflated Claims.

Unit 3:

Risk Management
a process that identifies loss exposures faced by an organization and selects the most appropriate
techniques for treating such exposures. Two categories of risk management: Pre-loss objectives
and Post-loss objectives.

Pre-Loss Objectives
(1) Minimize the "cost of risk".
(2) Reduce anxiety.
(3) Satisfy legal obligations.
(4) Social Responsibility.

Post-Loss Objectives
(1) Survival.
(2) Continued operation.
(3) Earnings stability.
(4) Continued growth.
(5) Social responsibility.

Steps in the Risk Management Process

1) Identify loss exposure.
2) Measure and analyze the loss exposures.
3) Select the appropriate combination of techniques for treating and loss exposures, ie risk
control and risk financing.
4) Implement and monitor the risk management program.

Identification Tools for Loss Exposure

Interviews, physical inspections, financial statements & other records, insurance questionnaires,
flow charts, historical loss data & experience & knowledge.

Analyzing Loss Exposure

Through frequency, severity and considering all combined losses that could result from a single
event.

Maximum Possible Loss

the worst loss that could happen to the firm during its lifetime

Maximum Probable Loss

the worst loss that is likely to happen

Risk Control
refers to techniques that reduce the frequency or severity of losses. Three aspects to it Avoidance,
Loss Prevention and Loss Reduction.

Avoidance
means a certain loss exposure is never acquired, or an existing loss exposure is abandoned. For
example, flood losses can be avoided by building a new plant on high ground.

Loss Prevention
refers to measures that reduce the frequency of a particular loss. For example, measures that
reduce truck accidents include driver examinations, zero tolerance for alcohol or drug abuse and
strict enforcement of safety rules.

Loss Reduction
refers to the measures that reduce the severity of a loss after it occurs. For example, installation
of an automatic sprinkler system that promptly extinguishes a fire.

Risk Financing
refers to techniques that provide for the funding of losses. Three aspects are Retention, NonInsurance Transfers and Insurance Transfers.

Retention
means that the firm retains part or all of the loss that can result from a given loss. Retention is
used when (1) no other method of treatment is available, (2) the worst possible loss is not serious
and (3) losses are fairly predictable.

Retention Level
which is the dollar amount of losses that the firm will retain.

Types of Retention
Current Net Income, Funded Reserve, Unfunded Reserve and Captive Insurer

Current Net Income

the firm can pay losses out of its current net income and treat losses as expenses for that year.

Funded Reserve
setting aside of liquid funds to pay losses. Many employers do not establish funded reserves
because the funds may yield a higher return by being used in the business. Also funded reserves
are non-tax deductible however losses are.

Unfunded Reserve
an unfunded reserve is a bookkeeping account that is charged with actual or expected losses for a
given exposure. Least formal.

Captive Insurer
an insurer owned by a parent firm for the purpose of insuring the parent firm's loss exposures.
Single parent captive is an insurer owned by only one parent such as a corporation whereas
association of group captive is an insurer owned by several parents. For example, corporations
that belong to a trade association may jointly own a captive insurer.

Advantages of Retention
1) Save on expenses.
2) Save on loss costs.
3) Encourage loss prevention
4) Increase cash flow

Disadvantages of Retention
1) Possible higher losses
2) Possible higher expenses
3) Possible higher taxes

Unit-4
Unit-5
Stock Insurance Company
a corporation owned by stockholders. The objective is to earn profits for stockholders.
Stockholders share in the profits and losses of the company. Policies are not assessable meaning
they cannot charge an additional premium during the policy period if losses are excessive.

Mutual Insurance Company

a corporation owned by the policy owners. There are no stockholders. Policy holders share in the
losses and profits of the company. Three types Advance Premium Mutual, Assessment Mutual
and Fraternal Insurer.

Advance Premium Mutual

owned by the policy owners; there are no stockholders, and the insurer can not issue assessable
policies.

Assessment Mutual
has the right to assess policy owners an additional amount if the insurer's financial operations are
favorable. They may assess additional premium if needed to cover losses.

Fraternal Insurer
a mutual insurer that provides life and health insurance to members of a social or religious
organization.

Reciprocal Exchange
defined as an unincorporated mutual. They pool and transfer risk on a relatively small scale. (1)
in it purest form, insurance is exchanged among the members; each member of the reciprocal
insures the other members and, in turn, is insured by them. (2) a reciprocal is managed by an
attorney-in-fact. (3) from a historical perspective, reciprocals can be classified as pure or
modified.

Lloyd's of London
not an insurer, but is the world's leading insurance market that provides services and physical
facilities for its members to write specialized lines of insurance. It is a meeting place where
members of Lloyd's come together to pool and spread risk. Lloyd's is famous for insuring
unusual exposure units, such as injury to a Kentucky Derby horse-race winner. The individual's
who write for Lloyd's are referred to as Names they belong to various syndicates and have
limited legal liability. Members of Lloyd's must meet stringent financial requirements. Lloyd's is
licensed only in a small number of jurisdictions in the U.S. Names had unlimited liability prior to
1996.

Agency System
agents represent the insurance company and have the authority to act on the insurer's behalf.

Broker System

brokers legally represent the insured generally for large business customers and for accessing
surplus lines insurers.

Non-admitted Insurance Company

an insurer not licensed to business in the state.

Surplus Lines Broker

a special type of broker who is licensed to place business with a non-admitted insurer for a type
of insurance which there is no available market for within the state.

Agency Building System

a life insurance system by which an insurer builds its own agency force by recruiting, financing,
training and supervising new agents. The new agents generally represent only the insurer. Two
types General Agency System & Managerial System.

General Agency System

the general agent is an independent contractor who represents only one insurer. The general agent
receives a commission based on the amount of business produced.

Managerial System
in this system branch officers are established in various areas. Manager is paid a salary and
commission based on the volume and quality of the insurance sold and the number of productive
agents hired.

Non-building System
a marketing system by which an insurer sells its products through established agents who are
already engaged in selling life insurance. Personal-producing general agent is a successful agent
who is hired primarily to sell insurance under a contract that provides both direct and overriding
commissions.

Direct Response System

a marketing system by which life and health insurance is sold directly to customers without the
services of an agent. Potential customers are solicited through television radio, mail, newspaper
and other media.

Interdependent Agency System

(1) Agency is independent contractor of insurance companies and receives commission based on
what type of insurance was sold, (2) agent represents more than one company, (3) agent "owns
expirations" where expirations are the rights to the renewal of customer policies.

Exclusive Agency System

the agent represents only one insurer or group of insurers under common ownership. Insurer
"owns expirations".

Direct Writer
an insurer in which the salesperson is an employee of the insurer, not an independent contractor.
Employee of an exclusive agency system.

Multiple Distribution System

Insurance system where more than one distribution system is used to sell insurance.

Unit-6
Analysis
Highly specialized mathematical analysis. They use past losses to project into the future to
determine the necessary reserves and the rates the insurer needs to charge. Actuaries determine
rates and premiums.

Underwriting
the process of classifying, selecting and pricing applicants for insurance into appropriate risk
classes so proper rates are applied. Fair discrimination is necessary to reduce adverse selection.
Basic principles of underwriting are: (1) attain an underwriting profit, (2) select prospective
insureds according to the company's underwriting standards, (3) provide equity among the policy
owners.

Claims Adjusting
involves basic objectives in adjusting claims, the different types of claim adjustors, and the
various steps in the claim-settlement process.

Types of Claims Adjustors

Insurance Agent, Company Adjustor, Independent Adjustor and Public Adjustor

Insurance Agent

used for smaller claims it is generally speedy, it reduces adjustment expenses and it preserves the
policy owners goodwill.

Company Adjustor
next in line as far as size of claim goes. They are usually salaried employees who represent only
one company.

Independent Adjustor
an organization or individual that adjusts claims for a fee, they adjust claims as a full-time job.
Generally used in the even of a catastrophic loss such as earthquakes and hurricanes where a
large number of claims are submitted at the same time.

Public Adjustor
the represent the insured rather than the insurance company and is paid a fee based on the
amount of the claim settlement.

Investigation of a Claim
1) Did the loss occur while the policy was in force?
2) Does the policy cover the peril that caused the loss?
3) Does the policy cover the property destroyed or damaged in the loss?
4) Is the claimant entitled to recover?
5) Did the loss occur at an insured location?
6) Is the type of loss covered?
7) Is the claim fraudulent?

Reinsurance
an arrangement by which the primary insurer that initially writes the insurance transfers to
another insurer (called the reinsurer) part or all of the potential losses associated with such
insurance. Protects insurer from catastrophic and increases insurer capacity (ability to sell
policies).

Ceding Insurer
the primary insurer that is initially writes the business.

Reinsurer
the insurer that accepts the risk from the ceding insurer.

Net retention or retention limit

the amount of insurance retained by the ceding insurer.

Cessions
the amount transferred or ceded to the reinsurer.

Unit-7
Negligence
failure to take reasonable precautions to protect others from the risk of harm

Compensatory Damages
awards that compensate injured victims for the losses actually incurred

General damages
awards for losses that cannot be specifically measured or itemized, such as compensation for
pain and suffering, disfigurement, or loss of companionship of a spouse.

Punitive damages
designed to punish people or organizations so that others are deterred from committing the same
wrongful act

Strict liability
means that liability is imposed regardless of negligence or fault. Because the potential harm is so
great, an individual may be held liable for the harm or injury to another even though negligence
cannot be proven. Another name for strict liability is absolute liability

contributory negligence law

Law that prevents a person from recovering damages if that person contributes in any way to his
or her own injury. Thus, if Driver A is judged to be 20 percent responsible for an accident, and
Driver B is judged to be 80 percent responsible, Driver A cannot collect any damages.

comparative negligence law

the injured person could collect, but the damage award
would be reduced

last chance rule

a plaintiff who is endangered by his or her own negligence can still recover damages from the
defendant if the defendant has a last clear chance to avoid the accident but fails to do so
ex: someone jaywalking

assumption of risk doctrine

A person who understands and recognizes the danger inherent in a particular activity can not
recover damages in the event of an injury (golf course or baseball games)

attractive nuisance
doctrine that says if a person keeps something on his or her premises that is likely to attract
children, that person must take reasonable steps to protect children against dangers the condition
might cause

Imputed negligence
under certain conditions, the negligence of one person can be attributed to another (employeremployee)

respondeat superior
an employer can be held liable for the negligent acts of employees while they are acting on the
employer's behalf. conditions:
- worker's legal status must be that of an employee
- the employee must be acting within the scope of employment when the negligent act occurred.

family purpose doctrine

A parent who furnishes a vehicle to the members of his or her family for customary convenience,
assumes liability for the tortious acts committed by those persons when the car is being driven
for a family purpose.
Key Words or Phrases:
1. parent who furnishes a vehicle to the members of his or her family
2. assumes liability for the tortious acts committed when the car is being driven for a family
purpose

collateral source rule

Under the Collateral Source Rule, if a third party provides benefits or reimbursement to the
plaintiff for losses caused by the defendant, no evidence of the money or benefits from the
collateral source may be introduced by the defendant to try to diminish the amount of damages
he owes to the plaintiff.
Key words:
1. third party provides money or benefit to plaintiff for losses caused by defendant
2. neither benefits nor money can be used as basis for set-off of damages owed by defendant

never events
External cause codes to identify the occurrence of wrong site surgery, wrong surgery and wrong
patient having surgery
Never events are a list of adverse medical events that are serious but largely preventable and of
concern to patients and healthcare providers
Joint Commission, Federal government and state governments use the never events list as the
basis of quality indicators and state-based reporting systems

Unit-8
Unit-9
Unit-10
Unit-11
Unit-12