Risk In Our Society

1st Session

I. What is Risk?

Uncertainty Concept

The majority of Insurance authors define risk as uncertainty.

If we consider Risk and Probability. If the probability of an event occuring is either zero or one, there is no Risk since there is no uncertainty.

Objective and Subjective Risk

Risk has both Objective and Subjective aspects.

Objective Risk: Defined as the relative variation of actual loss from

expected loss. Declines as the number of exposure units increases. Is measurable by using the standard deviation or

coefficient of variation. (Law of Large Numbers).

Objective and Subjective Risk

Subjective Risk: Defined as uncertainty based on one’s

mental condition or state of mind. Difficult to measure!

II. Chance of Loss

The chance of loss is closely related to the concept of Risk. The Chance of Loss is defined as: the probability that an event will occur. Like Risk, ”probability” has both Objective and Subjective aspects.

Objective and Subjective Probability

Objective Probability: Deductive Reasoning (A Priori)

Determined by logical deduction such as in games of chance.

Inductive Reasoning (Empirically)

Determined by induction through the analysis of data.

Objective and Subjective Probability

Subjective Probability: A personal estimate of the chance of loss. It

need not coincide with objective probability and is influenced by a variety of factors including age, sex, intelligence, education, personality, and the use of alcohol or other recreational drugs!

III. Basic Categories of Risk

Pure and Speculative Risk Pure Risk:

A situation where there are only the possibilities of Loss or no Loss.

Speculative Risk:

A situation where either profit or loss is possible.

Pure and Speculative Risk

Why the distinction between Pure and Speculative Risk is important:

Firstly, Private Insurance Companies generally only insure Pure Risks.Secondly, The Law of Large Numbers can be applied more easily to Pure Risks than to Speculative Risks.Thirdly, Society may benefit from a Speculative Risk even though a loss occurs, but it is harmed if a Pure Risk is present and a loss occurs.

Fundamental and Particular Risks

Fundamental Risk: Is a Risk that affects the entire economy or large numbers of people or groups within the economy. For example, economic recession or widespread hurricane damage.Particular Risk: Is a Risk that affects only individuals and not the entire community.

IV. Types of Pure Risks

Personal RisksThe four main Personal Risks are: premature death, old age, poor health, and unemployment.

Property RisksTypes of losses include: direct physical damage losses, theft losses, indirect or consequential losses, and extra expenses.

Liability RisksThe loss is: Legal liability for damages arising out of bodily injury or property damage to another party.

V. Burden of Risk on Society

Need for a larger Emergency Fund

It is prudent to set aside funds for an emergency. Loss of Needed Goods and Services

Society is deprived of certain goods and services. Fear and Worry

The mental unrest and fear caused by the presence of Risk.

VI. Methods of Handling Risk

AvoidanceIs one method of handling Risk!

Loss ControlLoss Prevention and Loss Reduction

RetentionActive (desirable): Is the deliberate choice to assume part or all of a loss exposure.Passive (dangerous): Often results from ignorance or inertia.

VI. Methods of Handling Risk

Non-Insurance Transfers

- Contracts

- Hedging

- Incorporation Insurance

For most people, Insurance is the most practical method for handling a Major Risk.