Chapter 1 s

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Chapter 1

Textbook


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Some useful links

The Insurance Claims Complaints Bureau (ICCB)*

www.iccb.org.hk/

Office of the Commissioner of Insurance

www.info.gov.hk/oci/ Insurance Institute of Hong Kong (IIHK)

http://www.iihk.org.hk/

Hong Kong Federation of Insurers

www.hkfi.org.hk The Chartered Insurance Institute, UK

www.cii.co.uk

USA - National Association of Insurance Commissioners(NAIC)

http://www.naic.org/
http://www.iccb.org.hk/http://www.info.gov.hk/oci/http://www.iihk.org.hk/http://www.hkfi.org.hk/http://www.cii.co.uk/http://www.naic.org/http://www.naic.org/http://www.cii.co.uk/http://www.hkfi.org.hk/http://www.iihk.org.hk/http://www.info.gov.hk/oci/http://www.iccb.org.hk/


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Case Presentation and Report

Any local or oversea cases you considerappropriate or

Cases from The Insurance Claims

Complaints Bureau (ICCB) www.iccb.org.hk/

Note: Do not use cases:

the McDonald coffee

The Philippines hong kong hostages bus hijack
http://www.iccb.org.hk/http://www.iccb.org.hk/


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Risk and Its Treatment

Different Definitions of Risk

Chance of Loss

Peril and Hazard

Classification of Risk

Major Personal Risks and Commercial Risks

Burden of Risk on Society

Techniques for Managing Risk


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How do you see Risk?

New Zealand a hot air-balloon crashed and burst (January 7, 2012)


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Definition ofRISKwebster.com

1: possibility of loss or injury : peril

2: someone or something that creates or suggests a hazard

3a: the chance of loss or the perils to the subject matter ofan insurance contract; also: the degree of probability ofsuch loss b: a person or thing that is a specified hazard toan insurer c: an insurance hazard from a specified cause orsource

4: the chance that an investment (as a stock or commodity)will lose value


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Risk: Uncertainty concerning the occurrence of a loss Expected loss

Riskier => greater frequency or severity of loss (any

examples?)

Riskier => The expected loss will be higher E.g. higher risk of Earthquake: Japan, higher risk of car

accident: drunk driving

Variability of loss (around expected value)

Riskier => more difficult to predict

E.g. Price change of stock vs price change of bonds

Loss Exposure: Any situation or circumstance in which a loss

is possible, regardless of whether a loss occurs.


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Objective Risk vs. Subjective Risk Objective risk is defined as the relative variation of actual loss

from expected loss

It can be statistically calculated using a measure of dispersion, such

as the standard deviation

Remember any graphs of normal distribution & standard deviation? How does the risk change with a larger units of exposure?

Subjective risk is defined as uncertainty based on a persons

mental condition or state of mind

Two persons in the same situation may have different perceptions of

risk (you may have no fear if you are being gun pointed if.)

High subjective risk often results in conservative behavior

Think about buying stocks


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Chance of Loss

Chance of loss: The probability that an event will occur

Objective Probability vs. Subjective Probability

Objective probability refers to the long-run relative frequency of

an event assuming an infinite number of observations and nochange in the underlying conditions

It can be determined by deductive or inductive reasoning

Subjective probability is the individuals personal estimate ofthe chance of loss

A persons perception of the chance of loss may differ from theobjective probability


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Peril and Hazard

A peril is defined as the cause of the loss

In an auto accident, the collision is the peril

A hazard is a condition that increases the chance of loss

Physical hazards are physical conditions that increase the chance

of loss (icy roads, defective wiring) Moral hazard is dishonesty or character defects in an individual,

that increase the chance of loss (faking accidents, inflating claimamounts)

Attitudinal Hazard (Morale Hazard) is carelessness or indifferenceto a loss, which increases the frequency or severity of a loss(leaving keys in an unlocked car)

Legal Hazard refers to characteristics of the legal system orregulatory environment that increase the chance of loss (largedamage awards in liability lawsuits)


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Questions

Given the following scenario, state which is thehazard, the peril, and the exposure, respectively?

You recently moved from Beijing to Taiwan andbought a home. A typhoon destroys your home.

True or False? Twin towers burn to the groundresulting in a complete loss. The fact that theconstruction material is steel is the peril involved

in this loss.


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Pure and Speculative Risk

A pure risk is one in which there are only the possibilities of lossor no loss (earthquake)

A speculative risk is one in which both profit or loss are possible

(gambling) Diversifiable Risk and Nondiversifiable Risk

A diversifiable risk affects only individuals or small groups (cartheft). It is also called nonsystematic or particular risk.

A nondiversifiable risk affects the entire economy or large

numbers of persons or groups within the economy (hurricane). Itis also called systematic risk or fundamental risk.

Government assistance may be necessary to insurenondiversifiable risks.


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Enterprise risk encompasses all major risks faced by abusiness firm, which include: pure risk, speculative risk,strategic risk, operational risk, and financial risk

Financial Risk refers to the uncertainty of loss because ofadverse changes in commodity prices, interest rates, foreign

exchange rates, and the value of money.

Enterprise Risk Management combines into a single unifiedtreatment program all major risks faced by the firm:

Pure risk

Speculative risk

Strategic risk

Operational risk

Financial risk


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Major Personal Risks andCommercial Risks

Personal risks involve the possibility of aloss or reduction in income, extraexpenses or depletion of financial assets:

Premature death of family head

Insufficient income during retirement

Most workers are not saving enough for a comfortableretirement

Poor health (catastrophic medical bills and lossof earned income)

Involuntary unemployment


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Exhibit 1.1 Reported Total Savings andInvestments among Those Responding, by Age

(not including value of primary residence or defined benefit plans)

What can you tell from the figures above?


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Property risks involve the possibility of lossesassociated with the destruction or theft of property:

Physical damage to home and personal property from fire,tornado, vandalism, or other causes

Direct loss vs. indirect loss

A direct loss is a financial loss that results from the physicaldamage, destruction, or theft of the property, such as firedamage to a home

An indirect loss results indirectly from the occurrence of a directphysical damage or theft loss, such as the additional livingexpenses after a fire to a home. These additional expenseswould be a consequential loss.

Rally over 'photo ban' shuts retailer Dolce & Gabbana in Tsim Sha

Tsui, Jan 10, 2012


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Have you heard about the BP oil spill 2010?

What is the direct loss?Indirect losses?


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Liability risks involve the possibility of being heldliable for bodily injury or property damage tosomeone else

There is no maximum upper limit with respect to the

amount of the loss A lien can be placed on your income and financial assets

Defense costs can be enormous


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Commercial Risks

Firms face a variety of pure risks that can have seriousfinancial consequences if a loss occurs:

Property risks, such as damage to buildings, furniture and

office equipment

Liability risks, such as suits for defective products, pollution ofthe environment, and sexual harassment

Loss of business income, when the firm must shut down forsome time after a physical damage loss

Other risks to firms include crime exposures, human resourceexposures, foreign loss exposures, intangible propertyexposures, and government exposures


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Burden of Risk on Society

The presence of risk results in three majorburdens on society:

In the absence of insurance, individuals would

have to maintain large emergency funds The risk of a liability lawsuit may discourage

innovation, depriving society of certain goodsand services

Risk causes worry and fear


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There are five major methods for managing risk Avoidance

Loss control Loss prevention refers to activities to reduce the frequency of losses

Loss reduction refers to activities to reduce the severity of losses Retention

An individual or firm retains all or part of a given risk

Active retention means that an individual is consciously aware of therisk and deliberately plans to retain all or part of it

Passive retention means risks may be unknowingly retained because

of ignorance, indifference, or laziness Self Insurance is a special form of planned retention by which part or

all of a given loss exposure is retained by the firm


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Noninsurance transfers

A risk may be transferred to another party by several methods:

A transfer of risk by contract, such as through a servicecontract or a hold-harmless clause in a contract

Hedging is a technique for transferring the risk of unfavorableprice fluctuations to a speculator by purchasing and sellingfutures contracts on an organized exchange

Incorporation of a business firm transfers to the creditors therisk of having insufficient assets to pay business debts

Insurance

For most people, insurance is the most practical method forhandling a major risk

What techniques do you think BP employed?


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Concept check

Fog that increases the chance of anautomobile accident is an example of a

A) speculative risk.

B) peril.

C) physical hazard.

D) moral hazard.


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Concept check

the cause of a loss is called________


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Mik M th d f H dli


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Mikes Methods of HandlingRisks

For each of the following risks and lossexposures, identify an appropriate RMtechnique that could have been used todeal with the exposure.

Physical damage to the 2000 Ford due toa collision with another motorist.

Mik M th d f H dli


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Liability lawsuit against Mike arising outof the negligent operation of his car.

Total loss of personal property due to a

fire in the kitchen of his rentedapartment.

Mik M th d f H dli


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Disappearance of one contact lens.

Waterbed leak that cause property damageto the apartment.

Mik M th d f H dli


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Physical assault on Mike by gang members who aredealing drugs in the park where he runs.

Loss of tuition assistance from Mikes father who iskilled by a drunk driver in an auto accident.

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