This document discusses risk management and insurance. It defines different types of risk like pure risk and insurable risk. It explains how insurance works by spreading risk among a large group. The risk management process involves identifying risks, assessing their impact, and using techniques like risk shifting through insurance or risk reduction. The document provides tips for reducing insurance costs such as increasing deductibles, purchasing group plans, and comparison shopping.

1. © 2010 South-Western, Cengage Learning
Chapter
© 2016 South-Western, Cengage Learning
21.1 Understanding Risk
21.2 Managing Risk
Introduction to
Risk Management
21
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2. © 2010 South-Western, Cengage Learning SLIDE 2
Chapter 21
Lesson 21.1
Understanding Risk
Learning Objectives
LO 1-1 Explain the concept of risk and list
several types of risk.
LO 1-2 Explain the concept of insurance
and how risks are spread.
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3. © 2010 South-Western, Cengage Learning SLIDE 3
Chapter 21
Types of Risk
Pure risk
Insurable risk
Economic risk
Speculative risk
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4. © 2010 South-Western, Cengage Learning SLIDE 4
Chapter 21
Pure Risk
 Pure risk is a chance of loss with no chance
for gain.
 Pure risks are random (can happen to anyone)
and result in loss (not gain).
 Examples of pure risk include the following:
 Accidents resulting in physical injury and damage to
property
 Illnesses that people get throughout life
 Acts of nature, resulting in damage to persons and
property
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5. © 2010 South-Western, Cengage Learning SLIDE 5
Chapter 21
Insurable Risk
 You can reduce negative consequences of a
pure risk by purchasing insurance.
 Insurance is a method for spreading individual
risk among a large group of people to make
losses more affordable for all.
 An insurable risk is a pure risk that is faced by
a large number of people and for which the
amount of the loss can be predicted.
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6. © 2010 South-Western, Cengage Learning SLIDE 6
Chapter 21
Insurable Risk
 Insurance companies can make these
predictions by examining the amount of loss
incurred from past events, such as flooding.
 To purchase insurance, you must have an insurable
interest to protect.
 An insurable interest is any financial interest in life
or property such that, if the life or property were lost
or harmed, the insured would suffer financially.
 There are three major insurable risks:
personal, property, and liability.
(continued)
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7. © 2010 South-Western, Cengage Learning SLIDE 7
Chapter 21
Personal Risk
 A personal risk is the chance of loss involving
your income and standard of living.
 You can protect yourself from personal risks by
buying life, health, and disability insurance.
 In addition, insurance against personal risks
protects others who are depending on your
income to provide food, clothing, shelter, and
the comforts of life.
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8. © 2010 South-Western, Cengage Learning SLIDE 8
Chapter 21
Property Risk
The chance of loss or harm to personal
or real property is called property risk.
Your home, car, or other possessions could
be damaged or destroyed by fire, theft, wind,
rain, accident, or other hazards.
To protect against such risks, you can
buy property insurance.
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9. © 2010 South-Western, Cengage Learning SLIDE 9
Chapter 21
Liability Risk
 A liability risk is the chance of loss that may
occur when your errors or actions result in
injuries to others or damages to their property.
 You could accidentally cause injury or damage to
others or their property by your conduct while
driving a car.
 A person could fall and break an arm because of
your home’s crumbling front steps.
 Liability insurance will protect you when others
sue you for injuring them or damaging their
property.
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10. © 2010 South-Western, Cengage Learning SLIDE 10
Chapter 21
Economic Risk
 Economic risk may result in gain or loss
because of changing economic conditions.
 For example, when the business cycle is in a period
of recovery or growth, most people and businesses
are realizing gains in their financial position.
 However, if the economy slows down, people lose
jobs and are unable to buy goods and services.
 As a result, many businesses find themselves
unable to meet their debts.
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11. © 2010 South-Western, Cengage Learning SLIDE 11
Chapter 21
Speculative Risk
 A speculative risk may result in either gain or
loss.
 Because speculative risks are not accidental or
random, and may result in either gain or loss,
you cannot protect yourself from losses in a
traditional manner.
 While hedging (making an investment to help
offset against loss) is a technique used to help
reduce losses from such risky acts, it does not
reduce the risk itself.
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12. © 2010 South-Western, Cengage Learning SLIDE 12
Chapter 21
Spreading the Risk
An insurance company, or insurer, is a
business that agrees to pay the cost of
potential future losses in exchange for
regular fee payments.
When people buy insurance, they join a
risk-sharing group by purchasing a
written insurance contract (a policy).
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13. © 2010 South-Western, Cengage Learning SLIDE 13
Chapter 21
Spreading the Risk
Under the policy, the insurer agrees to
assume an identified risk for a fee, called
the premium, usually paid at regular
intervals by the owner of the policy (the
policyholder).
The insurer collects insurance premiums
from policyholders under the assumption
that only a few policyholders will have
financial losses at any given time.
(continued)
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14. © 2010 South-Western, Cengage Learning SLIDE 14
Chapter 21
Indemnification
Insurance is not meant to enrich—only to
compensate for actual losses incurred.
Indemnification is the process of putting
the policyholder back in the same
financial condition he or she was in
before the loss occurred.
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15. © 2010 South-Western, Cengage Learning SLIDE 15
Chapter 21
Insurance Terminology
 Actuarial table
 Actuary
 Beneficiary
 Benefits
 Cash value
 Claim
 Coverage
 Deductible
 Exclusions
 Face amount
 Grace period
 Hazard
 Insurance agent
 Insured
 Insurer
 Loss
 Peril
 Probability
 Proof of loss
 Standard policy
 Unearned premium
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16. © 2010 South-Western, Cengage Learning SLIDE 16
Chapter 21
Lesson 21.2
Managing Risk
Learning Objectives
LO 2-1 Explain the risk management
process.
LO 2-2 Create a risk management plan.
LO 2-3 Identify ways to reduce the costs of
insurance.
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17. © 2010 South-Western, Cengage Learning SLIDE 17
Chapter 21
The Risk Management Process
While you cannot eliminate risk, you can
manage it so that a loss does not
become financially devastating.
Risk management is an organized
strategy for controlling financial loss from
pure risks.
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18. © 2010 South-Western, Cengage Learning SLIDE 18
Chapter 21
Risk Assessment
 Risk management begins with identification of
the potential risks of loss.
 This systematic study, or risk assessment,
involves understanding the types of risks faced
and their potential consequences.
 Risk assessment is a three-step process:
 Step 1: Identify risks of loss
 Step 2: Assess seriousness of risks
 Step 3: Handle risks
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19. © 2010 South-Western, Cengage Learning SLIDE 19
Chapter 21
Techniques for Handling Risks
Risk shifting or risk transfer
Risk avoidance
Risk reduction
Risk assumption
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20. © 2010 South-Western, Cengage Learning SLIDE 20
Chapter 21
Risk Shifting
Risk shifting, also called risk transfer,
occurs when you buy insurance to cover
financial losses caused by damaging
events, such as fire, theft, injury, or
death.
By making premium payments, you shift
the risk of major financial loss to the
insurance company.
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21. © 2010 South-Western, Cengage Learning SLIDE 21
Chapter 21
Risk Avoidance
Risk avoidance lowers the chance for
loss by not engaging in the activity that
could result in the loss.
Examples:
Instead of having a party at your house and
risking damage, you could reserve a section
of a restaurant.
Instead of participating in a dangerous sport,
you could go camping.
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22. © 2010 South-Western, Cengage Learning SLIDE 22
Chapter 21
Risk Reduction
Risk reduction lowers the chance of
loss by taking measures to lessen the
frequency or severity of losses that may
occur.
For example, you may put studded snow
tires on your car, install fire alarms or
sprinklers in your home, or use seat belts.
All of these steps would lessen the financial
risk of potential losses as well as the
severity of damages.
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23. © 2010 South-Western, Cengage Learning SLIDE 23
Chapter 21
Risk Assumption
 Risk assumption is the process of accepting
the consequences of risk.
 To help cushion your financial burden, you
could establish a monetary fund to help cover
the cost of a loss.
 People who self-insure plan to absorb the
costs of some risks themselves.
 This strategy can reduce the cost of insurance.
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24. © 2010 South-Western, Cengage Learning SLIDE 24
Chapter 21
The Risk-Management Plan
List identified risks.
List assessment of risks’ financial impact.
List techniques to manage each risk.
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25. © 2010 South-Western, Cengage Learning SLIDE 25
Chapter 21
Reducing Insurance Costs
Increase deductibles.
A deductible is the specified amount of a
loss that you as the insured must pay.
Generally, the higher the deductible, the
lower the insurance premium.
Purchase group insurance.
The premiums for group plans are usually
considerably lower than for an individual
plan, especially for health insurance.
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26. © 2010 South-Western, Cengage Learning SLIDE 26
Chapter 21
Reducing Insurance Costs
Consider payment options.
Monthly payments usually contain an extra
charge, while annual or semiannual
payments do not.
Having premiums automatically deducted
from your checking account or paying
electronically may also reduce your costs.
(continued)
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27. © 2010 South-Western, Cengage Learning SLIDE 27
Chapter 21
Reducing Insurance Costs
Look for discount opportunities.
 Many insurance companies offer discounts for
special conditions.
 Having more than one policy with the same
insurance company may result in a multi-line
discount.
Comparison shop.
 Get quotes from several insurers using the same
information so you can compare exact coverage
and costs.
(continued)
© 2016 South-Western, Cengage Learning