The Concept of Risk

1.

Basic problem with which insurance deals

2.

Insurance theorists have not been able to

agree on a definition

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Common Elements in Definitions of Risk

1.

Indeterminancy - at least two possible

outcomes

2.

Adversity - at least one of the outcomes is

undesirable

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The Texts Definition of Risk

Risk is a condition in which there is a
possibility of an adverse deviation from a
desired outcome that is expected or hoped for.
1. Risk not subjective - a state of the real
world
2. Risk can exist whether or not it is
perceived
3. Risk can be imagined where possibility of
loss does not exist
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Uncertainty and its Relationship to Risk

1. The most widely held meaning of uncertainty
refers to a state of mind characterized by a
lack of knowledge or doubt about the future.
2. It is contrasted with certainty, as in
I am certain I will get an A in this course.
I am uncertain what grade I will get.

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The Degree of Risk

1.

What is more risk or less risk?

2.

Varies with the probability of deviation

from what is expected in case of

aggregate data

from what is hoped for (no loss) in case

of individual

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Risk Distinguished From Peril and Hazard

Peril:

the cause of loss

Hazard:

a condition that creates or

increases the chance of loss

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Classifications of Hazards
Physical
Moral
Morale

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Classifications of Risk
1.

Financial and non-financial

2.

Static and dynamic

3.

Fundamental and particular

4.

Pure and speculative

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Static and Dynamic Risks

1.

Dynamic risks result from changes in the

economy (e.g., changes in price levels,
consumer taste, income, and output).

benefit society in the long run, by

adjusting misallocations of resources

2. Static risks would exist even in the absence

of economic change (from perils of nature
or human dishonesty).

not a source of gain to society

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Fundamental and Particular Risks

1.

Fundamental risks are impersonal in origin

and consequences. They are societal risks.

2.

It is held that society (rather than the

individual) should deal with them.

Particular risks involve losses that arise out

of individual events and are felt by
individuals rather than the entire group.

Particular risks are considered the

individuals own responsibility that are
properly addressed by the individual.
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Pure and Speculative Risks

1.

Speculative risks involve the possibility of

loss or gain. They are voluntarily accepted
because of the possibility of gain.

2.

Pure risks involve the possibility of loss or

no loss only.

3.

In general, insurance deals with pure risks

only.

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Classifications of Pure Risk

1.

Personal risks

2.

Property risks

3.

Liability risks

4.

Risks arising out of failure of others

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The Burden of Risk

1.

Some losses will occur

2.

The cost of accumulated reserves

3.

Deterrent effect on capital accumulation

4.

Higher cost of capital

5.

Feeling of frustration and mental unrest

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Methods of Dealing With Risk

1. Avoidance
2. Reduction
3. Retention
4. Transfer
5. Sharing

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