Course Overview

• Unit 1: Introduction 3LHs

• Unit 2: Risk Management 5LHs
• Unit 3: Insurance Device 4LHs
• Unit 4: Legal Framework of Insurance 5LHs
• Unit 5: Life Insurance Management 4LHs
• Unit 6: Non-Life Insurance Management 5LHs
• Unit 7: Reinsurance Business 3LHs
• Unit 8: Financial Convergence and Regulation 3LHs
Chapter 1: Introduction
• Concept of risk
• Current definition of risk
• Uncertainty and its relationship to risk
• Risk distinguished with peril and hazard
• Classification of risk
• Types of pure risk
• Major personal risk
• Commercial risk
• Liability risk
• Source of liability as tort
• Law of negligence
• Imputed negligence
• Risk in our society
• Techniques of managing risk ( Dealt in second chapter)
What comes in your mind after
reading these statements ????
• You see the crushed metal of two cars that have
collided on a highway.
• A fire engine with its siren screaming roars
down the street.
• A building in your neighborhood burns, or you
see an ambulance racing to the hospital.
Do these cometon your
mind????
• Such tragic events arouse your interest and emotions.
• After the noise and excitement have died down, you are grateful that
the loss did not happen to you and you may feel sorry for whoever
suffered the loss.
• But you’re glad that it wasn’t you. Losses like these happen to some
people, whereas others go along happily, free from misfortune.
• The fact that these losses or similar events could happen to you, and
the fact that you can’t tell for sure whether or not they will, is a
condition we call risk.

“Risk is a pervasive condition of human existence”

 Meaning of Risk
 There is no single definition of risk.
 Economists, behavioral scientists, risk theorists,
statisticians , each have their own concept of risk.
 But all of them consider the following definitions:
 Risk is the possibility of an unfortunate occurrence.
 Risk is a combination of hazards.
 Risk is unpredictability – the tendency that actual results
may differ from predicted results.
 Risk is uncertainty of loss.
 Risk is possibility of loss.

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 Cont.….
 Although the insurance theorists have not agreed on a
universal definition, there are common elements in all the
definitions: indeterminacy and loss.
 The notion of an indeterminate outcome is implicit in all
definitions of risk: the outcome must be in question.
 Risk is a condition in which there is a possibility of an
unfavorable deviation from a desired outcome that is
expected or hoped for.
 Risk is uncertainty concerning the occurrence of loss.

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 Current Definition of Risk
• There are common elements in all the definitions:
indeterminacy and loss.
• Indeterminacy: This implies uncertainty or
unpredictability in outcomes. In the context of risk, it
refers to the fact that when taking a risk, there is no
guarantee of the outcome
• Loss: This points to the potential negative consequence
or harm resulting from the uncertainty.

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Cont.…
 When risk is said to exist, there must always be different possible
outcomes.
 At least one of the possible outcomes is undesirable.
 Risk is potential variation in outcomes.
 If a loss is certain to occur, the outcome is one and known in
advance, therefore, there is no risk.
 It is when many outcomes are possible and when there is
uncertainty about the occurrence of a loss that the notion of risk is
to exist.
 The degree of risk is inversely related to the ability to predict
which outcome will actually occur.
 Thus, as greater the variation the greater risk.

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 Uncertainty and its Relationship to Risk

• “certainty” is “a state of being free from doubt,”

• The Antonym of certainty is “uncertainty” which is “doubt about our
ability to predict the future outcome of current actions.”
• Uncertainty refers to a feelings characterized by doubt, based on
the lack of knowledge about what will or will not happen in the
future. Uncertainty is doubt about our ability to predict the future.
• It is a subjective concept, so it cannot be measured directly by any
acceptable yardstick.
• Since it is a state of mind, uncertainty varies across individuals.

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 Risk vs. uncertainty

• On the other hand Risk refers to a

condition or combination of circumstances
in which there is a possibility of loss.
• Unlike uncertainty, risk can be measured.

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 Key Difference
• 1. The risk is defined as the situation of losing
something worthy. Uncertainty is a condition where
there is no knowledge about the future events.
• 2. Risk can be measured and quantified, through
theoretical models. Conversely, it is not possible to
measure uncertainty in quantitative terms, as the
future events are unpredictable.
• 3. The potential outcomes are known in risk, whereas
in the case of uncertainty, the outcomes are
unknown.
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 Key Difference
• 4. Risk can be controlled if proper measures are taken
to control it. On the other hand, uncertainty is beyond
the control of the person or enterprise, as the future
is uncertain.
• 5. Minimization of risk can be done, by taking
necessary precautions. As opposed to the uncertainty
that cannot be minimized.
• 6. In risk, probabilities are assigned to a set of
circumstances which is not possible in case of
uncertainty.
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 Risk, Peril and Hazard

• Peril is defined as the cause of loss that occurred. If a house

burns because of a fire, the peril, or cause of loss, is the fire.

• If a car is damaged in a collision with another car, collision is the

peril, or cause of loss.

• It is possible for something to be both a peril and a hazard. For

instance, sickness is a peril causing economic loss, but it is also a
hazard that increases the chance of loss from the peril of
premature death.

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 Types of hazard

Hazard : Anything that could cause harm

Physical hazard: A physical hazard is a physical condition
that increases the chance of loss.
It is a condition stemming from the physical
characteristics of an object that increases the probability
and severity of loss from given perils.
 Such hazards may or may not be within human
control.
 Some hazards for fire can be controlled by placing
restrictions on buildings or taking care while operating.
In contrary, some are not controllable – little can be
done to prevent or reduce their impact. Example, ocean
storms.
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 Cont.…
• Moral hazard: is dishonesty or character defects in an
individual that increase the frequency or severity of loss.
• Moral hazard refers to dishonest by an insured that increases
the frequency or severity of loss.
• Examples Moral hazard may exist where there is corrupt
intention to claim excessive amount of insurance for properties
that are no longer profitable.
• moral hazard include forged or calculated car accident,
submitting a fraudulent claim, intentionally burning unsold
insured merchandise and etc.
• Moral hazard may happen in all forms of insurance, and it
is difficult to control.

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 Cont.….
 Morale hazard: is carelessness or indifference to a
loss because of the existence of insurance.
 Some insured persons are careless or indifferent to a
loss because they have insurance.
 Examples of morale hazard include leaving car keys in
an unlocked car, which increase the chance of theft;
leaving a door unlocked that allows a robber to enter;
and changing tracks suddenly on a congested interstate
highway without signaling.
 Careless acts like these increase the chance of
loss.
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 Cont.….

 Morale hazard is also reflected in the attitude of

persons who are not insured.
 This includes the tendency of physician to provide
expensive examinations or tests when costs are to be
covered by insurance.
 Insurers try to control or reduce both moral and
morale hazard by carefully selecting their insured
and/or by providing contractual provisions that oblige
the insurer to pay some percentage of the loss.

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 Cont.….

 Legal hazard: refers to characteristics of the legal

system or regulatory environment that increase the
frequency or severity of losses.
 Examples include adverse jury decisions or large
damage awards in liability lawsuits, orders that
require insurers to include coverage for certain
benefits in health insurance plans, such as coverage
for alcoholism

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 Classification of Risk
1. Dynamic Risk
• Dynamic risks are those resulting from changes in the economy.
• Changes in the price level, consumer tastes, income and output, and
technology may cause financial loss to members of the economy.
2. Static Risk
• Static risks involve those losses that would occur even if there were no
changes in the economy.
• These losses arise from causes other than the changes in the economy, such
as the perils of nature and the dishonesty of other individuals.
• Static losses tend to occur with a degree of regularity over time, and as a
result, are generally predictable.

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 Classification of Risk
3. Fundamental Risk
• They are group risks caused, for the most part, by economic, social, and
political phenomena although they may result from physical occurrences.
• They affect large segments or even all of the population
• Unemployment, war, inflation, earthquakes, and floods are all fundamental
risks.
4. Particular Risk
• Particular risks involve losses that arise out of individual events and are
felt by individuals rather than by the entire group.
• They may be static or dynamic.
• The burning of a house and the robbery of a bank are particular risks.

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 Classification of Risk
5. Pure Risk
• The term pure risk is used to designate those situations
that involve only the chance of loss or no loss.
• One of the best examples of pure risk is the possibility
of loss surrounding the ownership of property.
• The person who buys an automobile, for example,
immediately faces the possibility that something may
happen to damage or destroy the automobile.
• The possible outcomes are loss or no loss.

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 Classification of Risk
6. Speculative Risk
• Speculative risk describes a situation in which there is
a possibility of loss but also a possibility of gain
• Gambling is a good example of a speculative risk. In a
gambling situation, risk is deliberately created in the
hope of gain.
• The student gambling $10 on the outcome of
Saturday’s game faces the possibility of loss, but this is
accompanied by the possibility of gain.

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 Types of pure risk
[Link] risks are risks that directly affect an individual.
• They involve the possibility of the complete loss or
reduction of earned income, extra expenses, and the
depletion of financial assets.
• There are four major personal risks.
Risk of premature death.
Risk of insufficient income during retirement.
Risk of poor health.
Risk of unemployment.

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 Cont.….

Risk of premature death: Premature death is defined as the death of

a household head with unfulfilled financial obligations.
These obligations can include dependents to support, a mortgage to
be paid off, or children to educate
Risk of insufficient income during the retirement: The major risk
associated with old age is insufficient income during retirement.
The vast majority of workers in the world are before age 65. When
they retire, they lose their earned income
Risk of Poor Health: Poor health is another important personal risk.
The risk of poor health includes both the payment of terrible medical
bills and the loss of earned income.

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 Cont.….

 Risk of Unemployment: The risk of unemployment is another

major threat to financial security.
 Unemployment can result from business cycle downswings,
technological and structure changes in the economy, seasonal
factors, and imperfections in the labor market.
2. Property Risks: the risk of having property damaged or lost
from numerous causes.
 Real estate and personal property can be damaged or destroyed
because of fire, lightning, tornadoes, windstorms, and numerous
other causes.
 There are two major types of loss associated with the
destruction or theft of property: direct loss and indirect loss or
consequential loss
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 Cont.….

 Direct loss: A direct loss is defined as financial loss that

results, from the physical damage, destruction, or theft of
the property.
 For example, assume a hotel that is damaged by a fire,
the physical damage to the hotel is known as a direct
loss.
 Indirect loss: An indirect loss is a financial loss that
results indirectly from the occurrence of a direct physical
damage or theft loss.
 Thus, in addition to the physical damage loss, the hotel
would lose profits for several months while the hotel is
being rebuilt.
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 Cont.….
[Link] risk: Liability risks are another important type of pure
risk that most persons face.
 One can be held legally liable if he/she does something that
result in bodily injury or property damage to someone else.
 A court of law may order him/her to pay substantial
damages to the person he/she has injured.
 Speculative risk: speculative risk is defined as a situation in
which either profit or loss is possible.
 For example, if you purchase 100 shares of common stock,
you would profit if the price of stock increases but would loss
if the price declines.

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 Commercial Risk
• Commercial risk is a type of business risk that can arise from a
company’s commercial activities.
• These risks can come from a variety of sources, including contracts,
product liability, employee relations, and competition.
• Some commercial risks are inherent in every business, while others
are specific to certain industries or types of businesses.
• Managing commercial risk is an important part of running a successful
business, as it can help protect the company’s bottom line and
reputation.
• There are many types of commercial risk, but they all essentially boil
down to the possibility of financial loss.

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 Tort
• Tort is a term used in insurance to refer to a legal concept involving a
wrongful act or omission by one party that causes harm or injury
to another party.
• The term "tort" may refer to the act of wrong doing and the resulting
legal claim for damages or compensation.

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 Tort
a. Intentional torts, where someone intentionally committed a
wrong and caused an injury to someone else. Eg Leaving the
dog to intentionally hurt someone.
b. Negligent torts, where someone violated a duty they owed
to the person harmed, such as running a red light and causing
an accident.
c. Strict liability torts, where it does not matter whether there
was intent or a duty breached; the defendant is liable because
the matter is so important. Strict Liability typically applies
to product liability. For example, if a defective product caused
an injury, then the manufacturer or store that sold it could be
held liable.
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 Law of Negligence
• The law of negligence is a fundamental concept
in tort law that addresses situations where one
party’s failure to exercise reasonable care
results in harm to another person.
• It holds individuals or entities legally
responsible for the damages or injuries caused
by their careless actions or omissions.

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 Element of Law of Negligence
• Duty of Care: This refers to the legal obligation one
person has to avoid causing harm to another. For
example, drivers owe a duty of care to other road users,
meaning they must drive safely and follow traffic laws.
• Breach of Duty: A breach occurs when someone fails
to act in accordance with the expected standard of care.
This can happen through actions (like running a red
light) or inaction (like failing to fix a dangerous
condition on one’s property).

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 Element of Law of Negligence
• Causation: The plaintiff must prove that
the breach of duty directly caused their
injury or loss.
• Damages: The plaintiff must have suffered
actual harm or loss, such as physical injury,
financial loss, or emotional distress, as a
result of the defendant’s actions.

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 Imputed Negligence
• Imputed negligence means that under certain conditions,
the negligence of one person can be attributed to
another.
• Several examples can illustrate this principle. First, an
employer–employee relationship may exist where the
employee is acting on behalf of the employer. The
negligent act of an employee can be imputed to the
employer.
• Therefore, if you are driving a car to deliver a package for
your employer and negligently injure another motorist,
your employer could be held liable for your actions.
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 Imputed Negligence
• Second, many states have some
type of vicarious liability law, by
which a motorist’s negligence is
imputed to the vehicle’s owner. For
example, if the driver is acting as
an agent for the owner of the
vehicle, the owner can be held
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 Lets Discuss…………
1. Two 9-year-old boys are watching a television
replay of a boxing match between Muhammad Ali
and Joe Frazier on a program called “Great Fights
of the Century.” Since the fight took place before
they were old enough to remember the outcome,
neither knows who won and they bet on the
outcome. Tom bets on Ali and Tim bets on Frazier.
Does risk exist in this situation? For Tim? For
Tom?

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 Lets Discuss…………
Yes, a bet is considered a risk.
In the context of the two boys betting on the boxing match:
Known unknowns: They know the possible outcomes (Ali wins or Frazier wins) and can
assign subjective probabilities based on their knowledge or gut feeling.

Measurable: While they may not have precise probabilities, they understand the potential
gains and losses associated with the bet.

Manageable: The risk can be managed by the amount of money they bet, their willingness
to accept potential losses, and their understanding of the sport.

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