Unity University College

Faculty of Business and Economics, Department of Management and Marketing

Unity University College

Faculty of Business and Economics
Department of Management and Marketing
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Course Title; Risk Management and Insurance.
Course Number; Mgmt 321
Credit Hours; 3
Prerequisite(s); Basic And / Or Managerial Statistics.
Course Descriptions;
The course is believed to familiarize students with the basic concepts of risk which is
said to be inherent in every business endeavor. The course covers from definitions to
every step taken in the management of risk to that of risk handling tools including
Insurance.
Course Objectives;
Up on accomplishing of this course student should be able to;
 Understand the meaning and concepts of risk and Insurance.
 Identify and classify risk.
 Measure qualitative and quantitative dimensions of risk.
 Apply tools of risk management.
 Understand the Social, Economic cost and benefits of insurance.
 Understand the fundamental contracts and Principles of insurance.
Grading System
 Attendance ---------------------- 5%
 Reading Assignment ------------5%
 Monthly Test----------------------15%
 Weekly Assignment--------------15%
 Team Assignment----------------5%
 Individual Assignment------------5%
 Final Exam-------------------------50%
Text Book;
C. Arthur Williams and Richard M. Heins, Risk Management and Insurance, 1985.
Reference Books;
George E. Rajda, Principles of Risk Management and Insurance, 2002
Unity University College, School of Distance and Continuing Education, Course Material
for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991.
Team Assignment;
Instructions; you will be given a list of topics where by you are expected to prepare a
condensed report.
Due date; The assignment is to be submitted on 12th Week.

1
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Individual Assignments; you are expected to develop a Utility and Worry factor model
based on the class demonstrations.
Due date; The assignment is to be submitted on 14th Week.

Module -1
Topic: Definitions, Meanings and Concepts of risk.
Sessions learning objectives
 At end of this session students’ will have a better understanding about
meaning and concepts of risk.

Discussion issues; Students are encouraged to come up with their own explanations
for meaning and concepts of risk. (10 Minuet)
 Meaning and Definitions of Risk.
 Various concepts in Risk.
Reading Text
DEFINITION OF RISK

There is no one universal and comprehensive definition of risk that exists so far. It is
defined in different forms by several authors with some differences in the wordings used.
The essence, however, is very similar. Some of the definitions are shown below:
- Risk is a condition in which there is a possibility of an adverse deviation from a
desired from a desired outcome that is expected or hoped for.
- Risk is the objectified uncertainty as to the occurrence of an undesired event.
- Risk is the possibility of an unfavorable deviation from expectations; it is the
possibility that something we do not want to happen will happen or something that we
want to happen will fail to do so.
- Risk is the variation in the outcomes that could occur over a specified period in a
given situation.
- Risk is the dispersion of actual from expected results.

From the above mentioned and other definitions of risk, we can infer that risk is
undesired outcome or it is the possibility of loss. The important point is there should be
more than one outcome for the risk to happen, i.e. there will be no risk if there is only one
outcome. This is because it is certain that only one outcome will take place. The absence
of risk in this case implies that the future is perfectly predictable. Variations in the
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

possible outcomes, then, lead to the existence of risk; and the greater the variability, the
greater the risk will be.

RISK VS UNCERTAINTY

Many textbooks use the terms risk and uncertainty interchangeably. However, the
distinction between the two must be noted. The “risk versus uncertainty” debate is long-
running and far from resolved at present. Although the two are closely related, quite
many authors make a distinction between the two terms. Uncertainty refers to the doubt
as to the occurrence of a certain desired outcome. It is more of subjective belief.
Subjective in a sense that it is based on the knowledge and attitudes of the person viewing
the situation and as the result different subjective uncertainties are possible for different
individuals under identical circumstances of the external world.

Knight defined “risk” as a measurable uncertainty that can be determined by objective

analysis based on prior experience and “uncertainty” as unmeasureable uncertainty that is
of a more subjective nature because it is with out precedent. Risk is dealt with every day
by weighing probabilities and surveying options, but uncertainty can be debilitating, even
paralyzing, because so much is new and unknown. The practical difference between the
two categories, risk and uncertainty, is that in the risk the distribution of the outcome in a
group of instances is known either through calculation a priori or from statistics of past
experience; while in the case of uncertainty this is not true, the reason being in general
that it is impossible to form a group of instances, because the situation dealt with is in a
high degree unique.

Preffer has noted the difference between risk and uncertainty as “Risk is a combination of
hazards and is measured by probability; uncertainty is measured by the degree of belief.
Risk is a state of the world; uncertainty is a state of the mind.”

In general, many authors indicated that risk is objective phenomenon that can be
measured mathematically or statistically. It is independent of the individuals belief.
Whereas, uncertainty is subjective that cannot be measured objectively. Of course, risk
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

and uncertainty may have some relationship. Uncertainty results from the imperfection of
knowledge of mankind of predicting the future. The higher the lack of knowledge about
the future the higher the uncertainty. But, it is debatable to say that higher uncertainty
leads to higher risk. The presence and absence of uncertain does not necessarily mean the
presence and absence of risk respectively. The following four situations underscore the
difference between risk and uncertainty:

1. Both risk and uncertainty are present

eg. a person may be exposed to risk of disability and may experience uncertainty
2. Both risk and uncertainty are absent
eg. sailors at present know that the earth is not flat.
There is no possibility of falling off the edge of the earth.
3. Risk is present and uncertainty absent
eg. the possibility of loss due to interruption of operation by fire. There may be no
uncertainty because of failure to recognize the existence of such risk, understatement of
the situation or because of preoccupation with other problems.
4. Risk absent but uncertainty present
eg. An hour ago, a man heard that a plane departing from the airport crashed. The man
knows that his wife was scheduled to fly from the airport earlier today, but he does not
know whether she was on the plane crashed. Here there is no risk as risk refers to future
outcomes. However, there is uncertainty since it relates to past, present and future
situations.

Hence, from the discussions above it is clear that risk is primarily objective while
uncertainty relates to the subjective sate of mind. Moreover, there may not be any
necessary relationship between risk and uncertainty Risk exists whether or not a person is
aware of it. It is a state of the world. Uncertainty, however, exists only with awareness; it
is a state of mind. For example, the risk of cancer from cigarette smoking existed the
moment cigarettes are produced. However, the uncertainty did not arise until the
relationship between cigarette smoking and cancer is established through scientific and
empirical research.

4
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Generally, it is possible to conclude that although there is relationship between risk and
uncertainty, they are different practically.

Synopsis of Lecture (30 Minuet)

Risk is potential variation in outcomes. When risk is present, outcomes cannot be

forecasted with certainty. William, Smith and Young
Risk is the variation in out comes that could accrue over a specified period in a given
situation. William’s and Heins

RISK vs. UNCERTANITY

Uncertainty, which is a state of doubt, could be objective or subjective. The latter one is
subjected to the individual state of mind.
Risk is objectified uncertainty that can be measured.

Peril and Hazard

 Peril, the actual or specific cause of the loss.
 Hazard, a condition that creates or aggravates the situation for the loss to
happen.

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 How do you understand risk?
 What are the similarities and differences b/n Risk and
uncertainty?
 What is the difference among Peril, Hazard and Risk?

Next Session Assignment

Students are expected to come prepared for the next class by reading about
the major classifications of risk.

5
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Module - 2
Topic: Classifications of risk.

Sessions learning objectives

 At the end of this session students will have a better understanding about major
classifications of risk.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about classifications of risk. (10 Minuet)
 Major classes of Risk.
 Bases for classifying Risk

Reading Text
CLASSIFICATION OF RISK

Risk can be classified in several ways according to the cause, their economic effect, or
some other dimensions. The following summarizes the different ways of classifying risks.

1. Financial Vs Non-financial risks

This way of classification is self explanatory. Financial risks result in losses that can be
expressed in financial terms. Non-financial risk does not have financial implication. For
example, loss of cars (property) is a financial risk, and deate of relatives is a non-
financial risk.

2. Static Vs Dynamic risks

Dynamic risks originate from changes in the over all economy which are associated with
such as human wants, improvements in technology and organization (price changes,
consumer taste changes, income distribution, political changes, etc.). They are less
predictable and hence beyond the control of risk managers some times.

Static risks, on the other hand, refer to those losses that can take place even though there
were no changes in the over all economy. They are losses arising from causes other than
changes in the overall economy. Unlike dynamic risks, they are predictable and could be
controlled to some extent by taking loss prevention measures.

3. Fundamental Vs Particular risks

Fundamental risks are essentially group risks; the conditions, which cause them, have no
relation to any particular individual. Most fundamental risks are economic, political or
social.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Particular risks are those due to particular and specific conditions, which obtain in
particular cases. They affect each individual separately. They are usually personal in
cause, almost always personal in their application. Because they are so largely personal in
their nature, the individual has certain degree of control over their causes.

Thus, fundamental risks affect the entire society or a large group of the population. They
are usually beyond the control of individuals. Therefore, the responsibility for controlling
these risks is left for the society it self. Examples include: unemployment, famine, flood,
inflation, war, etc. Particular risks are the responsibility of individuals. They can be
controlled by purchasing insurance policies and other risk handling tools. Examples
include: property losses, death, disability, etc

4. Objective Vs Subjective risks

Some authors classify risk in to objective and subjective. These two types of risk are also
mentioned as measurable and Non-measurable risk.

Objective risk has been defined as “the variation that exists in nature and is the same for
all persons facing the same situation”. it is the state of nature (world). However, each
individual’s estimate of the objective risk varies due to a number of factors. Thus, the
estimate of the objective risk which depends on the person’s psychological belief is the
subjective risk. The problem, however, is that it is difficult to obtain the true objective
risk in most business situation.

The characteristics of objective risk is that it is measurable. In other words, it can be

quantified using statistical or mathematical techniques.

5. Pure Vs Speculative risks

The distinction between pure and speculative risks rest primarily on profit/loss structure
of the underlying situation in which the event occurs. Pure risks refer to the situation in
which only a loss or no loss would occur. There are only two distinct outcomes: loss or
no loss. They are always undesirable and hence people take steps to avoid such risks.
Most pure risks are insurable. Pure risks are further classified in to three categories:
personal risk, property risk, and liability risk.

i. Property risk
This refers to losses associated with ownership of property such as destruction of
property by fire. Ownership of property puts a person or a firm to property exposure, i.e.
the property will be exposed to a wide range of perils.

ii. Personal risk

This refers to the possibility of loss to a person such as death, disability, loss of earning
power, etc. There are losses to a firm regarding its employees and their families. Personal
risks may arise due to accidents while off duty, industrial accident, occupational disease,
retirement, sickness, etc. Generally, financial losses caused by the death, poor health,
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

retirement, or unemployment of people are considered as personal losses. Either the

workers and their families or their employers may suffer such losses.

iii. Liability risk

The term liability is used in various ways in our present language. In general usage, the
term has become synonymous with “responsibility” and involves the concept of penalty
when a responsibility may not have been met. A person may be generally obligated to
another, because of moral or other reasons, to do or not to do something; the law,
however, does not recognize moral responsibility alone as legally enforceable. One
would be legally obliged to pay for the damage he/she inficted upon other persons or
their property.

Speculative risks, on the other hand, provide favorable or unfavorable consequences. The
situation is characterized by a possibility of either a loss or a gain. People are more
adverse to pure risks as compared to speculative risks. In speculative risk situation,
people may deliberately create the risk when they realize that the favorable outcome is so
promising. Speculative risks are generally uninsurable. For example, expansion of plant,
introduction of new product to the market, lottery, and gambling.

Both pure and speculative risks commonly exist at the same time. For instance, accidental
damage to a building (pure risk) and rise or fall in property values caused by general
economic conditions (speculative risk). Risk managers are concerned with most but not
all pure risks. For the detail refer unit 2.

Synopsis of Lecture (30 Minuet)

The Classification of Risk

Static risks, on the other hand, refer to those losses that can take place even though there
were no changes in the over all economy.
Fundamental risks are those, which arise from causes outside the control of any one
individual or even a group of individuals.
Particular risk: in comparison to fundamental risk ,particular risk are more personal in
their origins and the adverse effect of the risk felt with in the individual circle that
includes his/ her immediate families unlike a fundamental risk that affects a larger
segment of the populations.
Business Risk; this refers to risk associated with the physical, operation of a firm which
includes variation in the level of the firm sales, out put, cost and profit.
Financial risk; risk associated with debt financing, borrowing results a payment of
periodic interest charge and payment of a principal up on maturity. Examples include
bankruptcy, stock price decline and etc.
Interest rate risk; risk resulting from changes in the interest rate which affects the price
of financial securities like bonds.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Purchasing power risk; risk that arise out of an inflationary situation (a general rise of the
price of goods and services).

Synopsis of Lecture (30 Minuet)

The Classification of Risk

Financial: A financial risk is one where the outcome can be measured in monetary terms.
How ever in cases of non financial risk it difficult to express it on a monetary basis.
Pure risks involve two possible outcomes a loss or, at best, no loss.
The major types of pure risks that are associated with great financial and economic
insecurity include personal risks, property risks, and liability risks.
Personal risk is chiefly concerned with death and the time of its occurrence. And apart
from death, there is incapacity through accident, injury, illness or old age – loss of
earning power.
Property risk refers to losses associated with ownership of property such as a destruction
of property by fire, lightening, windstorm, flood and other force of nature. Loss of
property can be classified as;
Direct loss of property; the financial loss that arise out of physical damage, destruction or
theft of a property.
Indirect / Consequential loss; Financial loss that arise out of indirectly from a loss of a
property or income attached to it.
Liability risk is the possibility of loss arising from intentional or unintentional damage
made to other persons or to their property.

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What are some of the bases of classifying risk?
 State the difference between Financial and non financial risk?
Next Session Assignment

Students are expected to come prepared for the next class by reading further
about classifications of risk..

9
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Module - 3
Topic: Classifications of risk (Cont’d)
Sessions learning objectives
 At the end of this session students will have a better understanding about
major classifications of risk.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about classifications of risk. (10 Minuet)

 Risk related to business activities.

Reading Text
RISKS RELATED TO BUSINESS ACTIVITIES

Most risks in business environment are speculative in nature. The finance literature
considers five types of risks that business organizations face in the course of their normal
operation: business risk, financial risk, interest rate risk, purchasing power risk, and
market risk.

1. Business Risk: - This the risk associated with the physical operation of the firm.
Variations in the level of sales, costs, profits, are likely to occur due to a number of
factors inherent in the economic environment. Business risk is independent of the
company’s financial structure.

2. Financial Risk: - This is associated with debt financing. Borrowing results in the
payment of periodic interest charge and the payment of the principal upon maturity.
There is a risk of default by the company if operations are not profitable. Other financial
risks include: bankruptcy, stock price decline, insolvency, etc. Bond holders are less
exposed to financial risk than common stock holders because they have a priority claim
against the assets of an insolvent firm.

3. Interest Rate Risk: - This is a risk resulting from changes in interest rates. Changes in
interest rates affect the price of financial securities such as the price of bonds, stock,
etc---

4. Purchasing power Risk: - This risk arises under inflationary situations (general price
rise of goods and services) leading to a decline in the purchasing power of the asset held.
Financial assets lose purchasing power if increased inflationary tendencies prevail in the
economy.
5. Market Risk: - Market risk is related to stock market. It refers to stock price variability
caused by market forces. It is the result of investors reactions to real or psychological
expectations. The market in many cases, is also affected by such events like presidential
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

election, trade balances, wars, new inventories, etc. market risk is also called systematic
or non diversifiable risk. All investors are subject to this risk. It is the result of the
workings of the economy; and cannot be eliminated through portfolio diversification.

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 State the difference between Fundamental and particular risk?
 What are the risk related to business activities?

Next Session Assignment

Students are expected to come prepared for the next class by reading about
objectives of risk management.

Module - 4
Topic: Defining risk management and Objectives of risk
management.
Sessions Learning objectives
 At the end this session Students’ will have a better understanding about
risk management and its objectives.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about risk management. (10 Minuet)
 Defining Risk Management.
 Objectives of Risk Management.

Reading Text
DEFINITION OF RISK MANAGEMENT

Risk management is the identification, measurement, and treatment of property, liability,

and personnel pure-risk exposures. It involves the application of general management
concepts to a specialized area.

It requires the drawing up of plans, the organizing of material and individuals for the
undertaking, the maintaining of activity among personnel for the objectives involved, the

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

unifying and coordinating all the activities and efforts, and finally the controlling these
activities.

OBJECTIVES OF RISK MANAGEMENT

Risk management has several important objectives that can be classified into two
categories: pre-loss objectives and post-loss objectives.

Pre-loss objectives. A firm or organization has several risk management objectives prior
to the occurrence of a loss. The most important include economy, the reduction of
anxiety, and meeting externally imposed obligations.

The first goal means that the firm should prepare for potential losses in the most
economical way possible.
possible. This involves an analysis of safety program expenses,
insurance premiums, and the costs associated with the different techniques for handling
losses.
The second objective, the reduction of anxiety,
anxiety, is more complicated. Certain loss
exposures can cause greater worry and fear for the risk manager, key executives, and
stockholders than other exposures. For example, the threat of a catastrophic lawsuit from
a defective product can cause greater anxiety and concern than a possible small loss from
a minor fire. However, the risk manager wants to minimize the anxiety and fear
associated with all loss exposures.

The third objective is to meet any externally imposed obligations.

obligations. This means the firm
must meet certain obligations imposed on it by outsiders. For example, government
regulations may require a firm to install safety devices to protect workers from harm.
Similarly, a firm’s creditors may require that property pledged as collateral for a loan
must be insured. The risk manager must see that these externally imposed obligations are
met.

Post-loss objectives. The first and most important post-loss objective is survival of the
firm.
firm. Survival means that after a loss occurs, the firm can at least resume partial operation
within some reasonable time period if it chooses to do so.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

The second post-loss objective is to continue operating.

operating. For some firms, the ability to
operate after a severe loss is an extremely important objective. This is particularly true of
certain firms, such as public utility firm, which must continue to provide service. The
ability to operate is also important for firms that may lose customers to competitors if
they cannot operate after a loss occurs. This would include banks, bakeries, dairy farms,
and other competitive firms.

Stability of earnings is the third post-loss objective. The firm wants to maintain its
earnings per share after a loss occurs. This objective is closely related to the objective of
continued operations. Earning per share can be maintained if the firm continues to
operate. However, here may be substantial costs involved in achieving this goal ( such as
operating at another location), and perfect stability of earnings may not be attained.

The fourth post-loss objective is continued growth of the firm.

firm. A firm may grow by
developing new products and markets or by acquisitions and mergers. The risk manager
must consider the impact that a loss will have on the firm’s ability to grow.

Finally, the goal of social responsibility is to minimize the impact that a loss has on other
persons and on society.
society. A sever loss can adversely affect employees, customers,
suppliers, creditors, taxpayers, and the community in general. For example, a severe loss
that requires shutting down a plant in a small community for an extended period can lead
to depressed business conditions and substantial unemployment in the community.

Synopsis of Lecture. (30 Minuet)

Risk Management
Risk Management refers to the identification; measurement and treatment of exposure to
potential accidental losses almost always in situations where the only possible out comes
are losses or no change in the status.
Risk management has several important objectives that can be classified into two
categories: pre-loss objectives and post-loss objectives.
Pre-loss objectives. A firm or organization has several risk management objectives prior
to the occurrence of a loss. The most important include economy, the reduction of
anxiety, and meeting externally imposed obligations.
13
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Post-loss objectives. The first and most important post-loss objective is survival of the
firm. Survival means that after a loss occurs, the firm can at least resume partial operation
within some reasonable time period if it chooses to do so.
Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 How do you understand risk management?

 What are the Primary and secondary objectives of risk management.

Next Session Assignment

Students are expected to come prepared for the next class by reading about
the process of risk management.

Module - 5
Topic: THE Risk Management Process
Sessions learning objectives
 At the end of this session students’ will have a better understanding about the
process and steps in risk management.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the steps in risk management. (10 Minuet)

 Risk Identification

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Reading Text
RISK MANAGEMENT PROCESS

The process of Risk management includes the following five steps.

1. Risk identification
The loss exposures of the business or family must be identified. Risk identification is the
first and perhaps the most difficult function that the risk manager or administrator must
perform. Failure to identify all the exposures of the firm or family means that the risk
manager will have no opportunity to deal with these unknown exposures intelligently.

2. Risk Measurement: -
After risk identification, the next important step is the proper measurement of the losses
associated with these exposures. This measurement includes a determination of:
a) the probability or chance that the losses will occur
b) the impact the losses would have upon the financial affairs of the firm or family,
should they occur.
c) the ability to predict the losses that will actually occur during the budget period.

The measurement process is important because it indicates the exposures that are most
serious and consequently most in need of urgent attention. It also yields information
needed in risk treatment.

3. Tools of Risk Management

Once the exposures has been identified and measured the various tools of risk
management should be considered and a decision made with respect to the best
combination of tools to be used in attacking the problem. These tools include:
a) avoiding the risk
b) reducing the chance that the loss will occur or reducing its magnitude if it does
occur
c) transferring risk to some other party, and
d) retaining or bearing the risk internally

The third alternative includes, but not limited to the purchase of insurance. In selecting
the proper tool or combination of tools the risk manager must establish the cost and other
consequences of using each tool or combination of tools. He/she must also consider the
present financial condition /position/ of the firm or family, its over all policy with
reference to risk management and its specific objectives.

4. Implementation:
After deciding among the alternative tools of risk treatment the risk manager must
implement the decisions made. If insurance is to be purchased for example, establishing
proper coverage, obtaining reasonable rates, and selecting the insurer are part of the
implementation process.
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

5. Controlling/monitoring:
The results of the decisions made and implemented in the first four steps must be
monitored to evaluate the wisdom of those decisions and to determine whether changing
conditions suggest different solutions.

Synopsis of Lecture (30 Minuet)

THE Risk Management Process
The process involves five steps. These are:

i. Identifying loss exposures. The loss exposures of the business or family must be
identified. Risk identification is the first and perhaps the most difficult function that the
risk manager or administrator must perform. Failure to identify all the exposures of the
firm or family means that the risk manager will have no opportunity to deal with these
unknown exposures intelligently.

ii. Measuring the losses. After risk identification, the next important step is the proper
measurement of the losses associated with these exposures. This measurement includes a
determination of (a) the probability or chance that the losses will occur, (b) the impact the
losses would have upon the financial affairs of the firm or family, should they occur, and
(c) the ability to predict the losses that will actually occur during the budget period. The
measurement process is important because it indicates the exposures that are most serious
and consequently most in need of urgent attention.

iii. Selection of the risk management tools . Once the exposure has been identified and
measured, the various tools of risk management should be considered and a decision
made with respect to the best combination of tools to be used in attacking the problem.
These tools include primarily (a) avoiding the risk, (b) reducing the chance that the loss
will occur or reducing its magnitude if it does occur, (c) transferring the risk to some
other party, and (d) retaining or bearing the risk internally. The third alternative includes,
but is not limited to, the purchase of insurance. Selecting the proper tool or combination
of tools requires considering the present financial position of the firm or family, its
overall policy with reference to risk management, and its specific objectives.

16
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

iv. Implementing the decision made. After deciding among the alternative tools of risk
treatment, the risk manager must implement the decision made. If insurance is to be
purchased, for example, establishing proper coverage, obtaining reasonable rates, and
selecting the insurer are part of the implementation process.

v. Evaluating the result. The results of the decisions made and implemented in the
first four steps must be monitored to evaluate the wisdom of those decisions and to
determine whether changing conditions suggest different solutions.

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 Identify the major steps in risk management?

Weekly Assignment

Students are expected to come with a written repot on possible ways of

identifying loss exposures which includes personnel, property and liability loss
exposures. Not more than three pages.

17
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Module - 6
Topic: Risk identification and Sources of risk.
Sessions learning objectives
 At the end of this session students’ will have a better understanding about the steps in
risk management.
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about risk identification(10 Minuet)
 Risk Identification defined.
 Source of risk.
Reading Text
Risk Identification

Dear student, what idea do you have about risk identification? Please write down your
response in your own words in the space provided below.

Risk identification is the process by which an organization is able to learn areas in which
it is exposed to risk. Identification techniques are designed to develop information on
sources of risk, hazards, risk factors, perils, and exposures to loss. It seems quite logical
to inquire in to the sources of organizational risks at this particular moment. A discussion
of the sources is presented below.

Sources of Risk
Sources of risk are the sources of factors or hazards that may contribute to positive or
negative outcomes. Sources of risk can be classified in several ways. For instance, the
following sources of risk represent one listing:

i. Physical Environment. Clearly, the physical environment is a fundamental source of

risk. Earthquakes, drought, or excessive rainfall can all lead to loss. The ability to fully
understand our environment and the effects we have on it - as well as those it has on us -
is a central aspect of this source of risk. The physical environment
environment may be the source of
opportunity as well, for example, real estate as an investment, agribusiness, and weather
as a contributing factor to tourism.

18
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

ii. Social Environment. Changing traditions and values, human behavior, social struc-
struc-
tures, and institutions are a second source of risk.
iii. Political Environment. Within a single country, the political environment can be
an important source of risk. A new party can move the nation into a policy di rection that
might have dramatic effects on particular organizations (new stringent regulations on
toxic waste disposal). In the international
international realm, the political environment is even more
complex. Not all nations are democratic in their form of government, and some have very
undemocratic attitudes
attitudes and policies toward business. Foreign assets might be confiscated
by a host government or tax policies might change dramatically. The political
environment also can promote positive opportunities through fiscal and monetary policy,
enforcement
enforcement of laws, and the education of the population.
iv. Legal Environment. the expected laws and directives may be issued by the
government which may render risky environment to the businesses operating in the
country. In the international domain, complexity increases because
because legal standards can
vary dramatically from country to country. The legal environment also produces positive
outcomes in the sense that rights are protected and that the legal system provides a
stabilizing influence on society.
v. Operational Environment.
Environment. Processes and procedures of an organization generate
risk and uncertainty. A formal procedure for promoting, hiring, or firing employees may
generate a legal liability. The manufacturing process may put employees at risk of
physical harm. Activities of an organization may result in harm to the environment.
International businesses may suffer from risk or uncertainty due to unreliable
transportation systems. The operational environment also provides gains, as it is the
ultimate source of the goods and services by which an organization succeeds or fails.
vi. Economic Environment. Although the economic environment often flows directly
from the political realm, the dramatic expansion of the global marketplace has created an
environment that is greater than any single government. Although a particular
government’s actions may affect international capital markets, control of capital markets
is beyond the reach of a single nation. Inflation, recession, and depression are now

19
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

elements of interdependent economic systems. On a local level, interest rates and credit
policies can impose significant risk on an organization.
vii. Cognitive Environment. A risk manager’s ability to understand, see, measure, and
assess is far from perfect. An important source of risk for organizations is the difference
between the perception of the risk manager and reality. The cognitive environment is a
challenging source of risk to identify and analyze. The analyst must contemplate such
questions as “How do we understand the effect of uncertainty on the organization? and
“How do we know whether a perceived risk is real?” An evaluation of the cognitive
environment partly addresses the distinction between risk and uncertainty.

Synopsis of Lecture

RISK IDENTIFICATION
Risk identification is the process by which an organization is able to learn areas in which
it is exposed to risk. Identification techniques are designed to develop information on
sources of risk, hazards, risk factors, perils, and exposures to loss.
Sources of risk are the sources of factors or hazards that may contribute to positive or
negative outcomes. Sources of risk can be classified in several ways. For instance, the
following sources of risk represent one listing:
Physical Environment Clearly, the physical environment is a fundamental source of risk.
Earthquakes, drought, or excessive rainfall can all lead to loss.
Social Environment. Changing traditions and values, human behavior, social structures,
and institutions are a second source of risk.
Political Environment Within a single country, the political environment can be an
important source of risk. A new party can move the nation into a policy direction that
might have dramatic effects on particular organizations (new stringent regulations on
toxic waste disposal).
Legal Environment The expected laws and directives may be issued by the government
which may render risky environment to the businesses operating in the country. In the
international domain, complexity increases because legal standards can vary dramatically
from country to country.
Operational Environment Processes and procedures of an organization generate risk and
uncertainty. A formal procedure for promoting, hiring, or firing employees may generate
a legal liability.
Economic Environment Although the economic environment often flows directly from
the political realm, the dramatic expansion of the global marketplace has created an
environment that is greater than any single government.
20
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What is risk Identification?
 What are the possible sources of risk?

Next Session Assignment

Students are expected to come prepared for the next class by reading about
The Ranges of Risk Identification Techniques

Module - 7
Topic: Ranges of Risk Identification Techniques

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the various
techniques of risk identifications.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about risk identification techniques. (10 Minuet)
 Techniques of risk identifications
Reading Text
The Range of Risk Identification Techniques
How is risk to be identified? Where would you begin to start the task of identifying risk
in a major factory complex, a shopping center, an airport, a department store chain, a
bank? Do you expect that you would arrive at the premises, assuming always that the
actual premises existed and that we were not concerned with risks at the planning stage,
with a clipboard to begin the task? The world of industry and commerce is far too
complex and sophisticated to allow for proper risk identification
identification simply by a ‘walk round
the premises’.

21
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Specific techniques will have to be employed to aid your identification of risk. However,
no one method for risk identification will be appropriate for all forms of risk, or even for
similar forms of risk in different situations. There is a range of techniques
techniques available and
these techniques can be classified
classified in a number of ways.

 Some are best used on site, while others are ‘desk based’ methods not requiring site
visits.
 Some will be more appropriate to the development
development stages of a project, while others
are best used once the project has been commissioned and is up and running.
 There are qualitative techniques which make little or no use of statistical
measurement and others which are highly quantitative in their approach.
approach.
 Certain techniques are very general in their approach
approach to risk, while others are
extremely detailed,
detailed, even microscopic, in their approach.
 There are techniques, which are very appropriate
appropriate for post-loss situations, while others
are primarily
primarily for use prior to any loss having taken place.

These divisions highlight the variety of techniques, which are available, but in themselves
the divisions
divisions have no practical value. What they do underline
underline is the fact that there are
different ways in which risk can be identified and that techniques do exist to match
particular needs. As we work our way through the techniques, we will suggest the
advantages and disadvantages of each one and where each one could be used.

Organizational Charts
We start the list of risk identification techniques with organizational charts.
charts. These are
intended to highlight broad areas of risk rather than specific, individual risks such as fire,
security or liability. The organizational chart encourages the risk identifier
identifier to take a birds-
eye view of the organization: to stand back and above the day-to-day operation and take
stock of the risks which exist. This term ‘risk
‘risk identifier’ does need some explanation. In
many organizations there will be a risk or insurance
insurance manager employed whose job, in
part, will be the identification of risk. Where no risk manager
manager exists, it may be that the
insurance company performs the risk identification function. In other cases, an insurance
22
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

broker or consultant may take on the role of identifying risk. The term risk identifier
identifier is
intended to refer to anyone who has the task of identifying risk.

Physical Inspections
The organizational chart took a very broad view of the risks to which an organization
could exposed.
exposed. The physical inspection of premises, plant or processes takes a different
approach. Everyone understands what is meant by physical inspection, it is possibly the
most common and best understood
understood of all the techniques available.

The inspection of plant, processes or premises can be a time-consuming job, and the
nature of so many industrial sites is that they are complex. Prior to the actual visit, it is
necessary to do some preparation work so that time is not wasted during the visit itself.
This preparatory work would include finding out exactly what processes were carried out
at the premises, the nature of the service or product manufactured, the nature of the
machinery, the physical layout of the premises and the details from the last physical
inspection if there has been one. All of this information will help and may cut down the
time you have to spend on ascertaining
ascertaining basic information during the visit. The visit
should be kept for the identification of risk, not the finding of information, which was
available before the visit.
Checklists
Checklists deal with the particular problem of the time-consuming nature of physical
inspections. The basic idea of the checklist is that a pro-forrna is sent to the site for
completion by someone there. This dispenses with the need for a physical inspection
inspection and
hence cuts the time and cost of identification.
identification.

The checklist acts as the source of information about risk. It really takes the place of the
personal visit and so it has to be drawn up very carefully. It is wise, when constructing a
checklist for the first time, to consult as widely as possible in order to ensure that all
aspects of risks are taken into account. In particular, the following points are worth
keeping in mind:

23
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

 The checklist should be simple to understand

 The checklist should be free from ambiguity.
 The checklist should be short
 The checklist should not be threatening
Flow charts
We move now to a far more detailed form of risk identification than either the
organizational chart or the checklist, and one which is more specific in its identification
than the physical inspection.

In many organizations there is some kind of flow. This could take the form of:
 Production flow,
flow, where raw materials come in at one end of a process and a finished
product emerges at the other end. There was an identifiable
identifiable flow through the system.
 Service flow, where there may not be raw materials
materials but the business may depend on
flow of another form. It could be the flow of people, as in the case of a restaurant or
hotel.
 Money flow, as in the case of a bank or an insurance company. Money comes in at
one end and various promises are made, the effects of which are seen at some later date.
The Financial Statement Method
The financial statement method was proposed
proposed by A.H. Criddle (1962). Although this
approach was intended for private organizations,
organizations, the concepts of the financial statement
approach can be generalized in public sector organizations as well. By analyzing the
balance sheet, operating statements, and supporting documents, Criddle maintains, the
risk manager can identify property, liability, and human asset exposures of the
organization. By coupling
coupling these statements with financial forecasts and budgets, the risk
manager can discover future exposures. Financial statements reveal this information
because every organizational transaction ultimately involves either money or property.

24
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Synopsis of Lecture (30 Minuet)

Ranges of Risk Identification Techniques

Organizational Chart; it encourages the risk identifier to have a birds eye view of the
organizations, to stand back and above the day to day operations and take stock of risk
which exists.
Physical Inspections; the inspections of organizations premises, plants, or process takes a
different approach.
Check List Method; deals with particular problems of time consuming nature of physical
inspection. The basic idea of check list is that pro forma is sent to site for a completion by
some one out their.
Flow Chart; this method is far more specific than a physical inspection. A due
consideration will be given to each work flows and process such as production flow,
Service flow and etc…
Financial Statement Method; under this method each account is studied to determine
what potential risks it creates and the result of the study are reported under the account
titles.

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 List down some of risk identification techniques?
Next Session Assignment
Students are expected to come prepared for the next class by refreshing their
memories about their previous concepts of probability.

25
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Module - 8
Topic: Risk Measurement.
Sessions Learning objectives
 At the end of this session students’ will have a better understanding about the various
techniques of risk Measurements.
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about risk Measurements. (10 Minuet)
 Defining Risk measurement
Reading Text
RISK MEASUREMENT

After the risk manager has identified the various types of potential losses faced by his or
her firm, these exposures must be measured in order to determine their relative
importance and to obtain information that will help the risk manager to decide upon most
desirable combination of risk management tools.
Dimensions to be Measured

Information is needed concerning two dimensions of each exposure

1. The loss frequency or the number of losses that will occur and
2. The loss severity

Both loss frequency and loss severity data are needed to evaluate the relative importance
of an exposure to potential loss. However, the importance of an exposure depends mostly
upon the potential loss severity not the potential frequency. A potential loss with
catastrophic possibilities although infrequent, is far more serious than one expected to
produce frequent small losses and no large losses. On the other hand loss frequency
cannot be ignored.

If two exposures are characterized by the same loss severity, the exposure whose
frequency is greater should be ranked more important. There is no formula for ranking
the losses in order of importance, and different persons may develop different rankings.
The rational approach, however, is to place more emphasis on loss severity.

Loss-frequency Measures
One measure of loss frequency is the probability that a single unit will suffer one type of
loss from a single peril. Instead of estimating the probability that a single unit suffer one
type of loss from a single peril during the coming year, the risk manager can, in the same
way estimate the probability that the unit will suffer that type of loss from many perils.
This probability will be higher because of the additional possible causes of loss.

26
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Loss-severity Measures
Two measures commonly used to measure loss severity are:
1. the maximum possible loss, and
2. the maximum probable loss

The maximum possible loss is the worst loss that could possibly happen and the
maximum probable loss is the worst loss that is likely to happen. The maximum possible
loss, therefore, is usually greater than the maximum probable loss. Of these two
measures, the maximum probable loss is the most difficult to estimate but also the most
useful.

In estimating the maximum possible loss and the maximum possible loss and the
maximum probable loss the risk manager, ideally, would consider all types of losses that
might result from a given peril.

In determining loss severity the risk manager must be careful to include all the types of
losses that might occur as a result of a given event as well as their ultimate financial
impact upon the firm: direct, indirect and net income losses.

The potential direct property losses are rather generally appreciated in advance of any
loss, but potential indirect and net income losses that may result from the same event are
commonly ignored until the loss occurs. This same event may also cause liability and
personnel losses.

Synopsis of Lecture (30 Minuet)

RISK MEASUREMENT
Once the risk manager has identified the risks that the firm is facing, his next step would
be the evaluation and measurement of the risks. Risk measurement refers to the
measurement of the potential loss as to its size and the probability of occurrence.
Poisson distribution

The Poisson probability distribution can be used for the analysis. The only information

that is crucial in constructing a Poisson probability distribution is the expected number of

accidents (the mean). Once the mean is determined the probability of any number of

accidents will be easily calculated using the following formula:

27
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

p (r) = M r e –M

r!

Where e = 2.71828

r = number of occurrences

M = Expected number of Accidents = (pn)

STD = Standard Deviation = SQRT (M)

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What is Poisson probability distribution?
 What are the underlying assumptions of Poisson distribution?

Next Day Assignment;

Students are expected to come prepared for the next class by working on the
class exercises.

28
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Module - 9
Topic: Poisson Probability Distribution(Cont’d)

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
applications of Poisson probability distribution in measuring risk.
Discussion issues; based on the previous session class demonstrations the discussions
will goes on. (10 Minuet)
 Application of Poisson probability distribution.
Reading Text
Risk Measurement Methods
There are various methods used to measure the different aspects of a risk. Some of these methods are:

1. Poisson distribution method

2. Binomial distribution method, and
3. Normal distribution method

1. Poisson Distribution
The Poisson probability distribution can be used for the analysis of risk measurement.
The Poisson distribution works well when:

i) there are at least 50 units exposed independently to loss, and

ii) the probability that any particular unit will suffer a loss is the same for all units less
than 0.1 (1/10).

These conditions can be satisfied in two ways. First, the business can have at least 50
persons, properties, or activities each of which can suffer at most one occurrence per
year, and the probability being less than 0.1 (1/10) that any particular unit will have an
occurrence. Second, the number of persons, properties, or activities may be less than 50,
but each unit can have more than one occurrence during the exposure period.

The only information that is crucial in constructing a Poisson probability distribution is

the expected number of accidents (the main). Once the mean is determined, the

29
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

probability of any number of accidents will be easily calculated using the following
formula:

P(r) =

Where: M = Expected number of accidents

r = number of occurrences
e = 2.71828

To illustrate the application of this formula, assume that there are 5 cars and each has
experiencing about one collision every two years. The mean therefore is ½ or 0.5
collision per year. Then the probability distribution is developed as follows.

P(0) = = 0.6065

P(1) = = 0.3033

P(2) = = 0.0758

P(3) = = 0.0126

We continue like above until we found that the sum of probability of all accidents equal
to 1. Thus the probability distribution is:

No of Collisions Probability
0 0.6065
1 0.3033
2 0.0785
3 0.0126

Once the probability distribution is developed, it would not be difficult to determine the
probability of any number of accidents that are likely to occur. For example, the
probability of no collisions is almost 0.61 or 61%; the probability of more than three

30
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

collisions is 1- 0.9982 (0.6065 + 0.3033 + 0.758 + 0.0126) = 0.0018; and the probability
of more than one collision is 1 – (0.6065 + 0.3033) = 0.0902 or 9.02%.

Synopsis of Lecture (30 Minuet)

RISK RELATED TO MEAN & RISK RELATED TO THE NUMBER OF EXPOSUER

UNITS

Risk Related to Mean (Coefficient of Variation) RM

Rm= SD of Loss/ Expected Loss

OR
Rm= SD of accidents/ Expected number of accidents.

Rm indicates the variability of the total monetary loss form the expected value (the
mean). The higher the coefficient of variation the higher the risk, meaning the variability
increases.
Risk Related to the Number of exposures unit.

RN= SD of accidents/ number of exposures unit.

RN indicates the deviation from the expected out comes as a percentage of the total
number of exposure units.

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What does Rm ( Risk related to mean) indicates?
 What does RN ( Risk related to number of exposure units) indicates?
Next Session Assignment
Students are expected to come prepared for the next class by reading about
Binomial Probability Distribution

31
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Module - 10
Topic: Binomial Probability Distribution.

Sessions Learning objectives

At the end of this session students’ will have a better understanding about the
applications of Binomial probability distribution in measuring risk

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about Binomial probability distribution. (10 Minuet)

 Application of Binomial probability.

Reading Text
2. Binomial Distribution
Another method used by the risk manager to measure risk is binomial probability
distribution. To use the binomial distribution the risk manager must be familiar with the
basic assumption of the distribution.

The first assumption is that the objects are independently exposed to loss. The other
assumption is that each exposed unit suffered (experience) only one loss in a year (or
other budget period). Thus the probability that the firm will suffer r occurrences during
the year is calculated using the formula:

P(r) = pr(1 – p)n-r

Where: n = number of exposures

r = number of accidents (occurrences)
p = probability of occurrence

To illustrate, assume that there are 5 trucks which are operated by a business and if an
accident happens to a particular truck, it becomes a total loss. New trucks are purchased
at the beginning of every year to make up the lost ones so that the firm always starts the
new physical period with 5 trucks.

First it is assumed that monetary loss per accident is constant and it is Birr 5000.

32
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Year No of trucks No of accidents

Total monetary
loss
1 5 2 Br 10,000
2 5 2 10,000
3 5 3 15,000
4 5 2 10,000
5 5 1 5,000
Sum 25 10 50,000
Mean 5 2 10,000
Thus, the average monetary loss per accident = = 5,000, and the probability of an
accident can be estimated as P = 2/5 = 0.4

With this information as a point of departure it would be possible to construct a binomial

probability distribution for the following variables of interest:
1. number of accidents, and
2. total monetary losses

Given: n = 5 p = 0.4 q = 0.6 (1 – p)

Using the formula [p(r) = pr q(n – r)]the following probability distribution can be

constructed.

No of Monetary loss Probability Expected no of Expected

accidents accidents monetary loss
0 0 0.07776 0 Birr 0
1 5,000 0.25920 0.2592 1296
2 10,000 0.34560 0.6912 3456
3 15,000 0.23040 0.6912 3456
4 20,000 0.07680 0.3072 1536

33
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

5 25,000 0.01024 0.0512 256

Sum 1.00 2.00 10,000

Then from the above probability distribution we can determine the following:
1. the expected number of accidents or the average accidents to occur is 2.
2. the expected total monetary loss is Birr 10,000.

In addition, we can determine various aspects of the risk. For example, the probability
that the firm will face some accident is 0.92224 = 1 – 0.7776. This probability is so high
that implies the risk manager should take appropriate measures to handle the risk. The
probability that the firm will face some monetary loss is also 0.92224. And the
probability that monetary loss equals or exceeds Birr 10,000 is 0.66304 = (1 – (0.07776 +
0.25920).

Synopsis of Lecture. (30 Minuet)

Binomial Probability Distribution

The Risk Manager may also use the Binomial probability distribution to measure risk. To
use the Binomial distribution the Risk Manager must be familiar with the basic
assumptions of the distribution to avoid misleading results. The first assumption is that
the objects are independently exposed to loss. The other assumption is that each exposed
unit suffers only one loss in a year
P (r) = n!(Pr . q (n-r) )
[n – r]!
Where:p is the probability of accident
q is 1 –p
n is the number of items exposed to risk

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What are the underlying assumption of Binomial distribution?
34
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Weekly Assignment;
N.B The assignment is to be submitted on the next session.
Given the following Binomial Probability distribution calculate the following.

Number of Accidents Monetary Loss Probability.

0 Br. 0 0.60
1 5000 0.25
2 10,000 ?
3 15,000 0.10
4 20,000 0.03
Based on the above information determine,
A. The average number of accidents
B. The expected monetary loss per year.
C. The maximum possible loss
D. The probability that the firm will suffer some birr loss.

Module - 11
Topic: Binomial Probability Distribution (Cont’d)

Sessions Learning objectives

At the end of this session students’ will have a better understanding about the
applications of Binomial Distribution in measuring risk
Discussion issues; Students are encouraged to participate in the class based on the
class exercise given on the in the class. (10 Minuet)

 Applications of Binomial probability distribution.

Reading Text
Formula for the Mean and Standard Deviation (SD)

FOR POISSON DISTRIBUTION

Mean (M) = np
SD =
Where: n = number of exposure units
p = probability

35
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

FOR BINOMIAL DISTRIBUTION

Mean (M) = np
SD =
Where: n = number of exposure units
p = probability
q=1-p

Risk Measures
1. Risk relative to the mean (coefficient of variation). It indicates that the variability of
the total annual monetary losses from the expected value (the mean). It is calculated by
dividing standard deviation with mean. RM = SD
/M. The higher the coefficient of
variation (RM), the higher the risk, meaning variability increases.
2. Risk relative to the number of exposure units (Rn). It indicates the deviation from the
expected outcome as a percentage of the total number of exposure units. It is also
calculated by dividing standard deviation with number of exposure units
Rn = SD
/n. The higher the value, the higher the variability, and consequently, the higher
the risk.

Synopsis of Lecture. (30 Minuet)

FORMULA FOR MEAN AND SD OF A BINOMIAL DISTRIBUTION

The mean and the standard deviation of a binomial probability distribution can also be
determined using the following formula;
Mean = M = np
SD = SD = SQRT(npq)

Accordingly,

M = 5*0.4 =2
SD = SQRT(5*0.4*0 .6) = 1.095

36
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

RISK MEASURES

Risk Relative to Mean, (coefficient of variation)

RM = 1.095/2 = .5475

Risk relative to the number of exposure units

RN = 1.095/5 = 0.219
Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Wrap-Up Discussion Questions (10 Minuet)
 What does Rm indicates in binomial Prob distribution?
 What does RN indicates in binomial Prob distribution?

Next Session Assignment

Students are expected to come prepared for the next class by reading about
Normal Probability Distribution

Module - 12
Topic: Normal Distribution.

Sessions Learning objectives

At the end of this session students’ will have a better understanding about the
applications of Normal Distribution in measuring risk

Discussion issues; Students are encouraged to participate in the class based on the
weekly assignment given on the last session. (10 Minuet)

 Application of Normal distribution.

Reading Text
3. Normal Distribution
The risk manager may also use a normal distribution method to measure risks. The
assumption here is the number of accidents or total annual monetary losses are
approximately normally distributed. The normal distribution can be well explained by
identifying only two parameters: the mean and the standard deviation.

37
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

The normal distribution has the following assumptions:

1. 68.27% of the observations fall within the range of one standard deviation of the
mean (1).
2. 95.45% of the observations fall within the range of two standard deviation of the
mean (2).
3. 99.73% of the observations fall within the range of three standard deviations of
the mean (3).

Risk and Law of Large Number

Law of large number states that as the number of exposure units increases, risk decreases.
That means risk and number of exposure units are inversely related but not proportional.

Synopsis of Lecture (30 Minuet)

Normal Distribution
The risk Manager may assume that the numbers of accidents or total annual monetary
losses are approximately normally distributed. Under such circumstances, he may use the
Normal distribution in measuring the number of accidents or the total annual monetary
losses. The Normal distribution has the following properties:
68.27% of the observations fall within the range of one standard deviation of the mean.
95.45 % of the observations fall within the range of two standard deviation of the mean.
99.73% of the observations fall within the range of three standard deviations of the mean.
Formula
Rm = Z [np(1-p)]1/2 ,
Z = confidence level in number of standard deviations.
np

Rm = Z (np(l-p))1/2

r 2 m n2p2 = Z2 np(l-p)
n = Z2p(l-p)
r 2 m p2
n = Z2 (1-p)
r2m p

38
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What are the underlying assumptions of Normal Prob distribution?

Next Session Assignment

Students are expected to come prepared for the next class by reading about
Risk Handling Tools

Module - 13
Topic: Risk Handling Tools

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about
the various tools of risk control techniques.
Discussion issues; Students are encouraged to participate in the class based on their
previous readings risk handling tools. (10 Minuet)

 Various techniques of risk handling.

Reading Text
Risk Control Tools

Avoidance
One way to control a particular pure risk is to avoid the property, person, or activity with
which the exposure is associated by (1) refusing to assume it even momentarily or (2) an
exposure assumed earlier, most examples of risk avoidance fall in the risk category. To
illustrate a firm can avoid a flood loss by not building a plant in a flood plain. An existing
loss exposure may also be abandoned. For example, a firm that produces a highly toxic
product may stop manufacturing that product. Similarly, an individual can avoid third
party liability by not owning a car. Product liability can be avoided by dropping the
product. Leasing avoids the risk originating from property ownership.

39
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

The major advantage of avoidance is that the chance of loss is reduced to zero if the loss
exposure is not acquired. In addition, if an existing loss exposure is abandoned, the
possibility of loss is either eliminated or reduced because the activity or product that
could produce a loss has been abandoned.

Avoidance, however, has two disadvantages. First, it may not be possible to avoid all
losses. For example, a company cannot avoid the premature death of a key executive.
Similarly, a business has to own vehicles, building, machinery, inventory, etc… Without
them operations would become impossible. Under such circumstances avoidance is
impossible. In fact there are circumstances where avoidance is a viable alternative. For
example, it may be better to avoid the construction of a company near river bank,
volcano-prone areas, valleys, etc. because the risk is so great.

The second disadvantage of avoidance is that it may not be practical or feasible to avoid
the exposure. For example, a paint factory can avoid losses arising from the production of
paint. However, without any paint production, the firm will not be in business.

Loss Prevention and Reduction Measures

These measures refer to the safety actions taken by the firm to prevent the occurrence of a
loss or reduce its severity if the loss has already occurred. Prevention measures, in some
cases, eliminate the loss totally although their major effect is to reduce the probability of
loss substantially. Loss reduction measures try to minimize the severity of the loss once
the peril happened. For example, auto accidents can be prevented or reduced by having
good roads, better lights and sound traffic regulation and control, fast first-aid service and
control, fast first-aid service and the like. Loss prevention and Retention measures must
be considered before the Risk manager considers the application of any risk financing
measures.

Following are some examples of loss prevention and reduction plans.

40
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Loss Prevention Measures:

 Research on fire protection equipment and appliances.

 Construction using fire insensitive materials.
 Automatic smoke detectors, fire alarms.

 Burglar alarms in costly business situation, jewelry, diamonds.

 Locational choice, avoiding construction near petrol stations, chemical reservoirs,

waste disposal areas, etc.

 Tight quality control to prevent risk of product liability.

 Educational programs to the public using available media.

 Multiple suppliers, buffer stocks.

 Safety measures, adequate lighting, ventilation, special work clothes to prevent

industrial accidents.

 Regular inspection of machinery to prevent explosions, breakdowns, etc..

 Accounting controls (Internal Control).

 Electronic metal detectors to check passengers for arms and explosives in the
airline business.

 Automatic gates at crossing lines to prevent collisions train and motor vehicles.

 Warning posters (NO SMOKING!! DANGER ZONE!!)

Loss Reduction Measures:

 Installing automatic sprinklers.

 First aid kit

 Evacuation of people, CHERNOBYL

 Immediate clean-up operations, EXXON – VALDEZ, Alaska oil spill

 Fire extinguishers, guards.

41
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Synopsis of Lecture (30 Minuet)

Risk Control Tools

Avoidance
One way to control a particular pure risk is to avoid the property, person, or activity with
which the exposure is associated by
(1) Refusing to assume it even momentarily or
(2) An exposure assumed earlier, most examples of risk avoidance fall in the risk
category.
Avoiding a risk is not always the best option, cause when someone tries to avoid a risk he
/ she might create another risk.
Loss Prevention
These measures refer to the safety actions taken by the firm to prevent the occurrence of a
loss or reduce its severity if the loss has already occurred. Prevention measures, in some
cases, eliminate the loss totally although their major effect is to reduce the probability of
loss substantially.
Research on fire protection equipments.
Automatic smoke detector.
Burglary Alarm.
Educational program to the public.
Loss reduction
Loss reduction measures try to minimize the severity of the loss once the peril happened.
Installing automatic sprinkler.
First aid kit.
Evacuation of people.
Fire extinguishers. etc

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What are risk handling tools?
 What are some of the risk handling tools?

42
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Next Session Assignment

Students are expected to come prepared for the next class by reading further
about risk handling tools.

Module - 14
Topic: Risk Handling Tools (Cont’d)

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about
the various tools of risk control techniques.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings risk handling tools. (10 Minuet)

 Applications of risk handling tools

Reading Text
iii. Separation
Separation of the firm’s exposures to loss instead of concentrating them at one location
where they might all be involved in the same loss is the third risk control tool. For
example, instead of placing its entire inventory in one warehouse the firm may elect to
separate this exposure by placing equal parts of the inventory in ten widely separated
warehouse. To the extent that this separation of exposures reduces the maximum
probable loss to one event, it may be regarded as a form of loss reduction. Emphasis is
placed here, however, on the fact that through this separation the firm increases the
number of independent exposure units under its control. Other things being equal,
because of the law of large number, this increase reduces the risk, thus improving the
firm’s ability to predict what its loss experience will be.

iv. Combination/Diversification
Combination is a basic principle of insurance that follows the low of large numbers.
Combination increases the number of exposure units since it is a pooling process. It
reduces risk by making loses more predictable with a higher degree of accuracy. The

43
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

difference is that unlike separation, which spreads a specified number of exposure units,
combination increases the number of exposure units under the control of the firm.

In the case of firms, combination results in the pooling of resources of two or more firms.
One way a firm can combine risks is to expand through internal growth. For example, a
taxi-cab company may increase its fleet of automobiles. Combination also occurs when
two firms merge or one acquires another. The new firm has more buildings, more
automobiles, and more employees than either of the original companies. This leads to
financial strength, thereby minimizing the adverse effect of the potential loss. For
example, a merger in the same or different lines of business increases the available
resources to meet the probable loss.

Diversification is another risk handling tool, most speculative risk in business can be
dealt with diversification. Businesses diversify their product lines so that a decline in
profit of one product could be compensated by profits form others. For example farmers
diversify their products by growing different crops on their land. Diversification
however, has limited use in dealing with pure losses.

Synopsis of Lecture. (30 Minuet)

Risk Handling Tools

Separation
Separation of the firm’s exposures to loss instead of concentrating them at one location
where they might all be involved in the same loss is the third risk control tool. For
example, instead of placing its entire inventory in one warehouse the firm may elect to
separate this exposure by placing equal parts of the inventory in ten widely separated
warehouse

Combination/Diversification
Combination is a basic principle of insurance that follows the low of large numbers.
Combination increases the number of exposure units since it is a pooling process. It
reduces risk by making loses more predictable with a higher degree of accuracy.

44
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What is the similarity and difference between Separation and combination
as risk handling tools?

Next Session Assignment

Students are expected to come prepared for the next class by reading further
about risk Financing tools.

Module – 15
Topic: Risk Financing Tools

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about
the various tools of risk control techniques.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings risk handling tools. (10 Minuet)

 Risk financing defined and its applications.

Reading Text
Risk Financing Tools

i. Retention
Retention means that the firm retains part or all of the losses that result from a given loss
exposure. Retention can be effectively used in a risk management program when certain
conditions exist. First, no other method of treatment is available. Insurers may be
unwilling to write a certain type of coverage, or the coverage may be too expensive.
Noninsurance transfers may not be available. Loss control can reduce the frequency of
loss, but not all losses can be eliminated. In these cases, retention is a residual method. If
the exposure cannot be insured or transferred, then it must be retained.

45
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Second, the worst possible loss is not serious. For example, physical damage losses to
automobiles in a large firm's fleet will not bankrupt the firm if the automobiles are
separated by wide distances and are not likely to be simultaneously damaged.

Finally, losses are highly predictable. Retention can be effectively used for workers'
compensation claims, physical damage losses to automobiles, and shoplifting losses.
Based on past experience, the risk manager can estimate a probable range of frequency
and severity of actual losses. If most losses fall within that range, they can be budgeted
out of the firm's income.

ii. Insurance

Commercial insurance can also be used in a risk management program. Insurance can be

advantageously used for the treatment of loss exposures that have a low probability of

loss but the severity of a potential loss is high.

If the risk manager decides to use insurance to treat certain loss exposures, five key areas
must be emphasized.

- Selection of insurance coverage’s

- Selection of an insurer

- Negotiation of terms

- Dissemination of information concerning insurance

coverage

- Periodic review of the insurance programs

46
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Synopsis of Lecture. (30 Minuet)

Risk Financing Tools

Retention means that the firm retains part or all of the losses that result from a given loss
exposure. Retention can be effectively used in a risk management program when certain
conditions exist. First, no other method of treatment is available. Insurers may be
unwilling to write a certain type of coverage, or the coverage may be too expensive. Non
insurance transfers may not be available.

Passive Retention; the firm or the person has no clue about the loss happenings and he or
she is ignorantly living with the risk with no preparation.

Active Retention; the retention is said to be active when the firm has a prior knowledge
as to the occurrence of the loss and has the necessary preparedness to handle the risk.
Normally retention can be favored when the cost of handling the risk is less than that of
insurances premium and the firm might have adopted a loss control and prevention tools
in place. On the other a firm might prefer insurance than retention this is may be for the
following reasons; the cost of handling the risk is much cheaper with insurance than a
self insurance mechanism or the firm might have a negative attitude towards a risk and
prefers to transfer it.

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What is risk financing and how did it apply in the management of risk?
Next Session Assignment
Students are expected to come prepared for the next class by reading about
Risk management tools a Quantitative Approach.

Module - 16
Topic- Expected Utility Model

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about
the application of Utility model approach.

47
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the Utility model. (10 Minuet)

 The application of Utility model

Reading Text
Expected Utility Model
The expected utility model places emphasis on the risk manager’s attitude towards risk.
This means that the model takes into account differences in risk attitude of risk managers.
Risk managers are likely to assign varying utility points to a given monetary loss. As a
result their decisions as to which of the risk management tools to select for a particular
situation is likely to differ. Under this model, therefore, the risk manager is making a
decision on the basis of expected loss of utility.

The objective of this model is to select the technique that will minimize the expected loss
in utility. The expected utility models places emphasis on the risk manager’s attitude
towards risk as well as the changes in his/her satisfaction with certain increases or
decreases in wealth.
A person’s attitude towards risk is in fact the major determinant of the shape of his/her
utility function.
There are three different attitudes of risk by individual.
Risk averter: is a person who is willing to pay more than the expected monetary loss to
avoid the risk. This is an individual who doesn’t want to take risk at all. He wants to
transfer the risk to another person by paying more than the expected loss.
Risk neutral: Persons would be willing to pay the expected monetary loss to eliminate
the uncertainty, but no more. This person transfers the risk to somebody else by paying
the amount equal to the expected amount of loss, but not more.
Risk seeker: is a person who would prefer to retain the uncertainty unless the transfer
cost is less than the expected monetary value. He transfers risk only by paying the
amount less than the expected monetary loss.
Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

48
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Wrap-Up Discussion Questions (10 Minuet)

 What is a utility model ?
 What are the assumptions?

Next Session Assignment

Students are expected to come prepared for the next class by reading Further
about risk Expected utility model.

Module - 17
Topic- Expected Utility Model (Cont’d)
Sessions Learning objectives
 At the end of this session students’ will have a better understanding about
the application of Utility model approach.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the Utility model. (10 Minuet)

 Application of utility model

Reading Text
To illustrate the model, we have a constant monetary loss per accident, Birr 5000. The
probability distribution is as follows:
Number of Monetary Probability
Accidents Loss
0 0 0.07776
1 5000 0.25920
2 10000 0.34560
3 15000 0.23040
4 20000 0.07680
5 25000 0.01024

49
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

DERIVATION OF THE UTILITY FUNCTION

1. a. assign an arbitrary utility index of 1 to the maximum possible loss.
U (L max) = U(25000) = 1.00
b. assign an arbitrary utility index of zero to the minimum loss.
U(L min) = U(0) = 0
2. Ask the person how much he would be willing to pay in order to transfer the risk in

which he faces a 50 –50 chance of losing the maximum loss (Birr 25000) or nothing. The

amount the person is willing to pay to transfer the risk will have the following utility

value:

U(T 1) = 0.5(1) + 0.5(0) = 0.5 , T = Transfer cost

Suppose the person is willing to pay Birr 13750. The utility value assigned to this transfer
cost will be 0.5
2. Ask the person how much he would be willing to pay in order to transfer the risk in
which there is 50 percent chance of losing the transfer cost in (2) above, (Birr 13750) or
nothing. The amount he offers will have a utility value of:
U (T 2) = 0.5 (utility of T 1) + 0.5 (utility of zero)
= 0.5 (0.5) + 0.5 (0)
= 0.25

Suppose that the person is willing to pay transfer cost of Birr 7700. Consequently, the
utility value of Birr 7700 will be 0.25.

3. This procedure is continued until enough information is collected to construct the

utility function. The summary is given below:

50
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Possible Loss Probability Utility Index

25000 0.5 1.00

13750 0.5 0.50
7700 0.5 0.25
4389 0.5 0.125
2400 0.5 0.0625
1300 0.5 0.03125

The next step is to determine the utility index for losses of Birr 5000, 10000, 15000 and
20000 using linear interpolation.

Linear Interpolation
Given two extreme values, X U and X L, with a corresponding utility index of U (X U) and
U (X L), the utility index for X M, U (X M), will be found using the following formula:

U (X M) = U (X L) + [(X M - X L) ÷ (X U - X L)] [U (X U) - U (X L)]

Synopsis of Lecture (30 Minuet)

UTILITY MODEL (APPROACH)

The expected utility model places emphasis on the risk manager’s attitude towards risk.
This means that the model takes into account differences in risk attitude of risk managers.
Risk managers are likely to assign varying utility points to a given monetary loss. As a
result their decisions as to which of the risk management tools to select for a particular
situation is likely to differ. Under this model, therefore, the risk manager is making a
decision on the basis of expected loss of utility.
Derivation of the Utility Function
1. a. assign an arbitrary utility index of 1 to the maximum possible loss.
U (L max) = U(25000) = 1.00
assign an arbitrary utility index of zero to the minimum loss.
U(L min) = U(0) = 0
Linear Interpolation

51
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Given two extreme values, X U and x L, with a corresponding utility index of U (X U)

and U (x L), the utility index for X M, U (X M), will be found using the following
formula:
U (X M) = U (x L) + [(X M - x L) ÷ (X U - x L)] [U (X U) - U (x L)]
Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What is the relevance of Utility model in the management of risk?
Next Session Assignment
Students are expected to come prepared for the next class by exercising on
the class room example about the model.

Module - 18
Topic THE WORRY-FACTOR MODEL (APPROACH)

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about
the application of Utility model approach.
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about Worry factor model. (10 Minuet)
 The applications of Worry factor model

Reading Text
The Worry Factor Model
This model tries to assign a monetary value to the mental stress (worry) that may
experience because of the presence of risk. Consequently the monetary value assigned to
this worry is treated as part of the cost of managing the risk.

To apply the worry model the Risk manager will have to follow certain steps.
1. Determine the premium payment for each decision under consideration.
2. Determine the expected value of uncovered monetary loss.
3. Assign a worry value to the expected value of uncovered loss.
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

4. Determine the total loss for each decision. The total loss can be calculated by
summing up the premium, the expected value of the uncovered loss and the worry value.

What will be the decision rule?

The decision rule for this method is to select an alternative that has the lowest total loss.
For illustrative purpose s the four alternatives discussed under the expected utility model
are considered. Those alternatives are listed below.

Alternatives Premium
1. Complete coverage Br 25000 12000
2. Br 20000 insurance policy with Br 5000 deducted 7000
3. Br 15000 policy with Br 10000 deductibles 2500
4. Retention 0

EXPECTED VALUE OF UNCOVERED LOSS

The total loss would be the sum of the premium, the expected value of uncovered loss
(EVUL) and the worry value. That is,

TOTAL LOSS = PREMIUM + EVUL + WORRY VALUE

Therefore, the decision rule is to select the alternative that has the lowest total loss. Dear
student, please note that both tangible as well as intangible losses are considered in the
worry factor model. let’s see the computations of total loss under each of the above
alternatives.

i. Complete coverage Br. 25000

a. Premium = 12,000
b. EVUL = there is a full coverage
c. Worry value = 0  no mental stress
d. Total loss = 12,000 + 0 + 0 = 12,000

53
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

ii. Br. 20,000 insurance policy with Br 5000 deductibles

a. Premium = 7000
b. EVUL = 4611.20

Number of (a) (b) c = a –b Probability EVUL

accidents Monetary Insurance Uncovered
loss payment loss
0 0 0 0 0.07776 0
1 5000 0 5000 0.25920 1296
2 10000 5000 5000 0.34560 1728
3 15000 10000 5000 0.23040 1152
4 20000 15000 5000 0.07650 384
5 25000 20000 5000 0.01024 51.20

c. Worry value = 30% of EVUL is 30% (4611.20) = 1383

d. Total loss = 7000 + 4611 + 1383 = 12994

iii. Br 15000 policy with Br 10000 deductibles

a. Premium = 2500
b. EVUL = 7926

No. Of Monetary loss Insurance Insurance loss Prob. EVUL

accident payment
0 0 0 0 0.07776 -
1 5000 0 5000 0.25920 1296
2 10000 0 10000 0.34560 3456
3 15000 5000 10000 0.23040 2304
4 20000 10000 10000 0.07680 768
5 25000 15000 10000 0.01024 102.4

54
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

c. Worry value = 50% of EVUL

= 50% X 7926 = Birr. 3963
d. Total loss = 2500 + 7926 + 3963 = Birr. 14389

iv. Retention
a. Premium = 0
b. EVUL = Expected loss = 10000
c. Worry value = 75% X EVUL
= 75% X 10000 = 7500
d. Total loss = premium + EVUL + worry value
= 0 + 10000 + 7500 = 17500
Synopsis of Lecture. (30 Minuet)

THE WORRY-FACTOR MODEL (APPROACH)

The model tries to assign a monetary value to the mental stress (worry) that manager’s
experience because of the presence of risk.

Steps in the model

To apply the worry model the Risk manager will have to follow certain steps.
Determine the premium payment for each decision under consideration.
Determine the expected value of uncovered monetary loss.
Assign a worry value to the expected value of uncovered loss.
Determine the total loss for each decision. The total loss can be calculated by summing
up the premium, the expected value of the uncovered loss and the worry value.
What will be the decision rule?
The decision rule for this method is to select an alternative that has the lowest total loss

EXPECTED VALUE OF UNCOVERED LOSS

The total loss would be the sum of the premium, the expected value of uncovered loss
(EVUL) and the worry value. That is,

TOTAL LOSS = PREMIUM + EVUL + WORRY VALUE

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

55
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Wrap-Up Discussion Questions (10 Minuet)

 What is Worry factor model all about?
 What is its relvance in managing risk?

Next Session Assignment

Students are expected to come prepared for the next class by exercising on
the class room example about the model.

Module - 19
Topic - An Insurance Overview

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the meaning
of Insurance.
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about Insurance. (10 Minuet)

 Meaning and concepts of insurance.

Reading Text
DEFINITIONS

Insurance can be defined in several ways and probably no one brief definition does
autistic to its many new features. It may be defined from economic, legal, business, social
and mathematical point of views. In economic sense, for instance, insurance is a
mechanism of providing certainty or predictability of loss with regard to pure risk. It
accomplishes these by policy or charity of risk. By reducing uncertainty in the business
environment, it will create peace of mind that enables businessmen focus on their primary
activities instead of worrying about the existence of possibility of loss so that societies
can grow more.

From legal point of view,

view, insurance is a contract whereby, a consideration (price) paid to
a party adequate to the risk, becomes security to the other that he shall not suffer loss,
damage or prejudice by the happening of risks specified in the contract for which he may

56
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

be exposed to. The contracting parties are the insured, who is responsible to pay the price
for obtaining the security (premium), and the insurer, who will assume the risk
transferred. This makes insurance a means of transferring risk for a premium (price) from
one party known as the insured to another called insurer.

From business perspective insurance is defined as a cooperative device to spread the loss
caused by a particular risk over a number of persons who are exposed to and who agree
to ensure themselves against that risk. Every risk involves the loss of one or other kind.
The function of insurance is to spread the loss over a large number of persons who agreed
to cooperate each other at the time of loss. The risk cannot be averted but loss occurring
due to a certain peril can be distributed amongst the agreed persons. They agree to share
the loss because the chance of loss, i.e, the time and amount, to a person is not known.

Any of the insureds may suffer loss to a given risk; so, the rest of the persons who have
agreed will share the loss. The larger the number of such persons, the easier the process
of distribution of loss. In fact, they share the loss by payment of premium, which is
calculated on the basis of probability of loss.

From the social point of view insurance is defined as a device to accumulate funds to
meet uncertain losses of capital, which is carried at through the transfer of the risk of
many individual to one person or, to a group of persons.

Mathematically, insurance is the application of certain actuarial principles (insurance

mathematics). Law of probability and statistical techniques are used to achieve
predictability.

In summary insurance is an economic system for reducing uncertainty of loss through

pooling of losses together, a legal method of transferring risk from the insured to the
insurer in a contract of indemnity, a business undertaking for profit that provides many
jobs in a free enterprise economy, a social device in which the loss of few is covered by
the contribution of many, or an actuarial system of applied mathematics.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Synopsis of Lecture (30 Minuet)

An Insurance Overview
Insurance can be defined in several ways and probably no one brief definition does
autistic to its many new features. It may be defined from economic, legal, business, social
and mathematical point of views. In economic sense, for instance, insurance is a
mechanism of providing certainty or predictability of loss with regard to pure risk. It
accomplishes these by policy or charity of risk. By reducing uncertainty in the business
environment, it will create peace of mind that enables businessmen focus on their primary
activities instead of worrying about the existence of possibility of loss so that societies
can grow more.

. The contracting parties are the insured, who is responsible to pay the price for obtaining
the security (premium), and the insurer, who will assume the risk transferred. This makes
insurance a means of transferring risk for a premium (price) from one party known as the
insured to another called insurer.
From business perspective insurance is defined as a cooperative device to spread the loss
caused by a particular risk over a number of persons who are exposed to and who agree
to ensure themselves against that risk.
Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What is insurance from an individual point of view as well as from socio
economic perspectives?
Next Session Assignment
Students are expected to come prepared for the next class by reading about
social cost and benefits of insurance.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Module - 20
Topic- Role and importance of insurance

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about
the role and importance of Insurance.
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about role and imporrtanceInsurance. (10 Minuet)

 The Socio economic roles of insurance?

Reading Text
THE ROLES AND IMPORTANCE OF INSURANCE

The role and importance of insurance can be discussed in three phases:

i. Uses to individual
ii. Uses to special group of individuals, business or industry
iii. Uses to the society

i. Uses to an individual

a. Insurance provides security and safety. Insurance reduces the physical and mental

stress that insureds face concerning the possibility of death, disability and financial loss.

Insureds, through transfer of their risk to the insurer reduce their worry about any

financial loss they may face due to accidental misfortune. This means that insureds are to

a large extent certain that the loss, if at all occurs will be recovered from the insurer.

Insurance provides security against loss due to fire in fire insurance. In other types of

insurance, security is provided against loss at a given contingency. Moreover it provides

safety and security against the loss of earning at damage, destructions or disappearance of

property, goods, furniture etc.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

b. Insurance affords peace of mind. The knowledge that insurance exists to meet the

financial consequences of certain risks provides a form of peace of mind. This is

important for private individuals when they insure their car, house, possessions and so on,

but it is also of vital importance in industry and commerce.

The security provided by insurance banishes fear and uncertainty of fire, windstorm,
automobile accident and damage that are almost beyond the control of a human being.
The possibility of occurrence of any of these may frustrate or weaken the human mind
that would otherwise be obsessed with productive areas. The existence of insurance helps
individuals to have peace of mind and give them relief that eventually makes them
stimulated to more work.

c. Insurance protects mortgaged property. At the death of the owner of the

mortgaged property, or at the time of damage or destruction of the property, the insurer

will provide an adequate amount to the dependents at the early death of the owner to pay

off the unpaid loans, or the mortgage gets a deflated amount at the destruction of the

property.

ii. Uses to Business

a. Reduction of uncertainty

Why should a person put money into a business venture when there are so many risks
which could result in the loss of the money? Yet, if people did not invest in businesses
then there would be fewer jobs, less goods, the need for even higher imports and a
general reduction in wealth. Buying insurance allows the entrepreneur to transfer at least
some of the risks of being in business to an insurer, in the manner we have described
earlier. Uncertainty of business losses is reduced in the world of business. In commerce
and industry a huge number of properties are employed.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

With a slight carelessness or negligence, they may be turned in to ashes. Owners of the
business or managers might foresee contingencies that would bring great loss. To meet
such situations, they might decide to put aside annual reserve, but it may not be
economical for the money could have been invested in other activities. Instead, by
making an annual or even immediate payment, insurance policy can be taken.

b. Increasing business efficiency

Insurance also acts as a stimulus for the activity of businesses which are already in
existence. This is done through the release of funds for investment in the productive side
of the business, which would otherwise require to be held in easily accessible reserves to
cover any future loss. Medium sized and larger firms could certainly create reserves for
emergencies such as fires, thefts or serious injuries. However, this money would have to
be accessible reasonably quickly and hence the rate of interest which the company could
obtain would be much less than the normal rate. Quite apart from this is the fact that the
money would not be available for investment in the business itself.

Business efficiency is increased with insurance when the owner of a business is free from
botheration of losses, hence, certainly devote much time to the business. The carefree
owner can work better for the maximization of profit. The uncertainty of loss, damage,
destruction or disappearance of a property, may affect the mind of the businessmen
adversely. The insurance, removing the uncertainty, stimulates businesspersons to work
hard.

iii. Uses to society

a. Wealth protection
With the advancement of the society, the wealth or the property of the society attracts
more hazards resulting in the creation of new types of insurance invented to protect them
against the possible losses. The present, future and potential property resources are well –
protected through insurance in which each and every member will have financial security
against damage and destruction of wealth. Through prevention of losses, insurance
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

protects the society against degradation of resources and ensure stabilization and
expansion of business and industry.

b. Economic growth
Insurance provides strong hand and mind and protection against loss of property. In
addition to these, insurance companies accumulate large sum of money available for
investment purpose. Such money accumulated may be invested by the insurance
companies themselves or lent to others to produce more wealth. This will have its
contribution to the economic growth of a country.

The fact that the owner of a business has the funds available to recover from a loss
provides the stimulus to business activity that we noted earlier. It also means that jobs
may not be lost and goods or services can still be sold. The social benefit of this is that
people keep their jobs, their sources of income are maintained and they can continue to
contribute to the national economy. We all know the effects on a community when a
large employer moves or ceases operation; the area runs the risk of being depressed,
people have less money to spend and the consequences of this can be far reaching.

To a lesser extent, a major loss resulting in the closure of a business can have the same
impact on a community. It may not be as noticeable as the shut-down of a coal mine or
large factory, but when losses are aggregated throughout the country the effect is
considerable. It is not suggested that insurance alone keeps people in jobs, but it does
play a significant role in ensuring that there are not unnecessary economic hardships.

The three dimensions of benefits that we have already looked at, all follow on from the
protection offered by insurance. These benefits may be to the buyer of insurance or to the
economy as a whole, but they relate in some way to the basic idea of providing a risk
transfer mechanism.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Synopsis of Lecture (30 Minuet)

Role and importance of insurance

i. Use to individual; it reduces the physical and mental that individuals face
concerning the possibility of death, disability and financial loss.
ii. Insurance protects mortgaged properties, death of the owner of the mortgaged or
at the time of damage or destruction of the property the insurance will take her of
the unpaid balance of the mortgage.
iii. Reduction of uncertainty.
iv. It helps to increase business efficiencies.
v. It protects the wealth of the society.
vi. It helps for economic growth.

Reference Books;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What is the socio economic relevance of insurance?

Next Session Assignment

Students are expected to come prepared for the next class by reading about
the primary functions of insurance.

Module - 21
Topic- Primary functions of insurance

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
functions of Insurance.
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the primary functions of Insurance. (10 Minuet)

 Identifying the primary function of insurance.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Reading text
THE FUNCTIONS OF INSURANCE

The functions of insurance can be studied in two parts: primary and secondary functions.

Primary Functions

Insurance executes the following functions primarily.

a. Providing certainty. Insurance provides certainty of payment at the uncertainty of

loss. The uncertainty of loss can be reduced by better planning and administration.
Insurance removes all uncertainties and assurance is given to payment of compensation at
the time of loss. The insurer charges premium for providing the said certainty.

b. Protection. The main function of insurance is to provide protection against the

probable chances of loss. Insurance guarantees the payment of loss and this protects the
assured from sufferings.

c. Risk-sharing. When the risk takes place, all the persons who are exposed to the risk
share the loss.

Synopsis of Lecture (30 Minuet)

Primary functions of insurance

1. Providing Certainty; insurances provides certainty of payment at the uncertainty of

loss. The uncertainty of loss can be reduced by better planning and administration.
Insurance removes all uncertainties and assurance is given to payment of compensations
at the time of loss.

2. Protection; the main faction of insurance is to provide protection against the probable
chance of loss. The insurance guaranties the payment of loss and this protects the assured
from sufferings.

3. Risk Sharing; when the risk takes place, all the persons who are exposed to the risk
share the loss.

64
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Reference Books;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What are the primary functions of insurance?

Next Session Assignment

Students are expected to come prepared for the next class by reading about
the secondary functions of insurance.

Module - 22
Topic- Secondary functions of insurance

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
secondary functions of Insurance.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the Secondary functions of Insurance. (10 Minuet)

 Identifying the secondary function of insurance.

Reading Text
Secondary Functions

In addition to the aforementioned primary functions, insurance plays the following:

a. Prevention of loss. Insurance is primarily concerned with the financial consequences

of losses, but it would be fair to say that insurers have more than a passing interest in
loss control. It could be argued that insurers have no real interest in the complete
control of loss, as this would inevitably lead to an end to their business. This is a rather
shortsighted view. Insurers do have an interest in reducing the frequency and the
severity of loss. In a practical way, buyers of insurance will normally come into
contact with the loss control services offered by an insurer when they meet the
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

surveyor. The surveyor may be employed by the insurer, or indeed the insurance
broker, and part of his job is to give advice on loss control. Many insurers employ
specialist surveyors in fire, security, liability and other types of risk; others will
employ people with broader, but less detailed, knowledge.

The surveyor will assess the extent of the risk to which the insurance company is
exposed. In doing so he will also offer advice, which could take the form of pre-loss
control (minimizing the chance that something will happen) or post-loss control (after
an event has occurred). Traditionally, the expertise of surveyors was concentrated on
risks for which commercial insurance was available. Increasingly, risk control
surveyors employed by insurers and insurance brokers have extended the services
they offer to include identification and control of all risks faced by organizations, as
part of a wider risk management service.

The best time for a surveyor to be consulted is at the planning stage of a project. He
can then incorporate features which may minimize risk and control loss. A good
example of this is the installation of automatic fire-sprinkler systems. It is obviously
far simpler and cheaper to include a sprinkler system in the design of a building,
rather than to alter a building once it has been constructed to add sprinklers. Most
builders are alert to the value of fire prevention and control, but the same principle
applies to safety and security.

The insurance assist financially to the fire brigade, educational institutions and other
organizations, which are engaged in preventing the losses. In short, the function of
insurance is not merely compensating those who suffered loss at the time the risk
materializes. However, insurance must make sure that adequate loss prevention and
loss control mechanisms were implemented by the insured to minimize the
probability and severity of the loss.

b. Providing Capital. Insurance companies have, at their disposal, large amounts of

money. This arises due to the fact that there is a time gap between the receipt of a
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

premium and the payment of a claim. A premium could be paid in January and a claim
may not occur until December, if it occurs at all. The insurer has this money and can
invest it. In fact, the insurer will have the accumulated premiums of all insureds, over a
long period of time.

We have listed investment as one of the benefits of insurance in later discussions and
the benefit lies in the use to which the money is put. Insurers invest in a wide range of
different forms of investment. By having spread of investments, the insurance industry
helps national and international businesses in their borrowing. It also helps industry
and commerce, by making various forms of loan and by taking up shares which are
offered on the open market. Insurers make up part of what are termed the institutional
investors; the others include banks, building societies and pension funds. Investment is
also made in property.
Synopsis of Lecture (30 Minuet)

Secondary functions of insurance

1 Prevention of loss; apart from its primary function of financial compensations at the
time loss, insurance companies have a great on loss control aspect by reducing the
frequency and severity of the loss.
Experts from insurance company will assess the extent of risk to which an insurance
company is exposed in doing so the experts from the company will give advice which
could take the form of pre loss control ( minimizing the chance that something will
happen) or a pro loss control ( after an event has occurred) the traditional approach in this
area is the experts on the area concentrate on the risk for which the commercial insurance
is available .
Providing Capital: insurance companies have large amount of money at their disposals,
large amount of money. This arise due to a simple fact that there is a time gap between
the receipt of premium and the payment of the claim.
Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What are the secondary factions of insurance?
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Next Session Assignment

Students are expected to come prepared for the next class by reading about
the Operational functions of insurance.

Module - 23
Topic- Operational functions of insurance

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about
the functions of Insurance.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the operational functions of Insurance. (10 Minuet)

 Identifying the operational functions of insurance

Reading Text

Synopsis of Lecture (30 Minuet)

Operational functions of insurance

1. The Production Function: this aspect of insurance deals with securing a sufficient
numbers of applicants for the insurance to enable the company to operate. This function
of insurance is equivalent to sales function in an industrial firm.

2. Underwriting Functions: this function of insurance includes all activities and tasks
which are necessarily to select risks offered to the insurance company. To select a risk a
certain standards of criteria are set. A possible source of information for the selection
includes;
 The application of the insured.
 The information obtained from agents or brokers.
 Physical examination report. Etc.

3. Rate making function: insurance companies pricing decisions are set by the
market or business considerations and by the applicable law. The law requires that
insurance premium should be reasonable, adequate, and not unfairly discriminatory.

Reference Books;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
68
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Wrap-Up Discussion Questions (10 Minuet)

 What are the major operational functions of insurance?
Next Session Assignment
Students are expected to come prepared for the next class by reading further
about the Operational functions of insurance.

Module - 24
Topic- Operational functions of insurance (Cont’d)

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
functions of Insurance.
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the operational functions of Insurance. (10 Minuet)

 Identifying the operational functions of insurance

Synopsis of Lecture (30 Minuet)

Operational functions of insurance Cont’d

The Principal Pricing Methods,

A) Individual Rating: each insured is charged a unique premium based largely upon
the judgment of the person setting the rate, the rate maker can take in to account
competitions statistical data and premiums charged to similar insureds.
B) Class Rating; insureds are classified according to easily identifiable
characteristics and insured’s in each class are charged the same rate.
C) Merit Rating; the methods of pricing is based upon the previous experience of the
company.
2. Claims settlement / Managing Claims : the objective of this function of insurance
department is a faire and prompt settlement of claims. The insureds should realize that its
wrong fro the insurance to over pay claims as it is also wrong to under pay them.
The steps involved in the loss settlements are the followings:
1. Notice of Loss.
2. Investigation of loss.
3. Proof of loss.
4. Payment or denial of claims.
Reference Books;

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Unity University College, School of Distance and Continuing Education, Course

Material for Risk Management and Insurance (Degree Program).

Wrap-Up Discussion Questions (10 Minuet)

 How does insurance company set their premiums?
 What is the procedure in settling claims?

Next Session Assignment

Students are expected to come prepared for the next class by reading about
the Fundamentals of insurance contracts.

Module - 25
Topic- Fundamentals of Insurance Contracts

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
fundamentals of Insurance contracts.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the fundamentals of insurance contracts. (10 Minuet)

 Defining the fundamentals of insurance contract

Synopsis of Lecture. (30 Minuet)

Fundamentals of Insurance Contracts

A contract is a legally binding agreement between two or more parties . the first party
secures a promise that shifts the risk from one party to anther. The second party provides
for reduction of risk through the use of combinations methods and sharing the burden of
the loss.
Insurance contracts are agreements between the insurance companies and the insureds fro
the purpose of transferring from the insureds to the insurer part of the risk or loss that
arises out of contingent events.
The functions of the contracts are:
1. To define the risk to be transferred.
2. To state the conditions under which the contract applies.
3. To explain the procedures fro settling loss.
Requirements for valid contracts.

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Course Title: Risk management and Insurance
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 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

1. The contract must serve a legal purpose.

2. Their must be a definite offer and acceptance with ones free will.
3. Each contracting parties must make some considerations on behalf of the other party.
4. The contracting parties must be legally competent, on other words their shouldn’t be
minor, insane or a legally interdicted persons.
Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What are the common characteristics of insurance contracts?

Next Day Assignment

Students are expected to come prepared for the next class by reading about the unique
characteristics of insurance contracts.

Module - 26
Topic- Unique Characteristics of Insurance contracts

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the unique
character sticks of Insurance contracts.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the fundamentals of insurance contracts. (10 Minuet)

 Identifying the uniqueness of insurance contracts

Reading text
Unique Characteristics of Insurance contracts

1. Personal Contract; insurance contract are personal contracts, although the subject
matter of insurance is a piece of property what mattes most is the identity of the person is
an important factor. Insurance follows the person not the property, thus insurance is said
to be personal.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

2. Unilateral Contract: After the insured has paid the premium and the contract has gone
to effect, only insurers can be forced to perform because the insured has fulfilled his
promise to pay.
3. Conditional Contract: the insurer can refuse to perform if the insured does not satisfy
certain conditions contained in the contract.
4. Aleatory Contract; if the event insured against occurred the insurer will pay the
insured a sum of money much larger than the premium if not the insurer will not pay
thing.
5. Contract of Adhesion; insurance contracts are drawn by the insurance company the
insured seldom participate in the drafting of the policy.
6. Contract of Uberrimae Fidei; insurance contracts are contract of at most good faith, a
highest degree of mutual trust is expected from both parties.
7. Contract of Indemnity: contracts of property and liability contracts are contracts of
indemnity. The person insured should not benefit financially from the happening of
events.

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 Where does the uniqueness of insurance contract lies?

Next Session Assignment

Students are expected to come prepared for the next class by reading about the General
Principles of insurance.

Module - 27
Topic- General Principles of insurance

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
principles of Insurance contracts.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the Principles of insurance contracts. (10 Minuet)

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

 Identifying the governing principles of insurance

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Reading Text
LEGAL PRINCIPLES OF INSURANCE CONTRACTS

Insurance is affected by legal agreements called contracts or policies. A contract cannot

be complete in effect, but must be interpreted in light of the social environment of the
society in which it is made. The legal principles of insurance that are generally applicable
are discussed as follows.

i. The principle of insurable interest-

interest- A fundamental legal principle underlying all
insurance contracts is insurable interest. Under this principle an insured must demonstrate
the existence of financial relationship to the subject matter insured; otherwise the insured
will be unable to collect amounts due when the insured peril occurs. The principle applies
to both life and non-life insurance. The subject matter insured may include property of
value, life of a person, or an event that may cause a legal liability. For instance, in the
case of a property, the owner has a financial interest in the safety of the property for he
will suffer a financial loss in the event of destruction of the property by accidental
misfortune. In the case of life insurance, a clear example is the insurable interest of a wife
in the life of a husband and the vice versa. In the business environment a creditor has a
financial interest in the life of a debtor. Thus he has the right to purchase life insurance
policy for the life of the debtor to protect his financial interest. The doctrine of insurable
interest is also necessary to prevent insurance from becoming a gambling contract.

Insurance follows the person insured and not the property. A policy can be written
covering a certain piece of property and an individual may be named as the one who
would suffer a financial loss if the perils were to occur and cause damage. However, if at
the time of the loss the individual named no longer had an interest in the property, there
would be no liability under the policy. For example suppose that A owns and insured a
car, later he sells his car to B and shortly there after the car is destroyed. A cannot collect
under the policy, because he has no further financial interest in the car.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

When the insurable interest must exist?

In property and liability insurance it is possible to effect coverage on property in which
the insured doesn’t have an insurable interest at the time the policy is written, but in
which such an interest is expected in the future. In marine insurance a shipper often
obtains coverage on cargo it has not yet purchased in the anticipation of buying cargo for
a return trip. As a result the courts generally hold that in property insurance, insurable
interest need exist only at the time of the loss and not at the time in caption of the policy.
Whereas in life insurance, the insurable interest should exist at the time of inception of
the policy.

ii. Principle of indemnity. The principle of indemnity states that a person may not
collect more than the actual loss in the event of damage caused by an insured peril. Thus,
while a person may have purchased coverage in excess of the value of the property, the
person cannot make a profit by collecting more than the actual loss of the property that is
destroyed. Many insurance practices result from this important principle. In general only
contracts in property and liability insurance are subjected to this doctrine, although there
are exceptions where statutes have modified its application.

The principle of indemnity is closely related to insurable interest. The problem in

insurable interest is to determine whether any loss is suffered by a person insured, where
as in indemnity the problem is to obtain a measure of that loss. In the basic fire insurance
contracts, the measure of “actual cash loss” is the current replacement cost of destroyed
property loss plus an allowance for estimated depreciation. The whole purpose is to
restore the insured to his former financial position before the happening of the loss. Thus,
the principle eliminates the intention of gambling that incorporates profit motive.
Indemnity can take different forms: cash payment, replacement of the property or
reinstatement of the property.

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Course Title: Risk management and Insurance
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 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

iii. The principle of subrogation-

subrogation- Under the principle of subrogation, one who has
indemnified another loss is entitled to recover from liable third parties, if any, who are
responsible. Subrogation is corollary to the principle of indemnity. Consequently, it
doesn’t apply to life and personal accident insurance. The essence is that the insurer, after
claiming the amount of loss suffered obtains the legal right to take the place of the
insured and demand for a recovery to the loss, wholly or in part, from the third party
responsible for the loss. The objective behind such transfer of right from the insured to
the insurer is to eliminate the profit motive i.e. to prohibit the insured from collecting
double payments: from the insurer and from the third party. Thus if Mr. D negligently
causes damage to Mr. E’s property, E’s insurance company will indemnify E to the extent
of its liability for E’s loss and then have the right to proceed against D for any amount it
has paid out under Es policy. One of the important reasons for subrogation is to reinforce
the principle of indemnity that is to prevent the insured from collecting more than the
actual cash loss. If E’s insurer didn’t have the right to subrogation it would be possible
for E to recover from the policy and then recover again in a legal action against D. In this
case E would collect twice. It would be possible for E to arrange an accident with D,
collect twice, and split the profit with D. A moral hazard would exist and the contract
would tend to become an instrument of fraud.
Synopsis of Lecture (30 Minuet)

General Principles of insurance

The principle of insurable interest. A fundamental legal principle underlying all

insurance contracts is insurable interest. Under this principle an insured must demonstrate
the existence of financial relationship to the subject matter insured; otherwise the insured
will be unable to collect amounts due when the insured peril occurs
Principle of indemnity. The principle of indemnity states that a person may not
collect more than the actual loss in the event of damage caused by an insured peril. Thus,
while a person may have purchased coverage in excess of the value of the property, the
person cannot make a profit by collecting more than the actual loss of the property that is
destroyed.
The principle of subrogation. Under the principle of subrogation, one who has
indemnified another loss is entitled to recover from liable third parties, if any, who are
responsible.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Reference Books;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 Explain how the principle of Indemnity and the principle of Subrogation
correlate to each other?

Next Day Assignment;

Students are expected to come prepared for the next class by reading about
the General Principles of insurance.

Module - 28
Topic - General Principles of insurance (Cont’d)

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about
the principles of Insurance contracts.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the Principles of insurance contracts. (10 Minuet)

 Identifying the governing principles of insurance

Reading Text
iv. The principle of contribution- This also supports the principle of indemnity. It is
applied to a situation where a person or firm, for some reasons, purchase insurance from
two or more insurers to cover the same subject matter against loss or damage. Under such
circumstance, the insured cannot collect compensation from each insurer. If this happen,
insurance becomes a profit making mechanism. So, the insured is paid only to the extent
of the loss he has suffered. But, each insurer will make contribution to settle the claim.
The contribution may be a proportional amount based on the sum insured under the
respective insurers. However, to know if an insured has more than one insurer for the
same risk, especially in countries like ours could be difficult.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

v. The principle of utmost good faith- Insurance is said to be a contract of utmost

good faith. In effect, this principle imposes a higher standard of honesty on parties of
insurance agreement than is imposed on ordinary commercial contracts. Insurance
contracts are based on mutual trust. This means that both the insured and the insurer must
make full disclosure of material facts that have a bearing on the assessment of the risk.
Intentional concealment, misrepresentations and fraud may lead to the avoidance of the
insurance contract. The insured is bound to give all the facts having material effect on the
assessment of risk. The application of this principle can be expressed in representation,
concealment and warranties.

Synopsis of Lecture (30 Minuet)

General Principles of insurance.

The principle of utmost good faith- Insurance is said to be a contract of utmost good
faith. In effect, this principle imposes a higher standard of honesty on parties of insurance
agreement than is imposed on ordinary commercial contracts

Representation: A miss representations of a material fact will make the contract void able
at the options of the insurer.

Concealment: This is silence when one is obliged to speak; it’s a failure on the applicant
to reveal a material fact which is known to the insured but not the insurer .

Warranty: It is a close in insurance contract holding that before the insurer is liable a
certain part or conditions or circumstance affecting the risk must exist. Example a bank
can be insured on a condition that a certain burglary apparatus system be installed such
condition is a precedent and act as a warranty.

The principle of contribution- This also supports the principle of indemnity. It is applied
to a situation where a person or firm, for some reasons, purchase insurance from two or
more insurers to cover the same subject matter against loss or damage. Under such
circumstance, the insured cannot collect compensation from each insurer. If this happen,
insurance becomes a profit making mechanism.

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

 How does the principle of contribution applies if an individual bought

insurance from more than one insurance company
Weekly Assignment

Ato Belelegn Mandefro has recently bought a Toyota Mini bus from a local dealer worth
of Br. 120.000. with the intention of receiving high compensation incase of any auto
accident his has insured his auto with three insurance company in the following manner.
From ABC insurers Br 80,000 insurance, from PBC insures Br 100,000 insurance and
from XYZ insurers Br 60,000 insurance. Very recently the Toyota mini bus collided with
a reckless Isuzu driver and suffers damage estimated to be Br 25, 000

Required
A) Calculate the amount of money Ato Belelegn can claim form each insurance
company
B) Ato Belelegn has also made a deal with the Isuzu driver and received
Br.25000. Comment on the deal.

Module - 29
Topic - CLASSIFICATION OF INSURANCE
.
Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
Major classifications of Insurance
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the classifications of insurance (10 Minuet)

 Discussions on the major class of insurance.

Reading Text

The main purpose of life insurance is financial protection to the dependants of the insured
upon the premature death of the insured. The sum assured is, then, upon the death of the
insured will be paid to the beneficiaries. The financial compensation will provide security
for a certain period of time.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

The insured may also purchase life insurance policy with such objectives as settling
personal loans and other debts. If the insured dies before settling his debts, the insurer
will settle the debt outstanding to the creditors, hence protecting the family from financial
loss.

Life insurers are generally engaged in the provision of both protection and saving. The
protection is against financial loss difficulty and is acquired for a consideration called
premium, which is the price that keeps the policy in force. The protection given by the
insurer is death benefits to the beneficiary of the insured, or in the case of survival of the
insured, other financial benefits in accordance with the policy contract.

Essential Features of Life Insurance

 The benefits are determined in advance. The insured decides for himself the amount
of insurance protection he needs. The insurer will then decide on the corresponding
reasonableness of the amount of coverage and sets the corresponding premium.

 The amount of money required to pay the death benefits in a given period are to be
collected in advance so that there should not be shortage of funds to pay claims as
they occur.

 Each insured in the group should be charged an appropriate premium, which reflects
the amount of risk he brings to the group. In other words, losses are to be distributed
among the group of insureds in an equitable manner.

 The probability of claim increases with the passage of time since insureds exhibit
deteriorating health condition as they grow old.

 In addition to protection against uncertainty, life insurance has the function of

accumulation of money/saving.

Life insurance is not strictly a contract of indemnity for the value of a person cannot be
precisely put in financial terms. The provision of life assurance is a quite different
process from the provision of non-life insurance. The main distinction is that in life
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

assurance the event being assured is either certain to happen, in the case of those policies
paying on death, or scientifically calculable, in the case of policies not paying a benefit
on death.

Synopsis of Lecture (30 Minuet)

CLASSIFICATION OF INSURANCE
Life Insurance
Life insurance is a contract whereby the insurer for certain sum of money or premium
proportionate to the age, profession, health and other circumstances of the person whose
life is insured engage that if such person dies with in the period specified in the policy the
insurer will pay the amount specified by the policy according to the term there of to the
person in whose favor the policy was entered to.
Essential Features of Life Insurance
The benefits are determined in advance. The insured decides for himself the amount of
insurance protection he needs. The insurer will then decide on the corresponding
reasonableness of the amount of coverage and sets the corresponding premium.
The amount of money required to pay the death benefits in a given period are to be
collected in advance so that there should not be shortage of funds to pay claims as they
occur.
Each insured in the group should be charged an appropriate premium, which reflects the
amount of risk he brings to the group. In other words, losses are to be distributed among
the group of insureds in an equitable manner.
The probability of claim increases with the passage of time since insureds exhibit
deteriorating health condition as they grow old.
Reference Books;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What are the essentials of life insurance contract?

Next Day Assignment;

Students are expected to come prepared for the next class by reading about
the major classifications of insurance.

81
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Module - 30
Topic - CLASSIFICATION OF INSURANCE (Cont’d)

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about
the Major classifications of Insurance
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the classifications of insurance (10 Minuet)

 Discussions on the major class of insurance

Reading Text
In addition there are a number of special features

a. Premium payments. Life assurance premiums are payable by level amounts

throughout the period of the policy. This means that each person pays the same amount
throughout, that amount being determined by his age on effecting the policy. Premiums
can be paid annually, half-yearly, quarterly or monthly and are often met by standing
orders with banks whereby the policyholder instructs his bank to make the appropriate
payments at the correct times. It is also possible for the insured to pay premiums for a
specified period of time or even a single payment at lump sum at the time the policy is
purchased. (This will be discussed in detail in later section).
b. Participation in profits. Life assurance companies value their assets and liabilities at
regular intervals, say every year or others every three years. This valuation of their
operation allows them to determine whether any surplus exists after calculating all future
liabilities and allowing for other contingencies. Should such a surplus exist, it is
distributed among those policyholders who have 'with-profits' or 'participating' policies.
Such policies allow the policyholder to participate in any profits the company makes. It

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

does not guarantee a bonus to each policyholder, as the company may not have a surplus,
but it does mean that any available surplus will be distributed.

The policyholder pays an additional amount for the privilege of participating in profits.
The bonuses are then added to the sum assured and payable at the maturity date. They
can be either simple reversionary bonuses, that are computed at a rate percent on the
basic sum assured, or compound reversionary bonuses, that are computed at a rate
percent of the basic sum assured plus any existing bonus payments already declared.
c. Surrender values. When a person no longer wants his policy, or for some reason
cannot continue the premiums, he can ask for the surrender value. (this is discussed in
later sections).
d. [Link]
[Link] have already identified the life assurance industry as being of
considerable size by considering the number of policies in force and the value of
premiums paid each year. These vast amounts of money are held by companies to meet
future liabilities and are termed life assurance funds. These funds do not lie dormant
waiting for claims to come in; rather they are invested to provide income for the
companies and so assist policyholders and shareholders. Not only do these two groups
benefit, but the country as a whole benefits, as we have already seen in section 2 of this
unit.

Synopsis of Lecture (30 Minuet)

CLASSIFICATION OF INSURANCE.
In addition to these there are a number of special features, which are worth mentioning at
this stage:
Premium payments. Life assurance premiums are payable by level amounts throughout
the period of the policy. This means that each person pays the same amount throughout,
that amount being determined by his age on effecting the policy. Premiums can be paid
annually, half-yearly, quarterly or monthly and are often met by standing orders with
banks whereby the policyholder instructs his bank to make the appropriate payments at
the correct times. It is also possible for the insured to pay premiums for a specified period
of time or even a single payment at lump sum at the time the policy is purchased. (This
will be discussed in detail in later section)
Participation in profits. Life assurance companies value their assets and liabilities at
regular intervals, say every year or others every three years. This valuation of their
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

operation allows them to determine whether any surplus exists after calculating all future
liabilities and allowing for other contingencies. Should such a surplus exist, it is
distributed among those policyholders who have 'with-profits' or 'participating' policies.
Such policies allow the policyholder to participate in any profits the company makes. It
does not guarantee a bonus to each policyholder, as the company may not have a surplus,
but it does mean that any available surplus will be distributed.

The policyholder pays an additional amount for the privilege of participating in profits.
The bonuses are then added to the sum assured and payable at the maturity date. They
can be either simple reversionary bonuses, that are computed at a rate percent on the
basic sum assured, or compound reversionary bonuses, that are computed at a rate
percent of the basic sum assured plus any existing bonus payments already declared.
Surrender values. When a person no longer wants his policy, or for some reason cannot
continue the premiums, he can ask for the surrender value. (this is discussed in later
sections).
d. Investments. We have already identified the life assurance industry as being of
considerable size by considering the number of policies in force and the value of
premiums paid each year. These vast amounts of money are held by companies to meet
future liabilities and are termed life assurance funds. These funds do not lie dormant
waiting for claims to come in; rather they are invested to provide income for the
companies and so assist policyholders and shareholders.

Reference Books;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What are the privileges given to a policy holder by paying additional
premiums?
Next Session Assignment
Students are expected to come prepared for the next class by reading about
the Basic types of life insurance.

Module - 31
Topic - Basic Types of Life Insurance
.
Sessions Learning objectives

84
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

 At the end of this session students’ will have a better understanding about
the basic types of Insurance
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the basic types of Insurance. (10 Minuet)

 Identifying the basic types of insurance.

Reading text

Basic Types of Life Insurance

There are three basic types of life insurance

1. Whole Life Insurance

In this kind of life insurance, the sum assured is payable on the death of the life assured
whenever it occurs. Premiums are payable either throughout the life of the assured or can
cease at a certain age, often 80 or 85.

This policy provides protection to the dependants of the insured upon the event of his/her
death. I.e. the sum assured is payable only upon the death of the insured. One option is
that the insured pays annual premiums as long as he lives. The second option is that
premium payments are made for a specified number of years or up to a certain age limit,
normally up to the age of retirement. Premium payments after retirement are discontinued
because of a decline in the income of the insured. The policy provides permanent
protection to the insured’s dependants in the case of death. Besides this protection, whole
life insurance allows for the accumulation of savings over the life of the insured. In
essence, the policy encourages saving.

Whole life policy acquires cash value after two or three years of premium payment.
When a person no longer wants his policy, or for some reason cannot continue the
premiums, he can ask for the surrender value. He ceases payment and receives not a
proportion of the sum assured, but a proportion of the premiums already paid. Not all
policies allow a surrender value and surrender within the first few years of any policy
will not normally produce an amount for the policyholder. This is because surrender
value is calculated using the premiums paid, less expenses incurred in issuing and

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

renewing the policy, and less the cost of the life assurance cover provided during the
years it was in force. In view of the level premium system, any surrender value in the
early years will be low, if any accrues at all.

The cash value gradually grows to equal the sum assured upon maturity or at the time the
insured attains age 100. If the assured, for some reasons, discontinues premium payments
after the policy accumulates cash value, then the cash value can be used to keep the
policy in force under the automatic premium loan provision. Moreover, the assured can
apply for loans when the policy acquires cash value. In some cases, an alternative to the
surrender value is the paid-up policy. The premiums cease and the policy continues, but
on maturity a smaller sum than would originally have been paid will be due to the
policyholder. Depending on the policy and the company concerned, these paid-up
policies may or may not continue to participate in profits.

In general, whole life insurance has two salient features:

i. Protection – It protects the insured in the case of
premature death. If the insured died prematurely the face
amount is paid to the beneficiary.
ii. Saving - premium will accumulate with interest till the
date of maturity of the policy (age 100) the face value of
the policy will be paid to the beneficiary.
Synopsis of Lecture (30 Minuet)

Basic Types of Life Insurance.

There are three basic types of life insurance

1. Whole Life Insurance

In this kind of life insurance, the sum assured is payable on the death of the life assured
whenever it occurs. Premiums are payable either throughout the life of the assured or can
cease at a certain age, often 80 or 85.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

This policy provides protection to the dependants of the insured upon the event of his/her
death. I.e. the sum assured is payable only upon the death of the insured. One option is
that the insured pays annual premiums as long as he lives. The second option is that
premium payments are made for a specified number of years or up to a certain age limit,
normally up to the age of retirement. Premium payments after retirement are discontinued
because of a decline in the income of the insured. The policy provides permanent
protection to the insured’s dependants in the case of death. Besides this protection, whole
life insurance allows for the accumulation of savings over the life of the insured. In
essence, the policy encourages saving.

Whole life policy acquires cash value after two or three years of premium payment.
When a person no longer wants his policy, or for some reason cannot continue the
premiums, he can ask for the surrender value. He ceases payment and receives not a
proportion of the sum assured, but a proportion of the premiums already paid. Not all
policies allow a surrender value and surrender within the first few years of any policy
will not normally produce an amount for the policyholder. This is because surrender
value is calculated using the premiums paid, less expenses incurred in issuing and
renewing the policy, and less the cost of the life assurance cover provided during the
years it was in force. In view of the level premium system, any surrender value in the
early years will be low, if any accrues at all.
The cash value gradually grows to equal the sum assured upon maturity or at the time the
insured attains age 100. If the assured, for some reasons, discontinues premium payments
after the policy accumulates cash value, then the cash value can be used to keep the
policy in force under the automatic premium loan provision. Moreover, the assured can
apply for loans when the policy acquires cash value. In some cases, an alternative to the
surrender value is the paid-up policy.

In general, whole life insurance has two salient features:

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

iii. Protection – It protects the insured in the case of

premature death. If the insured died prematurely the face amount is paid to the
beneficiary.
iv. Saving - premium will accumulate with interest till the
date of maturity of the policy (age 100) the face value of the policy will be paid to the
beneficiary.

88
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Reference Books;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet

 What is the essence of whole life insurance?
 What are the two salient features of whole life insurance?
Next Session Assignment
Students are expected to come prepared for the next class by reading about
the Basic types of life insurance.

Module - 32
Topic- Basic Types of Life Insurance Cont’d

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
basic types of Insurance
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the basic types of Insurance. (10 Minuet)

 Identifying the basic types of life insurance.

Reading text
Depending upon the manner of premium payments, whole life insurance contracts are
classified as: straight life, limited pay and single pay policies.

A. Straight life insurance

It is also called ordinary life insurance. Under this policy, premiums are to be paid at
regular interval until the death of the insured or until the achievement of a specified age
limit, say 100 years. Such policy gives permanent protection at the lower cost

B. Limited pay life insurance

Under this insurance scheme, premiums are paid for a definite period of time which is
determined in advance. That is for 10, 15, 20, 25, and 30, years or up to age 85. After the
expiration of the specified time, the policy is said to be paid-up, which means that no
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

more premiums are to be paid to keep the policy in force until the time of death of the
insured at which time compensation amounting the face value of the initial policy is to be
made to the insured’s beneficiary. This policy is desirable when one intends to stop
payment of premiums after reaching a given age level, usually upon retirement, but wants
to continue with the insurance protection till the end of his life. Since premiums are to be
paid for a limited period, they are usually higher than those under the straight life policy.
Similarly, the cash values under the limited whole life insurance are higher than the
straight-line policy.

C. Single payment life insurance

Here, premium payment is made in one lump sum at the time of purchase of the whole
life insurance. In most cases, insurance buyers do not prefer this type of arrangement
(mode of payment).

Synopsis of Lecture (30 Minuet)

Basic Types of Life Insurance.

Depending upon the manner of premium payments, whole life insurance contracts are
classified as: straight life, limited pay and single pay policies.
A. Straight life insurance
It is also called ordinary life insurance. Under this policy, premiums are to be paid at
regular interval until the death of the insured or until the achievement of a specified age
limit, say 100 years. Such policy gives permanent protection at the lower cost
B. Limited pay life insurance
Under this insurance scheme, premiums are paid for a definite period of time which is
determined in advance. That is for 10, 15, 20, 25, and 30, years or up to age 85. After the
expiration of the specified time, the policy is said to be paid-up, which means that no
more premiums are to be paid to keep the policy in force until the time of death of the
insured at which time compensation amounting the face value of the initial policy is to be
made to the insured’s beneficiary.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

C. Single payment life insurance

Here, premium payment is made in one lump sum at the time of purchase of the whole
life insurance. In most cases, insurance buyers do not prefer this type of arrangement
(mode of payment).
Reference Books;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Wrap-Up Discussion Questions (10 Minuet)
 What are types of premium payments in whole life insurance?
Next Session Assignment
Students are expected to come prepared for the next class by reading about
the Basic types of life insurance.

Module - 33
Topic- Basic Types of Life Insurance (Cont’d)
.
Sessions Learning objectives

 At the end of this session students’ will have a better understanding about
the basic types of Insurance
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the basic types of Insurance. (10 Minuet)

 Identifying the basic types of life insurance.

Reading Text

2. Term life insurance

This insurance scheme provides compensation to the beneficiary if the insured dies
within the stated period mentioned in the policy. If the insured survives beyond the
specified time limit in the policy, the policy will expire and there will be no payment
made by the insurer. Term life policy gives temporary protection and there is no saving
element involved. Since the policy is taken for a specified period to deal with premature
death, the cost of this policy is relatively low. It is a form of temporary life insurance.

This is the simplest and oldest form of assurance and provides for payment of the sum
assured on death, provided death occurs within a specified term. Should the life assured
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

survive to the end of the term then the cover ceases and no money is payable. Depending
on the age of the life assured, this is a very cheap form of cover and would be suitable,
for example, in the case of a young married man with medium to low income who wants
to provide a reasonable sum for his wife in the event of his death.

Term policies do not provide the insured with loans, cash surrender or non-forfeiture
options. Insurance coverage terminates at the end of the period unless it provides an
option for conversion into other insurance schemes.

Term life policies can be single or level premium policy. Single premium policy requires
the insured to pay premiums at the time the policy is purchased at lump sum while level
premium requires the payment of equal amount of premiums at definite intervals. Most of
the term policies are level premium. More appropriately, term contracts can be classified
as: level term, renewable term or decreasing term.
A. Level term policy
Level term policy provides a constant sum assured throughout the term of the policy. For
example, under a 15-year term policy of birr 30,000, the amount of payment to the
insured will be birr 30,000 if the insured dies at any time during the policy period. Level
term policies can be convertible or nonconvertible.

I. Convertible term policy

Convertible term policy is a term policy that gives the policyholder the option to convert
his term policy into the other types during the tenure of the term policy. No new evidence
of insurability is required upon conversion. If conversion is not made, the policy lapses at
the end of the term. The term contract can be converted into whole life or endowment
insurance. Conversion may be effected using either the attained age at the time of
conversion of the term policy or using the date of the initial term policy issued. In the
case of the latter, premiums are calculated retroactively, and the insured would be
required to make up the difference in premiums including interest, through lump-sum
payment at the time of conversion. This is similar to term assurance but includes a clause
in the contract which allows the life assured to convert the policy into an endowment or
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Course Title: Risk management and Insurance
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 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

whole life contract at normal rates, without medical evidence. A young person can
therefore purchase low-cost life cover and convert it into the more expensive types as his
career progresses and he can afford more suitable contracts.

To eliminate anti-selection problem, the following requirements are expected upon

conversion.
a. There will not be an increase in the sum assured.
b. The option will have to be exercised within a specified period.

II. Nonconvertible term policy

Under this scheme, the term policy cannot be converted into other forms of life insurance
contracts. The policy terminates upon maturity. However, it could be renewable.

B. Renewable term policy

This is a term life insurance which can be renewed upon expiration. No new evidence of
insurability is required, but the premium charges are adjusted to reflect the standard
premium at the attained age. Accordingly, yearly renewable term policies require renewal
every year. Similarly, a 5-year term policy may be renewed upon its maturity. In most
cases, group policies fail under this category.

C. Decreasing term insurance

In a decreasing term insurance, the sum assured decreases periodically. These policies are
usually issued to cover the outstanding claims (debts) of a creditor (debtor) in the event
of accidental death of the debtor. The outstanding claims (debts) diminish periodically as
installment payments are made by the debtor at regular intervals. In its basic form this is
a type of decreasing term assurance, with the benefit on death paid out by installments
every month or quarter. It is intended to replace the income which the life assured would
have produced for his family if he or she were still alive.

In each case, under the basic term, decreasing term, convertible term, or family income
policy, the benefit is only paid if the life assured dies within the term of the policy. It
should be noted that all these types of policy can also be coupled with an endowment
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Course Title: Risk management and Insurance
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 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

assurance. This is particularly true of decreasing term assurance, where the combination
can be used in conjunction with a standing mortgage. In this case, the benefit will be paid
on death within the policy period, or the endowment part only on survival to the end of
the period.

This type of policies provides financial protection to the policyholder (creditor) and the
family (dependants) of the debtor. The dependants of the insured are saved from raising
funds or selling certain property in order to pay the outstanding loans.

Premiums for a decreasing term insurance are made in a lump-sum payment at the
beginning (single payment).

3. Endowment insurance
This policy provides payment if the insured manages to live till the end of the endowment
period specified in the policy, or upon the death at the time during the term of the policy
or whichever occurs first. The period of this policy is shorter than that for whole life
insurance, and hence the premiums are higher than for the same age level. The shorter the
endowment period the higher the premium. The sum assured is payable in the event of
death within a specified period of, say 15, 20, 25 or 30 years. However, if the life assured
survives until the end of this period (until the 'maturity date') the sum assured will also be
paid. For a given level of cover, the endowment has the highest premium because the life
assurance company is guaranteeing to pay out the sum assured at a given date, or before
it if the person dies. The maturity date is usually no later than the date when the life
assured will reach age 65.

The whole life assurance, mentioned earlier, will be slightly cheaper than a long-term
endowment because the average policy will not become a claim by death until a person is
in his or her seventies. The company has the premiums to invest for a longer period and
can charge lower premiums. The shorter the term of an endowment policy, the more
expensive per sum assured it becomes, since the company has fewer years in which to
collect premiums.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Those buying houses can use endowment assurance. The assurance policy is taken out for
the amount of the loan, or mortgage if a building society is involved, and written in such
a way that the sum assured is payable to the lender or society. The borrower then pays the
interest and the premium. At the end of the term of the loan, the endowment policy
matures and repays the amount borrowed (the capital sum) to the lender. In the event of
the borrower dying prior to the end of the repayment period, the interest to date will have
been paid and the endowment policy will payout to repay the capital sum.

This can be an expensive method of protecting a loan for house purchase, and therefore
many building societies accept modifications involving convertible or decreasing term
and endowment combinations, which are considerably less expensive, but still provide
the same security.

In addition to the above-indicated types of life insurance contracts, the following can also
be considered.

Synopsis of Lecture (30 Minuet)

Basic Types of Life Insurance

2. Term life insurance
This insurance scheme provides compensation to the beneficiary if the insured dies
within the stated period mentioned in the policy. If the insured survives beyond the
specified time limit in the policy, the policy will expire and there will be no payment
made by the insurer.
This is the simplest and oldest form of assurance and provides for payment of the sum
assured on death, provided death occurs within a specified term.
A. Level term policy
Level term policy provides a constant sum assured throughout the term of the policy. For
example, under a 15-year term policy of birr 30,000, the amount of payment to the
insured will be birr 30,000 if the insured dies at any time during the policy period. Level
term policies can be convertible or nonconvertible.
I. Convertible term policy
Convertible term policy is a term policy that gives the policyholder the option to convert
his term policy into the other types during the tenure of the term policy. No new evidence
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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

of insurability is required upon conversion. If conversion is not made, the policy lapses at
the end of the term.
II. Nonconvertible term policy
Under this scheme, the term policy cannot be converted into other forms of life insurance
contracts. The policy terminates upon maturity. However, it could be renewable.

B. Renewable term policy

This is a term life insurance which can be renewed upon expiration. No new evidence of
insurability is required, but the premium charges are adjusted to reflect the standard
premium at the attained age. Accordingly, yearly renewable term policies require renewal
every year. Similarly, a 5-year term policy may be renewed upon its maturity. In most
cases, group policies fail under this category.
C. Decreasing term insurance
In a decreasing term insurance, the sum assured decreases periodically. These policies are
usually issued to cover the outstanding claims (debts) of a creditor (debtor) in the event
of accidental death of the debtor. The outstanding claims (debts) diminish periodically as
installment payments are made by the debtor at regular intervals.

3. Endowment insurance
This policy provides payment if the insured manages to live till the end of the endowment
period specified in the policy, or upon the death with in the policy period or whichever
occurs first. The period of this policy is shorter than that for whole life insurance, and
hence the premiums are higher than for the same age level. The shorter the endowment
period the higher the premium.

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What does decreasing term insurance mean?
 What does it mean endowment insurance has a “ win –win scenario”?

Next Session Assignment

Students are expected to come prepared for the next class by reading about
the Basic types of none life insurance.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Module - 34
Topic- Types of None Life Insurance

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
types of none life Insurance
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the types of non life Insurance. (10 Minuet)

 Identifying the non life insurance class.

Reading text

Non life Insurance

As insurance has developed, the various types of cover have been grouped into several
classes, which have come about by practice within insurance company offices, and by the
influence of legislation controlling the financial aspects of transacting insurance.
Insurance offices are generally split up into departments or sections, each of which will
deal with types of risk, which have an affiliation with each other. There is a very wide
variety in the way in which companies organize their business, but the following
divisions are not unusual:
 Fire, including business interruption;
 Accident, including theft, all risks, goods in transit, glass, money, credit, fidelity
 Liability, including employers' liability, public liability, products and professional
indemnity;
 Motor; engineering; marine and aviation; life and pensions.

Personal Accident Insurance

This type of cover is devised to compensate the insured that is temporarily or totally
disabled from engaging in his usual occupation due to sickness. Personal accident
and sickness policies are renewable annually and, if a claim has occurred, which

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Course Title: Risk management and Insurance
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 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

could be of a recurring nature, the cover may be restricted at renewal or in severe

cases renewal may not be offered.
Permanent Health Insurance
This type of cover has been devised to overcome the limitation of the personal
accident and sickness policies. It provides benefits for those who are disabled for
longer periods or who, due to accident or illness, have to change to a lower paid
occupation. It may also be called long term disability insurance.

It is usual to arrange cover to exclude the first month, six months or twelve months of
disablement with appropriate discounts in the premium rates, since many people will
receive a substantial part of their salaries for a certain period when off-work. Cover
cannot continue beyond age 65 and in order to save premium some people elect for
cover to cease at age 55 or 60. The maximum benefit payable is usually 66 per cent
or 75 per cent of earnings, less any other disability benefits payable.

The intention of the basic policy is to provide compensation in the event of an

accident causing death or injury. What are termed capital sums are paid in the event
of death or certain specified injuries, such as the loss of limbs or sight as may be
defined in the policy.

The policy is usually extended to include a weekly benefit for up to 104 weeks, or
compensation if the insured is temporarily totally disabled due to an accident and a
reduced weekly benefit if he is temporarily only partially disabled from carrying out
his normal duties. In the event of permanent total disablement (other than loss of eyes
or limbs) an annuity is paid.

In addition to the purchase of personal accident insurance by individuals, it is also

possible for companies to arrange coverage on behalf of their employees and many
organizations arrange 'group schemes' to this end.

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Course Title: Risk management and Insurance
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 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Synopsis of Lecture (30 Minuet)

Types of None Life Insurance

As insurance has developed, the various types of cover have been grouped into several
classes, which have come about by practice within insurance company offices, and by the
influence of legislation controlling the financial aspects of transacting insurance. Fire,
including business interruption;
Accident, including theft, all risks, goods in transit, glass, money, credit, fidelity
Liability, including employers' liability, public liability, products and professional
indemnity;
Motor; engineering; marine and aviation; life and pensions.

Personal Accident Insurance

This type of cover is devised to compensate the insured that is temporarily or totally
disabled from engaging in his usual occupation due to sickness. Personal accident and
sickness policies are renewable annually and, if a claim has occurred, which could be of a
recurring nature, the cover may be restricted at renewal or in severe cases renewal may
not be offered.
Permanent Health Insurance
This type of cover has been devised to overcome the limitation of the personal accident
and sickness policies. It provides benefits for those who are disabled for longer periods or
who, due to accident or illness, have to change to a lower paid occupation. It may also be
called long term disability insurance.

It is usual to arrange cover to exclude the first month, six months or twelve months of
disablement with appropriate discounts in the premium rates, since many people will
receive a substantial part of their salaries for a certain period when off-work. Cover
cannot continue beyond age 65 and in order to save premium some people elect for cover
to cease at age 55 or 60. The maximum benefit payable is usually 66 per cent or 75 per
cent of earnings, less any other disability benefits payable.

The intention of the basic policy is to provide compensation in the event of an accident
causing death or injury. What are termed capital sums are paid in the event of death or
certain specified injuries, such as the loss of limbs or sight as may be defined in the
policy.

The policy is usually extended to include a weekly benefit for up to 104 weeks, or
compensation if the insured is temporarily totally disabled due to an accident and a
reduced weekly benefit if he is temporarily only partially disabled from carrying out his
normal duties. In the event of permanent total disablement (other than loss of eyes or
limbs) an annuity is paid.

99
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What are the major types of non life insurance?
Next Session Assignment
Students are expected to come prepared for the next class by reading about
the Basic types of none life insurance.

Module - 35
Topic - Types of None Life Insurance (Cont’d)
Sessions Learning objectives

 At the end of this session students’ will have a better understanding about
the types of none life Insurance
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the types of non life Insurance. (10 Minuet)

 Identifying the basic types of life insurance

Reading Text
Motor Insurance
The minimum requirement by law is to provide insurance in respect of legal liability
to pay damages arising out of injury caused to any person. Policies with various
levels of cover are available:

 Third party only: provides cover in respect of liability incurred through death or
injury to a third party, or damage to third party property.

 Third party, fire and theft: provides cover as above and in addition includes cover for
damage to the vehicle from fire or theft.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

 Comprehensive: provides cover as above and in addition including cover for

accidental loss of, or damage to, the vehicle itself. This is the most common form of
policy.

Private car insurance applies to private cars used for social and domestic purposes and/or
business purposes. Comprehensive policies issued to individuals also include personal
accident benefits for the insured and spouse, medical expenses and loss of, or damage to,
rugs, clothing and personal effects.

Vehicles used for commercial purposes (including lorries, taxis, vans, hire cars, milk
floats and police cars) are not insured under private car policies, but under special
contracts known as commercial vehicle policies.

Separate cover is available for motorcycles. The type of policy depends upon the
machine, whether it is a moped or a high-powered motorcycle, and on the age and
experience of the cyclist. The cover is comparatively inexpensive relative to motorcar
insurance.

Special policies are offered to garages and other people within the motor trade, to ensure
that their liability is covered while using vehicles on the road. Damage to vehicles in
garages and showrooms can also be included under such policies.

In addition to private cars, motorcycles and commercial vehicles, there are a number of
vehicles which fall into a category known to insurers as 'special types'. These will include
forklift trucks, mobile cranes, bulldozers and excavators. Such vehicles may travel on
roads as well as building sites and other private ground. Where these vehicles are not
used on roads and are transported from site to site, it is more appropriate to insure the
liability under a public liability policy, since the vehicle is really being used as a 'tool of
trade' rather than a motor vehicle and include fire, theft, collision and a wide range of
other perils.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Marine and Transport Insurance

I. Marine cargo
Marine policies relate to three areas of risk: the hull, cargo and freight. While hull and
cargo are self explanatory, the word freight may not be: it is the sum paid for transporting
goods, or for the hire of a ship. When goods are lost by marine perils then freight, or part
of it, is lost; hence the need for cover.

The risks against which these items are normally insured are collectively termed 'perils of
the sea' Cargo is usually insured on a warehouse (of departure) to warehouse (of arrival)
basis and frequently covering all risks. Terms of sale and conditions of carriage have
important implications for cargo insurers where goods may change ownership and pass
through the hands of more than one shipper or haulier. It is vitally important in cargo
insurance to establish who is responsible for the insurance cover and to work out when
the risk passes from the consignor to the consignee.

Insurers often rely on inadequate packing/loading to modify claims under cargo covers.
Where appropriate insurers will pay claims and then seek recoveries from carriers.

II. Marine liabilities

The custom has been to provide insurance for three-quarters of the ship owner’s liability
for collisions at sea under a marine policy. The remaining quarter, and all other forms of
liability, are catered for by associations set up for the purpose by ship owners and known
as Protecting and Indemnity Clubs (P and I clubs). It should be noted that the P and I
clubs can now insure hull and machinery as well as liabilities.

III. Aviation insurance

The use of aircraft as a means of transport is increasing each year and because of the
specialist and technical nature of the risks associated with it, plus the high potential cost
of accidents, all aviation risks, from component parts to complete jumbo jets, are insured
in the aviation insurance market.

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Course Title: Risk management and Insurance
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 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Most policies are issued on an 'all risks' basis, subject to certain restrictions. The buyers
of these policies include the large commercial airlines, corporate aircraft owners, private
owners and flying clubs. Usually a comprehensive policy is issued covering the aircraft
itself (the hull), the liabilities to passengers and the liabilities to others.

Liability for accidents to passengers is governed by a maze of international agreements

and national laws around the world. The main ones are the Warsaw Convention 1929,
which made signatories liable to passengers without negligence, subject to certain
maximum amounts, and the Hague Protocol 1955, which raised some of these limits. The
national laws may place higher limits on domestic flights. For domestic flights within the
UK the provisions of the Carriage by Air Act 1961 apply together with Orders made
under it. You will find reference to limits of liability in the small print, which forms part
of the standard airline ticket.

The position has been made more complex by some governments imposing on their
national airlines increased limits of liability, which do not have worldwide approval.
Although the appropriate rules for calculation of legal liability are normally determined
by reference to the country at point of departure and the country of destination recorded
on the ticket, an airline disaster may produce claims from passengers of many
nationalities.

It is interesting to note that in Goldman v. Thai Airlines International (1981), it was

held that the limits did not apply when the aircrews were 'reckless' in flying the aircraft.
In the aftermath of the Lockerbie disaster, there have been a number of attempts at
securing much higher compensation than the agreements laid down. Some claims have
been settled for higher amounts, especially when the limits have appeared low in relation
to the earning capacity of the passenger.

There have been unsuccessful efforts to increase the Warsaw/Hague limits. Change will
only be piecemeal without the support of the major airline operating countries, notably
the United States of America.

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Course Title: Risk management and Insurance
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 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

The two international agreements also place limits on liability for goods carried by air.
Unless of special risk or value, cargo is usually insured 'all risks' in the marine or general
markets rather than in the aviation market. Other groups of persons requiring aviation
liability cover are aircraft and aircraft component manufacturers, and airport authorities.

Fire and Other Property Damage Insurance

There are a number of different ways in which property can be damaged. One needs only
to think of a small factory unit to imagine all that can be damaged and all the ways in
which damage can be sustained. Fire and theft probably come to mind first, but then there
are very many different forms of accidental damages.

I. Fire Insurance
In most commercial policies the insured will require cover for buildings, machinery and
plant, and stock. These are the three main headings under which property is insured and
in some cases a list of such items can run to many pages, depending upon the size of the
insured company.

In addition to these areas it may be necessary to arrange cover for property while it is still
being built, that is buildings in course of erection, but this form of cover is gradually
giving way to a policy known as 'contractors all risks' which will be discussed later.

A standard fire policy is used for almost all business insurances, with Lloyd's of London
also issuing a standard fire policy that is slightly different in its wording. The basic
intention of the fire policy is to provide compensation to the insured person in the event
of there being damage to the property insured. It is not possible, in the commercial world,
to issue a policy that will provide compensation regardless of how the damage occurs.
The insurance companies, the insurers, have to know which perils they are insuring
against.

The standard fire policy covers damage to property caused by fire, lightning or explosion,
where this explosion is brought about by gas or boilers not used for any industrial
purpose.
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Course Title: Risk management and Insurance
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 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

This is limited in its scope because property can be damaged in other ways and, to meet
this need, a number of extra perils (known as special perils) can be added on to the basic
policy. These perils are:
 Storm, tempest or flood;
 Burst pipes;
 Earthquake;
 Aircraft;
 Riot, civil commotion;
 Malicious damage;
 Explosion;
 Impact.
It is important to remember that these additional perils must result in damage to the
property, and it is as well to precede each by saying 'damage to the property caused by
special peril element'.

II. Theft insurance

Theft policies have the same aim as the standard fire policy, in that they intend to provide
compensation to the insured in the event of loss of the property insured.

The property to be insured, for a commercial venture, will be the same as under the fire
policy, of course except for the buildings. The theft policy will, in addition, show a more
detailed definition of the stock. The reason for this is that fire is indiscriminate, whereas a
thief is not, so the insurers charge more for stock which is attractive to thieves.

The law has its own definition for theft having an impact on insurance companies, as it
defined the term 'theft'. The legal definition was wider than that which the companies
were prepared to offer, especially for business premises, because the definition did not
mention any need for there to be force and violence in committing a theft. This meant
that shoplifting, for example, was 'theft' and this kind of risk had traditionally been
uninsurable. To remedy the problem, insurance companies included in their policies a
phrase to the effect that theft, within the meaning of the policy, was to include force and
violence either in breaking into or out of the premises of the insured.

105
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Synopsis of Lecture (30 Minuet)

Types of None Life Insurance

Motor Insurance
The minimum requirement by law is to provide insurance in respect of legal liability to
pay damages arising out of injury caused to any person. Policies with various levels of
cover are available:
Third party only: provides cover in respect of liability incurred through death or injury
to a third party, or damage to third party property.

 Third party, fire and theft: provides cover as above and in addition includes
cover for damage to the vehicle from fire or theft.

Comprehensive: provides cover as above and in addition including cover for accidental
loss of, or damage to, the vehicle itself. This is the most common form Marine and
Transport Insurance

I. Marine cargo
Marine policies relate to three areas of risk: the hull, cargo and freight. While hull and
cargo are self explanatory, the word freight may not be: it is the sum paid for transporting
goods, or for the hire of a ship.
II. Marine liabilities
The custom has been to provide insurance for three-quarters of the ship owner’s liability
for collisions at sea under a marine policy.

III. Aviation insurance

The use of aircraft as a means of transport is increasing each year and because of the
specialist and technical nature of the risks associated with it, plus the high potential cost
of accidents, all aviation risks, from component parts to complete jumbo jets, are insured
in the aviation insurance market.

106
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Fire and Other Property Damage Insurance

There are a number of different ways in which property can be damaged. One needs only
to think of a small factory unit to imagine all that can be damaged and all the ways in
which damage can be sustained. Fire and theft probably come to mind first, but then there
are very many different forms of accidental damages.
Theft insurance
Theft policies have the same aim as the standard fire policy, in that they intend to provide
compensation to the insured in the event of loss of the property insured.

The property to be insured, for a commercial venture, will be the same as under the fire
policy, of course except for the buildings. The theft policy will, in addition, show a more
detailed definition of the stock. The reason for this is that fire is indiscriminate, whereas a
thief is not, so the insurers charge more for stock which is attractive to thieves.
Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 Explain briefly about aviation insurance and marine liabilities?

Next Session Assignment

Students are expected to come prepared for the next class by reading about
the limitation of insurance.

Module - 36
Topic- Life insurance premium determination

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
computations in life insurance premium determinations.
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about premium determinations in life Insurance. (10 Minuet)

 Identifying the limitations of insurance.

107
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Reading Text
Life Insurance Premium Calculations
The determination of a price for insurance is a complex activity and involves the
incorporation of a mathematical analysis into competitive business decision processes.
This price is known as premium, which may be paid annually, semi-annually, quarterly or
monthly.

Life insurance premium are influenced by the following major determinants:

1. Expected mortality rates in the insured population. The morality table can be prepared
from the census records or from the records of the first class insurance companies.
2. Investment income earned by the insurer on invested premium Income-Interest factor.
Life insurance is a long term contact and premium so received is invested in securities or
deposited in a bank yielding interest. Such income may help reduce the cost of insurance.
So interest-earning is also a factor for calculating the premium rate.
3. Expenses incurred in operating an insurance enterprise and in providing insurance –
related services. The expense includes policy expenses, commission to agents, cost of
preparing policy, administrative and local charges loaded, and other service charges.
4. Other factors required to determine premium rate include: age and sex of the insured,
period of the insurance policy, and sum assured.

Types of life insurance premiums

1. Net premium. The determination of net premium considers only the mortality rate
and rate of interest. It ignores operating costs charged by the insurer. N.B. Net premium
provides the insurer only with the amount of money required to pay death claims. The net
premium to be paid could be single or level premium. Net single premium is the net
premium to be paid as a single sum at the beginning of the contract while a net level
premium is a premium charge that doesn't change from year to year throughout the term
of the policy.
2. Gross Premium. The insurer's costs of operating the business are added to the net
premium, which is called loading. Loading is the act of adding costs of running business
to the net premium costs including operating expenses, commissions, advertisement
expenses, etc.

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Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Synopsis of Lecture (30 Minuet)

Life insurance premium determination

Insurance premium is the price of an insurance protection. It keeps the policy enforce,
premium may be paid annually, semi annually quarterly or monthly,

Net Premium, the premium rate determine on the basis of mortality rate and interest rate
only. It does not include the operating cost charged by the insurer, hence it only provides
with the money required to pay death claims.

Net single premium; The total net premium of an insurance policy is paid at a single sum
at the beginning of the contract, this is the present value of all claims divided by number
of policy holders.

Net Level Premium; A premium charge that does not change from year to year through
the term of the policy . in other words the policy holder pays the same amount of
premium each year.

Gross Premium; When portion of all the insures cost of running the business are added to
the net premium, the resultant premium is called gross premium . Then gross premium is
the amount the policy holder pays to the insure to keep the policy in force. Insurance
terminology the addition of insures cost of doing business to the net premium is called
loading. This cost includes the operating expenses, commissions, advertisement expenses
and etc.

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What is the difference between net premiums and the Gross premium
collected by insurance companies?

Next Session Assignment

Students are expected to come prepared for the next class by reading about
the basic assumptions in premium determination.
109
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Module - 37
Topic- The required information and Basic Assumption in
Premium Determinations

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
computations in life insurance premium determinations and the underlining
assumptions.

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about the assumptions in premium determinations. (10 Minuet)
 Basic assumption in premium determinations.

Reading Text

Required information and Basic Assumption in Premium Determinations

The required information for selections of risks and premium determination can be
obtained from
 From the insured’s application
 From the agent’s recommendation
 From further investigation made by the insurance expertise
The required information includes;
A) Age and Sex of the insured.
B) Mortality rate: the ratio of number of dying at a given year to a number of living at
the beginning of the policy period.
C) The interest rate.
D) The policy amount,

The Basic Assumptions;

1. Premiums are to be collected in advance.
2. Payment of death benefit will be made at the end of the year.
3. The payment collected in advance will be invested in a bank to earn interest income.
4. Every insured is expected to contribute to the fun of the further expected claims. Net
single premium is obtained by summing up the products of the face value of the policy,
mortality rate and discount factor the term of the policy.

110
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Synopsis of lecture

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 What are the underlying assumptions before the premium determination is done?

Next Session Assignment

Students are expected to come prepared for the next class by reading about
premium determination for term insurance.

Module - 38
Topic- Term Insurance Premium Determinations

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
computations made in term insurance

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about premium determinations in term Insurance. (10 Minuet)

 Application of term insurance premium determinations

Reading Text

General Illustrations on Premium Determinations

According to a recent census made in a certain city,

Initial Population of 1,000,000.
960,000 of them are expected to live at the age 35.
The number of people expected to die at this age is estimated to be 2,100.
By assuming further that XYZ insurance company has issued a one year Term insurance
to all residents of the city who are expected to live at the given age.
111
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

All premiums are to be collected at the beginning of the policy period.

Interest rate 10%.
Death benefit/ Death claim for the beneficiaries Br,5000
[Link] Death. = Number of people expected to die at the given age
Total number living at the given age.

2100 = 0.00218
960,000
Expected amount of death claim = 2100x 5000= Br, 10,500,000
The present value of death claims (PV= FV (1+i)-1 = Br=9,545,454.55

Synopsis of Lecture
Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Next Session Assignment

Students are expected to come prepared for the next class by exercising on
premium determination for term insurance.

Module - 39
Topic- Term Insurance Premium Determinations

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
computations made in term insurance

Discussion issues; Students are encouraged to participate in the class based on their
previous readings about premium determinations in term Insurance. (10 Minuet)

 Computations in term insurance premium determinations

112
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Reading Text
Term Insurance Premium Determinations
This insurance scheme provides compensation to the beneficiary if the insured dies
within the stated period mentioned in the policy. If the insured survives beyond the
specified time limit in the policy, the policy will expire and there will be no payment
made by the insurer.
This is the simplest and oldest form of assurance and provides for payment of the sum
assured on death, provided death occurs within a specified term.

NSP (Net Single Premium) = Present Value of Total Death claim

Number living at the beginning.
NLP (Net Level Premium) = NSP Term
PV of Birr 1 Premium payment per insured.
GSP (Gross Single Premium) = NSP
(1-Loading %)
GLP (Gross Level Premium) = NLP
(1-Loading %)

Synopsis of Lecture

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Next Session Assignment

Students are expected to come prepared for the next class by exercising on
premium determination for term insurance.

Module - 40
Topic- Term Insurance Premium Determinations

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about
the computations made in term insurance

Discussion issues; Students are encouraged to participate in the class based on the
exercise given in the class. (10 Minuet)
113
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

 Computations in term insurance premium determinations

Reading Text
Class Room Exercise on Term Insurance

Assume that XYZ CO, has issued a 3-years term insurance for residents of X- City, out of
an initial population of 1.5mil, 960,000 them are expected to live at the age35,
Year Age Number Living Number Dying Death Claim
1 35 960,000 1600 Br 5000
2 36 958,400 2400 5000
3 37 956,000 1000 5000
(4 ) 38 955,000 -
Calculate,

A) NSP ( Net Single Premium)

B) NLP ( Net Level Premium)
C) GSP( Gross Single Premium)
D) GLP ( Gross Level Premium)
 Assume that the Loading Percentage is 30%.

Synopsis of Lecture

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Next Session Assignment

Students are expected to come prepared for the next class by reading about
premium determination for Endowment insurance.

114
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Module – 41
Topic- Endowment Insurance Premium Determinations

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
computations made in Endowment insurance.
Discussion issues; Students are encouraged to participate in the class based on their
previous readings about endowment insurance. (10 Minuet)

 Computations in Endowment insurance premium determinations

Reading Text

Endowment Insurance Premium Determinations

Pure Endowment; the sum assured will be given if the insured manages to live till the end
of the endowment period.
Survival Rate= (Number Living at the end of the policy period)
Number living at the end of the policy period)
NSP Pure Endowment = ( Sum assured x Prob. Survival X Present value factor)

NLP Pure Endowment = ( NSP Pure endowment)

PV of Birr 1Premium payment
Ordinary Endowment; The sum assured will be given to the Beneficiaries if the insured
dies with the endowment period or he/ she take the sum assured if he/ she manages to live
till the end of endowment period.( Win – Win) case.

NSP Ordinary Endowment = ( NSP Pure Endowment + NSP Term )

NLP Ordinary Endowment= (NSP Ordinary Endowment)

Present value of Birr 1 Premium payment

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

115
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Wrap-Up Discussion Questions (10 Minuet)

 What is the difference between Term and Endowment insurance premium
computations?

Next Session Assignment

Students are expected to come prepared for the next class by exercising on
endowment insurance.

Module - 42
Topic- Endowment Insurance Premium Determinations

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
computations made in term insurance

Discussion issues; Students are encouraged to participate in the class based on the
exercise given in the class. (10 Minuet)

 The computations made on Endowment insurances.

Reading Text

Class Room Exercise on Endowment Insurance

Assume that ABC, has issued a 4-years Ordinary endowment insurance for residents of
X- City, out of an initial population of 700.000
450,000 them are expected to live at the age30,
Year Age Number Living Number Dying Death Claim
1 30 450,000 11,000 Br 7000
2 31 439,000 11,800 7000
3 32 427,200 12,600 7000
4 33 414,600 13,000
(5 ) 34 401,600 - .

Calculate;

A)NSP, Pure Endowment.

B) NLP, Pure Endowment
C)NSP Ordinary Endowment)

116
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

D)NLP Ordinary Endowment

E.) GSP Ordinary Endowment.

 Assume that the Loading Percentage is 30%.

Synopsis of Lecture

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Next Session Assignment

Students are expected to come prepared for the next class by reading about
premium determination for Whole life insurance.

Module - 43
Topic- Whole Life Insurance Premium Determinations

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about the
computations made in Whole life insurance

Discussion issues; Students are encouraged to participate in the class based on their
pervious readings about whole life insurance
 Whole life insurance premium determinations.
Reading Text

Whole Life Insurance Premium Determinations

In this kind of life insurance, the sum assured is payable on the death of the life assured
whenever it occurs. Premiums are payable either throughout the life of the assured or can
cease at a certain age,
This policy provides protection to the dependants of the insured upon the event of his/her
death. I.e. the sum assured is payable only upon the death of the insured.
 One option is that the insured pays annual premiums as long as he lives.
 The second option is that premium payments are made for a specified number of
years or up to a certain age limit, normally up to the age of retirement.

117
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Premium payments after retirement are discontinued because of a decline in the income
of the insured.
 The policy provides permanent protection to the insured’s dependants in the case
of death. Besides this protection, whole life insurance allows for the
accumulation of savings over the life of the insured. In essence, the policy
encourages saving.

Whole life policy acquires cash value after two or three years of premium payment.
When a person no longer wants his policy, or for some reason cannot continue the
premiums, he can ask for the surrender value.

Synopsis of Lecture

Reference Texts;
Unity University College, School of Distance and Continuing Education, Course
Material for Risk Management and Insurance (Degree Program).
Hailu Zelleke, Risk Management and Insurance AAU, 1991

Wrap-Up Discussion Questions (10 Minuet)

 How does whole life insurance provides permant protection ?
Next Session Assignment
Students are expected to come prepared for the next class by reading about
Re Insurance and its applications.

Module - 44
Topic- Concept of Re-Insurance and Its Applications

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about
the concept s, meanings of reinsurance and it applications.

Discussion issues; Students are encouraged to participate in the class based on their
pervious readings about whole life insurance (10 Minuet)
 The meaning and concepts of reinsurance.

118
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Reading Text

Concept of Re-Insurance and Its Applications

Definitions
 Reinsurance is shifting of part of or all of the insurance originally written by one
insurer to an other insurance.

Reasons for Reinsurances

 To increase underwriting capacity.
 To stabilize profit.
 To reduce unearned premium reserve.
 To provide protection against a catastrophic loss.

Considerations in setting Retention amount

3. The size of the insurance company.
4. The financial condition
5. The insurers’ management philosophies.
6. Characteristics of the exposure under consideration.

Parties in the Insurance Business:

1. The Primary (Ceding ) Insurer.
2. The Re insurer.

Synopsis of Lecture
Reference Books;
George E. Rajda, George E. Rajda, Principles of Risk Management and Insurance,
2002

Wrap-Up Discussion Questions (10 Minuet)

 What does reinsurance mean?
 What sort of advantages does it provide?

Next Session Assignment

Students are expected to come prepared for the next class by reading further
about Re Insurance and its applications.

119
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Module - 45
Topic- Concept of Re-Insurance and Its Applications (Cont’d)

Sessions Learning objectives

 At the end of this session students’ will have a better understanding about
the concept s, meanings of reinsurance and it applications.

Discussion issues; Students are encouraged to participate in the class based on their
pervious readings about whole life insurance (10 Minuet)

 The application of Re insurance.

Reading Text

Synopsis of Lecture (30 Minuet)

Concept of Re-Insurance and Its Applications

Types of Reinsurance;
There are two principal forms of re insurance;
1. Facultative Re insurance; an optional case by case method that is used when the
ceding company receives an application for insurance that exceeds the retention limit.
Before the policy is issued, the primary insurer shops around for reinsurance and contacts
several reinsurances.

Facultative reinsurance is frequently used when a large amount of insurance is desired.

2. Treaty Re insurance; in this case the primary insurer has agreed to cede the insurance
to the insurer and the re insurer has agreed to accept the business. Among the several
advantages of treaty reinsurance it is automatic and no uncertainty or delay is involved.
There Are several types of re insurance treaty arrangements.
[Link] share treaty.
2. Surplus share treaty.
3. Excess of loss treaty.
4. Re insurance pool.

Reference Books;
George E. Rajda, George E. Rajda, Principles of Risk Management and Insurance,
2002

120
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum
 Unity University College
Faculty of Business and Economics, Department of Management and Marketing

Wrap-Up Discussion Questions (10 Minuet)

 What are the types of reinsurance treaties?
 What is the difference between Facultative reinsurance and Treaty
reinsurance?

=Final Exam=

121
Course Title: Risk management and Insurance
Prepared By: Robel Seyoum