Home Work Assignment - Chapter 2

FIN 604 OL1

7/15/2018

1. Describe the personal risk management process.

- the risk management process includes the financial planner reviewing all of the client’s
risk exposures and determining the appropriate risk management technique for each risk.
- The six step process includes:
(1) determining the objectives of the risk management program.
(2) identifying the client’s risk exposure.
(3) evaluating the identified risks for probability of occurrence and severity of
loss.
(4)determining the alternatives for managing the risks and selecting alternatives
for each risk
(5) implementing risk management selected recommendations.
(6) periodically reviewing the risk management program.

2. list the four responses to managing risk.

- the four responses to managing risk are
- Risk reduction: the process of reducing the likelihood of a pure risk that us high
in frequency and low in severity.
- Risk transfer: transferring a low frequency and high severity risk to third party.
- Risk retention: accepting some or all of the potential loss exposure for risks that
are low in frequency and low in severity.
- Risk avoidance: a risk management technique used for any risks that are high in
frequency and high in severity.

3. define a peril
- Peril are the immediate cause ad reason for a loss occurring. It can be the result of an
accident or sickness. Common perils include accidental death, disability caused by
sickness or accident, and property losses caused by fire, windstorm, tornado, earthquake,
burglary, and collision.

6. explain the difference between pure risk and speculative risk.

- pure risk is the chance of a loss or no loss occurring. With pure risks, there is no chance
of experiencing a gain. Example of pure risks include: Premature death of primary wage
earner, A prolonged illness or injury of a client or family member. Speculative risk is the
chance of loss. Speculative risk is the risk that an investor takes when buying a stock or
an entrepreneur takes when starting a business. Insurance is not available for speculative
risks because most speculative risks are willingly entered into for the purpose of making
a profit.

8. describe the law of large numbers and why it is useful for insurance.
 - The law of large number is a principle that states that actual outcomes will approach the
mean probability as the sample size increase. And it tells us that the more similar the
events or exposures, the more likely the actual losses will equal the expected losses.
- The law of large numbers is useful for insurance companies because the lager the
insured pool, the more likely actual losses will approach the expected losses, thereby
reducing forecasting error and objective risk. This results in insurance premiums that are
more efficient and thus are less costly to the insured.

15. explain the difference between the principal of indemnity and a subrogation clause.
- The principle of indemnity asserts that an insurer will only compensate the insured to
the extent the insured has suffered an actual financial loss. The insured cannot make a
profit from insurance. However, The principle of indemnity does not assert that an
insured will recoup 100 percent of any loss, as most policies will have deductibles and
limits on the amount of losses covered.
- A subrogation clause in an insurance policy requires that the insured relinquish a claim
against a negligent third party, if the insurer has already indemnified the insured. A
subrogation clause entitles the insurer to seek a claim against a negligent third party, for
any claims paid to the insured

16. when must an insurable interest exist for property, liability, and life insurance.
- An insurable interest for property and liability insurance must exist both at the inception
of the policy and at the time of loss. An insurable interest for life insurance need only
exist at the inception of the policy.

24. differentiate between a rider and an endorsement

- A rider is a modification or change to a life or health insurance policy, and a rider can
be add to a disability policy that waives the premium if the insured becomes disabled for
a short period of time. An endorsement is a modification or change to the existing
property insurance policy. A property policy is typically endorsed the insured owns
property in excess of the coverage limits within the policy.

25. describe the purpose of a deductible.

- Deductible is the first dollars in a loss, which the insured is responsible to pay. The
purpose of a deductible is to reduce the filling of small claims, reduce premiums, and
eliminate moral and morale hazard. Deductible also serve as motivation for an insured to
take precautions to avoid losses or to prevent the filling of false claims since an insured
with a deductible will not receive 100 percent of the value of loss.

Multiple-choice problems:

1. D
2. A
3. B
4. B
5. A