Chapter One: The Problem of Risk

Question 1 

A risk is a form of uncertainty about an anticipated outcome, whereby there is a probability of an undesirable deviation from the expected outcome. 

Question 2 

Risk is classified as either static or dynamic, fundamental or particular, and pure or speculative. Dynamic risks emerged from changes in the economy, while static risks are independent of economic changes. Fundamental risks are uncertainties that emerge from impersonal origins and consequences such as social, political, and economic origins, while particular risks emerge from individual origins or events such as unemployment or inflation. Pure risks involve situations where the only two outcomes are loss or no loss, while speculative risks involves chances of loss or gain. 

Question 3 

Fundamental risks can be covered by public policies, such as the federal terrorist reinsurance program by Congress in 2002, while particular risks are the individual responsibility of people, and can be addressed by risk prevention or personal insurance. 

Question 4 

Pure risks can result in loss of income, or assets, property destruction, and liability risks whereby a risk results in the unintentional injury of people, or damage of property. 

Question 5 

Personal risks, for example, unemployment. 

Property risks, for example, house destruction by fire. 

Liability risks, for example, sexual harassment lawsuits. 

Risk emanating from failure of other, for example, building burning down because of a faulty alarm system. 

Question 6 

Burden of risk can be felt through opportunity costs and deterred economic growth and capital accumulation. 

Question 7 

Perils are origins of losses, while hazards are conditions or entities that increase a chance of loss from a particular peril. An example of a peril is fire, while a hazard can be a gas leak that causes the fire to spread. 

Question 8 

Physical hazard- physical and tangible properties that increase the chances of a loss for a peril. For example, the type of building in case of a fire. 

Moral hazard- increased chances of a loss due to dishonesty and character flaws of people, such as the increased cost of insurance due to fraud. 

Morale hazard-increase risk of loss due to attitude differences towards loss. For example, carelessness due to insurance. 

Legal hazards- increased risk of loss due to legal doctrines and legislation. For example, statutory requirements of building codes that cause the demolition of a building. 

Question 9 

Risks are evolving, and each time, capital investment leads to an increase in risk for financial loss. This could be due to the human intention to maximize profit, limit risks, and control the environment around them, making them to perceive any barrier in their way as a risk. 

Question 10 

Peril- earthquake, sickness. Hazard- a careless act, worry and an economic depression. 

Chapter Two: Introduction to Risk Management 

Question 1 

Decision theory- based on operations research and management science. 

Risk financing- incorporates aspects of finance and insurance. 

Risk control- emerged from aerospace and military industry as traditional safety management and loss prevention. 

Question 2 

Risk control and risk financing 

Question 3 

Risk avoidance- this is where a risk manager avoids decisions that can lead to a risk. For example, a company may shun away from producing certain goods due to their inherent risks. 

Risk reduction- this technique aims at reducing the potential severity of a loss by controlling the frequency of the risk. For example, preventing employee loss by providing protective gear. 

Risk-retention is the intentional or unintentional retaining of a risk by doing nothing when they occur, such as underinsurance. 

Risk transfer- entails the intentional shift of risk from one form to another, such as the purchase of insurance contacts. 

Question 4 

This change in philosophy shifted from insurance purchasing to risk management that emphasized cost-benefit analyses, and expected value among other scientific decision-making tools. 

Question 5 

Determination of objectives- this entails deciding what the company desires its risk management tool to be. The objectives must address value maximization, the primary objective of survival, and significant policy decisions. 

Identification of risks- this step ensures all risks are known before they can be managed. It involves seeking information by analyzing documents, internal communication systems, using risk identification tools such as checklists on insurance policies, risk analysis, and expert opinions. 

Evaluation of risks- it includes ranking the risks in terms of their severity and frequency. 

Consideration of alternatives and selection of the risk treatment device- this step includes making decisions on which available tool should be used to address a risk. 

Implementation of the decision- depending on the decision made, whether to retain or transfer a risk, this phase puts it into action. 

Evaluation and review- this step gauges past risk management processes' execution and effectiveness, in line with the objectives. 

Question 6 

The development of risk management took place as a change in philosophy from insurance buying to risk management. This change was brought about by a shift in the business college curriculum to introduce operations research and management science. The need to reduce loss in aerospace and military industry also became a significant force in risk management development. The change of the insurance buyer’s company’s name to Risk and Insurance Management Society (RIMS) marked the entry of risk management as a business function. 

Question 7 

Risk managers are expected to perform risk management functions, make decisions on the pure risks faced by an organization, handle the employee’s benefit plan and undertake loss prevention activities. The risk manager’s function is often tied to the financial division, and in some cases, they are in the safety division. 

Question 8 

Risk management is a derivative of insurance management. However, the two differ in scope and philosophy. Risk management is broader because it deals with insurable and uninsurable risks, while insurance management focuses on insurable risks. Risk management philosophy seeks the justification of insurance while insurance management views insurance as the norm, and thus seeks to justify a premium reduction. 

Question 9 

Risk management applies to giant organizations. It developed due to the nature of literature, where many professional risk managers work in large companies. 

Risk management is anti-insurance. This misconception developed from literature, where in many cases, risk management is obsessed with risk retention, and self-insurance. 

Question 10 

Traditional risk management entails the management of insurable and uninsurable pure risks. Financial risk management is the management of market risk, credit risk, and liquidity risk. Enterprise risk management, on the other hand, refers to the comprehensive management of speculative and pure risks.