CHAPTER 1
THE NATURE OF RISKS
LEARNING OBJECTIVES
Upon completion of this chapter, you should
be able to :
Define some common terminology
Describe the concept of risk, perils,hazard and loss
Explain different types of probabilities theories
Discuss classification risk
Distinguish different types of pure risk
Overview
Concept Of Risk
Concepts Of Peril, Hazards And Loss
Probability Theories
Classifications Of Risks
Types Of Pure Risks
CONCEPT OF RISK
Life is full of risks.
– Name the risks faced by you once you decided to pursue
Bachelor Degree? Risks facing you when you are driving
car?
Risk is inherent in all aspects of our lives.
Risk creates both problems and opportunities
– Name the bright and dark side of risks- Computer failures
Definition of risk
A condition in which there is a possibility of adverse deviation
from a desire outcome that is expected or hoped for.
Implies some form of uncertainty about an outcome in a
given situation.
It contrast with chance. Though chance implies some
doubt but the outcome is normally a favorable outcome.
Possibility of
an unfortunate
occurrence
Risks implies;
• Some form of Uncertainty about an
Possibility of
Unpredictable outcome in a given situation.
Loss
• Both doubt about future
Definition
of RISKS
• Outcome will leave us in a worse
position
Combination Uncertainty of
of Hazards loss
Risk & Chance
RISK CHANCE
• Uncertainty about an outcome of • Some doubt or uncertainty
an event. about the outcome of an event
• The outcome normally • The outcome normally a
NEGATIVE
POSITIVE.
• Eg;
• Bukit Antarabangsa
Condominium Residents
• Smoker
Concept of RISK
Risk is a situation in which some kind of loss is possible and
part of life.
Insurance protect risk, where it those who purchase
insurance are financially compensated in case of loss.
Although we are uncertain as to when the future losses will
take place, it is possible to estimate the probability of loss by
applying the probability theories provided that there is a
large number of exposures.
CONCEPTS OF PERIL, HAZARD AND LOSS
Loss Hazard
• A reduction or • A condition that increases the
disappearance of chance of loss
economic value • Physical Hazard
Peril • Physical condition that increases
the condition of loss
• Is a cause of loss • Moral Hazard
• A character defect in an
individual that increases the
chance of loss
• Morale Hazard
• A character defect in an
individual that increases the
chance of loss with the
knowledge that insurance exists
PROBABILITY THEORIES
A Priori Probability
• Determined when the total number of possible events
are known.
• Example: the probability of getting a six on a roll of dice
is 1/6.
• This concept has a limited practical application in the
study of risk because situations where a number of
possible outcome are known are very rare.
Empirical Probability
• Determined on the basis of historical data
• Example: road accidents.
• The underlying concept that makes it possible for empirical probability to be
measured accurately is that as the number of observations increases, the
predicted loss tends to approach the actual loss (the law of large numbers)
Law of large numbers is a concept with the following requirements:
• Large number of similar loss exposures
• Loss exposures must be independent
• Random occurrence of losses.
Judgmental Probability
• Determined based on the judgment of the person
predicting the outcome.
• It is used when there is lack of historical data or credible
statistics.
• Example: Astronaut program by Malaysia. The
insurance company in Malaysia uses judgmental
probability due to lack of credible statistics.
CLASSIFICATIONS OF RISKS
Fundamental and Particular Risks
• Fundamental risk
• Affects the entire economy or large number of persons/groups within the
economy
• Affects the society in general and cannot be controlled
• Example: Tsunami, earthquake
• Particular risk
• Those future outcomes that we can partially control
• Arises from individual decisions
• Example: to further study or to drive a car
Pure and Speculative Risks
• Pure Risk
• There are possibility of loss or no loss
• Example: to pass or to fail the exam
• Speculative Risk
• Possibility of loss, no loss or profit
• Example: investment
Financial and Non Financial Risks
• Financial Risks
• Outcome can be measured by monetary terms
• Example; Property damages can be measured in terms
of loss of profit
• Non Financial Risks
• Outcome cannot be measured by monetary terms
• Example: Choice of career will affect ones quality of life.
TYPES OF PURE RISKS
Personal Risks
Property Risks
Liability Risks
Personal Risks
• Risk of premature death
• Significant losses: loss of human value and additional expenses
• Risk of old age
• Significant loss: insufficient income during retirement
• Risk of poor health
• Significant losses: Expensive medical charges and loss of earned
income
• Risk of unemployment
• Significant losses: loss of earned income and depletion of
accumulation financial assets.
Property Risk
• Direct Loss
• Damage to property by a peril.
• Example: house destroyed by fire
• Indirect loss
• Loss in consequence of a direct loss
• Example: loss of profit
• Extra expenses
• Extra costs incurred as a result of the loss
• Example: owner have to rent another building to continue operation/
living.
Liability risks
• Risks of being sued because of neglect, malpractice, or
causing willful injury either to another person or to
someone else's property.
• Possibility of financial loss if you are found liable, or the
financial loss incurred just defending yourself, even if
you are not found liable.
