Beruflich Dokumente
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Learning Objectives
1:1 Meaning of Risk.
1:2 Perils & Hazards.
1:3 Basic Categories of Risk.
1:4 Types of Pure Risk.
1:5 Evolutionary Process of Risk
“There is nothing certain in the world except death and tax: yet death and tax are uncertain as no
body knows when he will die or when the tax will change” – Benjamin Franklin
We live in a risky world. Forces that threaten our Financial well being constantly surround us and are
largely outside our direct control. Some people experience the pre-mature death of their near and dear
ones, loss and destruction of their property from both manmade and natural disasters.
Majority of Insurance authors have defined Risk in terms of uncertainty. Based on this theory, risk is
defined as “Uncertainty concerning the occurrence of a loss”. Risk therefore arises out of uncertainty.
It is measured in terms of the likelihood of it happening and, the consequences that will arise if it does
happen. Chance of loss is the likelihood of the occurrence of an event causing a loss. It is the relative
frequency of occurrence of an event resulting in loss. It is calculated as the ratio of the number of expected
losses to a total number of actual losses that actually occur.
Chances of loss = Number of likely losses / Total number of possible losses
For example: There are 1000 houses in a community. Out of past experience and records, there is a
possibility that 10 of these houses will be damaged by fire during a given period of time. Then, the chance
of loss due to fire is 1% (10/1000).
All of us encounter risks in everything we do – driving a car to work or even shopping in the supermarket.
Most of us try to reduce the likelihood of risk that can affect our daily activities.
A few examples will illustrate the extent of the uncertainties to which all sections of society are exposed.
Individuals and families are exposed to the chances of loss due to disease, accidental injuries, death,
unemployment, loss of possessions due to perils which may befall liability for injury caused to others, and
many other events which may diminish their welfare. On the brighter side there can be unexpected gains
too, such as a large win on a game-show, or a chance encounter that may lead to a better job.
From the above discussion, we can conclude that Risk has the following characteristics:-
Risk is unpredictable.
Definition
Risk is the possibility of harm, injury, loss, danger, or destruction.
Physical hazards are the conditions in which the physical characteristics of an object or an individual tend
to increase the frequency of loss.
For example, bad weather conditions increase the chances of airplane accidents, defective materials used
in construction of buildings result in collapse of buildings and unsafe conditions in the workplace increase
the chance of accidents to the workers.
It is a situation wherein the frequency and severity of loss increases due to an individual’s dishonesty. A
While moral hazards occur due to defects in an individual’s character, morale hazards are due to an
individual’s indifference or negligence. An individual’s indifference to the risk because of the existence of an
insurance cover constitutes a morale hazard.
Examples of morale hazards are rash driving, leaving the car unlocked and not checking whether the house
doors are locked properly before leaving on a holiday thus inviting burglary etc.
In its broadest context, the term risk includes all situations in which there is an exposure to adversity. In some
cases, the adversity involves financial loss, while in others it does not. There is some element of risk in every
aspect of human endeavour, and many of these risks have no (or only incidental) financial consequences.
Here, in this book, we will concentrate only on those risks, which may give rise to a financial loss.
Subjective risk arises out of an individual’s mental state. It is the result of an individual’s uncertainty about
the outcome of an event. Subjective risks occur due to psychological fear about the outcome of an event
whether it will be favorable or not to an individual.
Objective risks as the term suggests, can be observed and, for that reason, capable of measurement
unlike subjective risks which are not. Here, the probability of an event occurring can be determined in two
ways: either by deductive reasoning (as in the case of a balanced coin being tossed) or, by inductive
reasoning (as in the case of an actuary determining the probability of death of a person at a certain age).
1:3:3 Fundamental and Particular risks
Fundamental risks are group risks, which occur due to social, economic and political changes in the
country. Large numbers of people are affected by these fundamental risks. Fundamental risks also arise
due to natural calamities.
Examples: Crisis in the economy, widespread unemployment, sudden wars, poverty, dramatic changes in
government policies, inflation, floods, earthquakes, famine, volcanic eruptions and other natural calamities
are also described as fundamental risks.
Particular risks, on the contrary, are personal in nature. These arise from individual causes and the
consequences and affect only the individuals.
Examples: Injury due to accidents, poor health condition, robbery, damage due to fire etc.
Generally governments formulate certain programmes to deal with fundamental risks whereas an affected
individual’s deals with particular risks by using suitable risk management techniques.
Static risks can be pure or speculative. Natural events such as storms, snowfalls and death are described
as pure static risks. Industries in a stable economy are a good example of static speculative risks.
Dynamic risks can also be pure or speculative risks. Dynamic risks will affect the whole economy. These
risks are beyond the control of an individual. Dynamic risks arise out of socio- economic changes such as
globalization of the economy, the impact of IT, the information explosion and other major changes affecting
society. Society often benefits due to dynamic risks, though only in the long term.
Pure risk is used to designate those situations that involve only the chance of loss or no loss. Pure risks
do not have favorable outcomes; at best, we are left in the same situation in which we were before the event
causing loss occurred. Fires in a godown or a factory, an injury at the work place or on the road or a theft
or burglary in the home are all instances of pure risks.
Speculative risk describes situations in which there are three possible outcomes namely-:
a possibility of loss,
a possibility of gain or
Personal risks are those risks that directly affect an individual. They cause financial insecurity because
they usually result in a reduction or stoppage of income, an increase in expenses and a depletion of
financial resources.
Some of the major personal risks are:
1:4:1:1 Risk of premature death
1:4:1:2 Risk of poor health
1:4:1:3 Risk of temporary or permanent disability
1:4:1:4 Risk of insufficient income during retirement
If a person who has obligations like dependents to support, loans to pay off or children to educate dies,
then the surviving family members face financial insecurity. They need sufficient replacement income to
take care of their obligations.
The risk of poor health may result in depletion of financial resources due to increased medical expenses as
well as loss of income. Unless a person has adequate financial resources, the risk of poor health can
cause financial insecurity.
As with the risk of poor health, the risk of temporary or permanent disability may also cause financial insecurity
due to depletion of financial resources as a result of increased medical expenses and loss of income.
Most people experience a significant reduction in their income when they retire. Unless they have saved for
their retirement in a planned manner, they are likely to experience financial insecurity.
Persons owning property face the risk of having that property damaged, destroyed or lost due to different
causes. They cause financial insecurity because they affect the income streams being produced from the
usage of the property. They also increase expenses because the damaged/destroyed/lost assets need to
be repaired / replaced. Property risks can cause loss in two major ways:
1:4:2:1 Direct Loss
1:4:2:2 Loss of Income from properties used for business purposes.
1:4:2:3 Indirect or Consequential Loss
A direct loss results from physical damage, destruction or theft of property. For example if your house is
damaged due to earthquake, the amount of loss is known as direct loss.
This loss arises as a result of a disability, injury, or business disruption. For example if a shop is destroyed
by a fire, apart from the physical damage: the shop-owner will face a loss in income till he can start his
business again.
An indirect loss results from the consequences of a direct loss. For example, if your house is destroyed in
an earthquake, you may have to live in a rented house till your house is repaired. The rent that you pay is
the indirect loss.
Liability risks arise from the possibility of being held legally liable for the loss to another person. If a person
commits a mistake or, because of negligence, causes bodily harm or injury to another person, a court of
law can order that individual to pay damages to the injured party.
Liability risks can be categorized into:
1:4:3:1 Statutory Liability
1:4:3:2 Common Law
1:4:3:3 Contract
These represent any liability arising out of specific statute. For example Third Party Liability in Motor
Vehicle’s Act, & Industrial Dispute Act
These represent any liability arising out of common law. For example Libel or Slander
1:4:3:3 Contract
These represent any liability arising out of mutual agreement between two or more parties. For example:
liabilities arising out of contractual obligations.
All these liabilities may arise in a Personal or a Professional capacity.
Personal liability arises when a person acts negligently or carelessly during the course of his personal life
and causes harm to another. For example, if you hit a pedestrian with your car while jumping traffic lights,
you may be asked to bear expenses for the treatment and also pay damages to the victim.
Professional liability arises when a person harms another while performing as a professional. For example,
a doctor who causes harm due to a wrong diagnosis can be held professionally liable to pay damages to
the patient.
Liability risks cause financial insecurity because they result in depletion of existing financial resources.
When a third person agrees to perform a service for another individual, the third person undertakes an
obligation that one presumes will be met. When the failure of the third person to meet the obligation results
in a financial loss, risk exists.
Ex: Failure of a contractor to complete a construction project as scheduled, or failure of debtors to make
payments as expected. With the development of the Internet and the rapid evolution of e-commerce, a
variety of new risks relating to the failure of others have emerged.
Liability risks cause financial insecurity because they result in depletion of existing financial resources.
Key Concepts
Risk Uncertainty
Peril Hazard Moral Hazard
Morale Hazard Static Risk
Dynamic Risk Fundamental Risk
Particular Risk Pure Risk
Speculative Risk Personal Risk
Property Risk Liability Risk
Review Questions
1. Define Risk. In your definition, state the difference between Risk and Uncertainty?
2. Distinguish between peril and hazard with example?
3. What are the 3 categories of hazard? Explain your answer with suitable illustrations.
4. Risk may be classified in several ways. List the 3 principal ways in which risk may be
categorized, and explain the distinguishing character of each class?
5. List the 4 types of pure risk facing an individual or an organization with example?
Chapter Review