• uncertainty concerning the occurrence of loss
• the possibility of an adverse deviation from a desired outcome that is expected or hoped for

Mental state of an individual who experiences doubt or worry as to the outcome of a given event.

It is essentially the psychological uncertainty that arises from an individual's mental attitude or state of mind

The relative variation of actual loss from expected loss.

more precisely observable and therefore measurable.

Indifferent towards Risk.

Value of Risky Situation is Expected Loss

Prefer to avoid Risk.

Willing to pay more than expected loss to avoid risk.

People who buy insurance

people are risk averse in general

Prefer Risk

Would pay more than expected return to engage in risky situation

Lottery Players

Insurance charges more than the expected loss to account for overhead. If everyone was a risk seeker there would be no insurance.

measures both dimensions-probability of loss and severity of loss- simultaneously.

Probable variation of actual from expected losses.

• Variance
• Standard Deviation
• Coefficient of Variation

• If a loss has already occurred the probable variation of actual from expected losses is zero (therefore the objective risk is 0)
• If it is impossible for loss to occur the probable variation is also zero
• In measuring objective risk, results are meaningful only in terms of a group large enough to be analyzed statistically

Legal judgments may result in payments made to compensate injured parties as well as to punish those responsible for the injuries even if the individual is absolved of liability the expenses involved in the defense may be substantial.

All individuals who own or use real property are suscpetible to liability losses if others are injured on the premises. 

• The possibility of the untimely death of a star salesperson
• The potential death of a parent with young children
• Employees who become ill or injured in accidents
• Insufficient income for retirement
• Unemployment

• Include credit risk, foreign exchange risk, commodity risk, and interest rate risk
• These risks must be identified and assessed in order for the firm to achieve its business goals

Specific contingency that may cause a loss (accident)

(cause of a loss)

• stems from an individual's mental attitude
• associated with intentional actions designed either to cause a loss or to increase its severity
• also describes the change in attitude that can occur when insurance is available to pay for loss (such as the tendency for individuals to consume more health care if the costs are covered by insurance)
• ex: fraud

Carelessness or indifference to a loss which increases the frequency or severity of a loss

The mental attitude of a careless or accident-prone person

Legal and Cultural

characteristics of the legal system or regulatory environment that increase the frequency or severity of losses

• outlays to reduce risk
• opportunity cost of activities forgone due to risk considerations
• expenses of strategies to finance potential losses (buying insurance)
• The cost of unreimbursed losses

• Identify Risks
• Evaluate Risks
• Select Risk Management techniques
• Implement and review decisions

• survival and growth
• compliance with government regulations
• efficiency
• procedures and principles are implemented and followed

• survive the loss
• provide a foundation to grow and prosper
• behave responsibly as a good corporate citizen

or:

• survival
• continue operating
• stability of earnings
• continued growth
• minimize effects loss will have on others and society

Unit or object subject to a potential loss

• specifies numerous potential sources of loss from the destruction of assets and from legal liability
• some are designed for specific industries
• others focus on a specific category of exposure

• It is not unusual for contracts to state that some losses, if they occur, are to be borne by specific parties
• may be found in construction contracts, sales contracts and lease agreements
• ideally the specification of who is to pay for various losses should be conscious decision that is made as part of the overall contract negotiation process

• Involves arraying risks in a matrix (one dimension is the frequency/the other is the severity)
• Each risk is marked to indicate whether it is covered by insurance or not.

long term frequency of occurrence.

1. As the number of homogeneous exposure units increases, the degree of risk decreases
2. Given a constant number of exposure units as the probability of loss increases, the degree of risk decreases

constructs probability distributions of the risks alone and in various combinations. 

• To obtain estimates of the risk of loss at various probability levels
• yields a numerical statement of maximum expected loss in a specific time and at a given probability level
• provides the firm with an assessment of the overall impact of risk on the firm
• considers correlation between different categories of risk

• attempts to allocate risk costs to many different activities of the firm
• assesses how much capital would be required by the organizations various activities to keep the probability of bankruptcy below a specified level

• a conscious decision not to expose oneself or one's firm to a particular risk
• can be said to decrease one's chance of loss to zero
• when risk is avoided, the potential benefits as well as costs are given up

• When particular risks cannot be avoided, actions may be taken to reduce the losses associated with them
• The firm or individual is still engaging in operations that give rise to particular risks
• Involves making conscious decisions regarding the manner in which those activities will be conducted

1. Heredity and social environments which cause a person to act a particular way
2. personal fault which it the failure of individuals to respond appropriately in a given situation
3. an unsafe act or the existence of a physical hazard
4. accident 
5. injury

If any of the dominos prior to the final one are removed the injury will not occur. Emphasis on loss control should be on the third domino.

involves the reduction of the maximum probable loss associated with some kinds of risks. (spreading exposure units out separately)

• repair/replacement of damaged property
• income losses due to destruction of property
• extra costs to maintain operations following a loss
• adverse liability judgments
• medical costs to treat injuries
• income losses due to death or diabilities

• Put money aside in case of event
• involves a conscious and deliberate assumption of recognized risk
• sometimes occurs because it is the most convenient risk treatment technique or because there are no alternatives short of avoidance

when a firm or individual does not recognize that a risk exists and unwittingly believes that no loss could occur.

sometimes occurs even when existence of a risk is acknowledged

if the maximum possible loss associated witha recognized risk is significantly underestimated.

• may provide some limited opportunities to fund losses that result from retained risks
• usually not viable source of funds for the payment of large losses
• credit line established with bank, and borrowed funds may be used to pay losses as they occur. Interest must be paid.

Sometimes established to pay for losses arising out of risks a firm has decided to retain.

When the maximum possible loss is quite large a reserve fund may not be appropriate

If the firm has a group of exposure units large enough to reduce risk and thereby predict losses, the establishment of a fund to pay for those losses is a special form of planned funded retention. 

Will not involve a transfer of risk

Need existence of a group of exposure units that is sufficiently large enough to enable accurate loss prediction.

 is a risk management method in which a calculated amount of money is set aside to compensate for the potential future loss.

If self insurance is approached as a serious risk management technique, money is set aside using actuarial and insurance information and the law of large numbers so that the amount set aside (similar to an insurance premium) is enough to cover the future uncertain loss.

Insurer owned by a parent firm for the purpose of insuring the parent firm's loss exposures

combines the techniques of risk retention and risk transfer

• Provisions inserted into many different kinds of contracts
• can transfer responsibility for some types of losses to a party different than the one that would otherwise bear it.
• Also known as indemnity agreements
• intent of these clauses is to specify the party that will be responsible for paying for various losses (usually no dollar amount is listed)

• Limited- clarifies that all parties are responsible for liabilities from their own actions
• Intermediate- transferee (receiver) agrees to pay for any losses in which both are jointly liable
• Broad- requires the transferee (receiver) to be responsible for all losses arising out of a particular situation regardless of fault

risk transfer where a firm is a sole proprietorship the owners personal assets can be attached by creditors for satisfication of debts. 

The most that an incorporated firm can ever lose is the total amount of its assets. Personal assets of the owners in a firm cannot be attached to help pay for business losses. 

Results in transfer of risk across business units

combining businesses or geographic locations in one firm can even result in a reduction in total risk

• The size of an emergency fund must be increased
• Society is deprived of certain goods and services
• Worry and Fear are present

1. Problem-Real World
2. "Translated" problem-Model World
3. Model Solution
4. Solution

• Avoid Risks if possible
• Implement appropriate loss control measures
• Select the optimal mix of risk retention and risk transfer

• Low Frequency/Low Severity- Retention
• Low Frequency/High Severity- Transfer (Insurance)
• High Frequency/Low Severity-Retention/Loss Prevention
• High Frequency/High Severity- Avoidance

• Risk Retention is optimal for losses that have a low expected severity, with the rule becoming especially appropriate when expected frequency is high
• Risk Transfer is the optimal choice in situations with low frequency but high severity
• When losses have high severity and high frequency it is likely that risk transfer, risk retention, and loss control all need to be used in varying degrees

• selecting a deductible is one way of mixing retention and risk transfer
• Deductibles help lower the cost of insurance as well as increase its availability
• Deductibles may also make management more loss conscious because a firm must absorb losses 

• the firm can afford the associated losses
• sufficient premiums savings will result

• provision by which a specified amount is subtracted from the loss payment otherwise payable to the insured.
• a deductible is used to eliminate small claims and the administrative expense of adjusting these claims
•  portion of any claim that is not covered by the insurance provider. It is the amount of expenses that must be paid out of pocket before an insurer will cover any expenses. 

• Management may prefer stable predictable insurance premiums each year rather than use self-insurance
• some companies prefer to avoid details of managing self-insurance programs instead focus on their main operations

• plan may be tailored to fit the needs of the group
• has lower fixed costs than a fully insured plans
• can use independent measures to save the most money
• Interest accumulated is considered income
• reasonably and competitively priced
• simplifies budgeting
• simpler, faster

• do not perform identical functions
• broker is not as familiar with the internal affairs of the company
• Risk manager's primary concern is the firm
• responsibility is too important for an outsider

• Risk manager supervises a variety of activities including all kinds of insurance, self-insurance programs, foreign risks, and safety administration
• Claims and Loss Records are under Risk Manager control
• Risk manager is only 2 levels below the president and may have 5-10 professional employees too assist