2. NATURE OF RISK AND MANAGEMENT
1.1 Concept of Risk
1.2 Related Concept
1.3 Basic Categories of Risk
1.4 Methods of Handling Risk
1.5 Risk Management
1.6 Characteristics of Insurable Risk
3. 1.1 Concept of Risk
RISK?
โ an uncertainty regarding loss in future โ
๏variation in outcomes in a given situation
๏the possibility of loss
๏the exposure to danger
๏the subject matter of insurance
4. 1.1 Concept of Risk
Measurement of Risk
PROBABILITY
โ an area of study which measures the chance of
occurrence of a particular event โ
i. Priori Probability
ii.Empirical Probability
iii.Judgmental Probability
5. 1.1 Concept of Risk
i. Priori Probability
๏ determined when the total number of possible
events are known
๏ limited practical application
ii. Empirical Probability
๏ determined on the basis of historical data
๏ it possible for empirical probability to be measured
accurately is the law of large numbers
6. 1.1 Concept of Risk
iii. Judgmental Probability
๏ determined based on the judgment of the person
predicting the outcome
๏ it is used when there is a lack of historical
data/credible statistics
in practice, actual outcomes differ from expected
outcomes
๏ depend on the availability & credibility of data
7. 1.2 Related Concept
Peril
๏ is a cause of loss
Loss
๏ is a reduction or disappearance of economic value
Peril Losses
Fire Property
Profit/revenue
Illness Future earning
Medical expenses
Negligence Court awards
Legal expenses
8. 1.2 Related Concept
โ Direct loss
โข Loss that occurs resulting from a catastrophe
โข E.g: a factory manufacturing electrical equipment was
burned down in a fire one night
โ Indirect loss
โข Additional loss that result from direct loss
โข E.g: inability of factory to operate as usual would cause
a disruption in production, sales and normal profits
9. 1.2 Related Concept
Hazard
๏ is a condition that increases the chance of loss
i. Physical Hazard
๏ a physical chance that increases the condition of loss
โ E.g:
โข Worn-out tyres of a car
โข Flammable liquids kept in the cabinet
โข Smoking cigarettes
โข House located next to an electricity generator
ii. Moral Hazard
๏ a character defect in an individual that increases the chance of loss
๏ E.g : a person who conceals important health information during the
application of insurance is considered as moral hazard
10. 1.2 Related Concept
iii. Morale Hazard
๏Refers to an individualโs careless or indifferent
attitude that increases the severity or frequency of
loss due to the presence of insurance
๏E.g: leaving the front door unlocked while no one at
home
11. 1.3 Basic Categories of Risk
1. Fundamental & Particular Risks
i. Fundamental risk affects the entire eco. or large
numbers of persons/groups
๏ Responsibility of the government & the society
ii. Particular risk affects individual & not the entire
community
๏ Responsibility of individuals
12. 1.3 Basic Categories of Risk
FUNDAMENTAL RISK
โข high inflation
โข Unemployment
โข War
โข natural disasters such as
earthquakes, hurricanes,
tornadoes, and floods.
PARTICULAR RISK
โข Burglary
โข Theft
โข auto accident
โข dwelling fires.
13. 1.3 Basic Categories of Risk
2. Pure & Speculative Risks
i. Pure risk exist when there is possibility of loss or nor
loss
๏ more predictable (apply law of large numbers)
๏ can be handled by insurance technique
ii. Speculative risk exist when there is the possibility of
profit, loss or no loss
๏ not predictable
๏ canโt be handled by insurance
14. 1.3 Basic Categories of Risk
PURE RISK
โข Physical damage risk to property (at the
enterprise level) such as caused by fire,
flood, weather damage
โข Liability risk exposure (such as products
liability, premise liability, employment
practice liability)
โข Innovational or technical obsolescence
risk
โข Operational risk: mistakes in process or
procedure that cause losses
โข Environmental risks: water, air,
hazardous-chemical, and other pollution;
depletion of resources; irreversible
destruction of food chains
โข Natural disaster damage: floods,
earthquakes, windstorms
SPECULATIVE RISK
โข Market risks: interest risk, foreign
exchange risk, stock market risk
โข Reputational risk
โข Brand risk
โข Credit risk (at the individual
enterprise level)
โข Product success risk
โข Public relation risk
โข Population changes
โข Regulatory change risk
15. 1.4 Methods of Handling Risk
i. Risk Avoidance
ii. Loss Control
iii. Risk Retention
iv. Risk Transfer
16. 1.4 Methods of Handling Risk
i. Risk Avoidance
๏ avoiding the property, person or activity which produces
the risk
ii. Loss Control
๏ reduce the total amount of loss
๏ influenced by the frequency & severity of losses
๏ frequency is the number of times a loss producing event will
occur over a given period of time
๏ Loss prevention; by reducing the frequency
๏ severity is the amount of loss, in money terms (RM)
๏ Loss minimisation; by reducing the severity or amount of
loss
17. 1.4 Methods of Handling Risk
iii. Risk Retention
๏ the retaining of risks by an individual/organization
๏ loss incurred are borne by the party retaining the
risks
๏ Planned; risks are retained deliberately
๏ Unplanned; risk retention involves retaining of risks
unknowingly
18. 1.4 Methods of Handling Risk
iv. Risk Transfer
๏ Involves the transferring of risks to an
organization/individual
๏ Losses will be paid by the organization/individual to
whom the risk is transferred
๏ Insurance contract; insurance policy
๏ Non insurance contract; business agreement
19. 1.5 Risk Management
๏a systematic approach to dealing with risks
that threaten assets & earning of a business
๏Process:
i. Identifying Loss Exposures
ii. Evaluating Potential Losses
iii.Selecting Techniques of Risk Handling
iv.Implementing The Risk Mgt. Program
v. Controlling The Risk Mgt. Program
20. 1.5 Risk Management
i. Identifying Loss Exposures
๏ Loss exposure; physical damage to property, liability
lawsuits etc.
๏ Identified from various sources including questionnaires,
financial statements etc.
ii. Evaluating Potential Losses
๏ Estimation of frequency & severity of loss exposures
๏ Ranking according to their relative importance
๏ Loss exposures with high loss potential will be given priority
21. 1.5 Risk Management
iii. Selecting Techniques of Risk Handling
๏ Risk handling techniques (refer 2.4)
๏ Based on financial criteria will consider how the choice will
affect the organizationโs profitability
๏ Non-financial considerations will include humanitarian
aspects & legal requirements
iv. Implementing The Risk Mgt. Program
๏ After the selection of the most appropriate
technique/combination of techniques; implement
22. 1.5 Risk Management
v. Controlling The Risk Mgt. Program
๏ A risk mgt. program needs to be monitored to ensure that it
is achieving the result expected
๏ Make changes to the program, if necessary
23. 1.6 Characteristics of Insurable Risk
i. Financial Value
๏ monetary compensation following a loss
๏ losses that are capable of being financially measured
ii. Large Number of Similar Risks
๏ 2 reason:
๏ผ to enable the insurer to predict losses more accurately
๏ผ If there are only few risks, the principle of losses of a few
to be borne by many cannot be applied
24. 1.6 Characteristics of Insurable Risk
iii. Pure Risks Only
๏ pure risk situation, one will suffer a loss/no loss
๏ speculative risks; loss/B-E/ profit
๏ insured would be less inclined to put in efforts to bring
about a gain when any loss will be indemnified by the
insurer
iv. No Catastrophic Losses
๏ the loss should not be so catastrophic in nature as to render
it too heavy to be borne by an insurer
๏ a catastrophic loss arises when a very large number of risks
incur losses at the same time/one risk results in a huge loss
25. 1.6 Characteristics of Insurable Risk
v. Fortuitous Losses
๏ is one that is accidental and unintentional
๏ insurance cannot function properly & efficiently if losses are
intentionally/fraudulently
vi. Insurable Interest
๏ must have insurable interest in the property/life/potential
liability/etc
๏ existence of insurable interest in contract of insurance that
differentiates insurance from gambling
26. 1.6 Characteristics of Insurable Risk
vii. Legal & Not Against Public policy
๏ the object/subject matter must be legal
๏ a ship engaged in smuggling is illegal/fines & penalties
imposed by law is against public policy
viii.Reasonable Premium
๏ must be reasonable in relation to potential loss
๏ insurance premium required to cover the risk of fire on a
ball-point pen worth a few cents may be quite
unreasonable in relation to the potential loss in view of the
insurerโs claim handling expenses