NATURE OF RISK PDF

The Nature of Risk  Definition of Risk Vaughan and Vaughan (2013) defined risk as “a condition in which there is a possibility of adverse deviation from a desired outcome that is expected or hoped for”. In other words, risk implies some form of uncertainty about an outco...

The Nature of Risk  Definition of Risk Vaughan and Vaughan (2013) defined risk as “a condition in which there is a possibility of adverse deviation from a desired outcome that is expected or hoped for”. In other words, risk implies some form of uncertainty about an outcome in a given situation and normally the outcome will be unfavorable or undesirable.  Definition of Risk The possibility of loss Chance of loss Uncertainty The dispersion Possibility of of actual from an unfortunate Risk expected occurrence results  Concept of Risk Risk is inherent in all aspects of our lives. Risk implies some form of uncertainty about an outcome in a given situation. Risk creates both problems and opportunities. Risk brings surprises to us and makes our lives interesting. Risk always implies negative consequences.  Elements of Risk A state of mind characterized by doubt, based on lack of knowledge about what will or will not happen in the future. Uncertainty Example : we are not able to predict whether you will involve in road accident or not. The frequency of loss : how often will the loss occur ? The Degree of Risk The severity of loss : how severe will the loss be once it has occurred? The actual and active cause of loss under an insurance policy. Proximate Cause In the event of loss where there are many causes, the insurer is only liable for losses proximately cause by an insured peril.  Level of Risk In insurance, it is usual to have a high frequency and low severity incidents and a low frequency and high severity incidents. For example, there are more motor accidents every day as compared to plane crashes. Motor accidents are frequent, but the outcome is less severe whereas plane crashes seldom occur, but the consequences are very high.  Peril A peril is a cause of loss. Examples : fire, lightning, explosion, accident, burglary, housebreaking, theft, windstorm, hail, illness, premature death, legal liability etc. Additional Perils (Special Perils) in Insurance : Social - strike, riot and civil commotion, malicious damage and etc. Miscellaneous - aircraft impact damage, bursting and overflowing of water tanks and etc. Nature - flood, typhoon, hurricane, storm, tempest, volcanic eruption, earthquake, landslide, landslip, subsidence or sinking of the soil and etc.  Hazard A hazard is a condition that may create or increase the chance of loss. Hazards are normally classified into three categories: a) Physical hazard b) Moral hazard c) Morale hazard  Types of Hazard A physical condition that increases the chance of loss. Physical Relates to the physical or tangible aspect of risks, which are likely to influence the occurrence and / or severity of loss. A character defect in an individual that increases the chance of loss. Moral Results from the dishonest tendencies in the character of the insured person. An attitudinal defect in an individual which increases the chance of loss with the knowledge that insurance exits. Morale Acts to increase losses where insurance exits, not necessarily because of dishonesty but because of a different attitude toward losses that will be paid by insurance.  Examples of Hazards Physical Moral Morale Hazard Hazard (Conscious) Hazard (Unconscious) Types of construction Dishonesty or Failure in safeguarding The location of property intentionally cause a loss own property The occupancy of the (fraud) Drive recklessly building Exaggerating Claim Unhealthy lifestyles Road & vehicles condition Speeding Dangerous hobbies Poor wiring system Smoking (jumping of a cliff, Defective door lock Carelessness parachuting, skydiving, Poor housekeeping bungee jumping etc.) Overweight  Loss Loss is a reduction or disappearance of economic value. Perils Loss Fire, lightning, explosion property damage, bodily injury, death, loss of income Accident (collision or overturning) cost of repair, bodily injury or death, property damage, legal cost Burglary, housebreaking, theft loss of property, property damage due to attempted to theft Legal liability sued at tort, court awards and legal expenses Illness medical cost, loss of income Premature death funeral expenses, living expenses  Peril, Hazard and Loss Peril Perils Hazard Loss Perils is a cause of loss. Fire storage of hazardous property damage lightning materials bodily injury Examples : fire, lightning, explosion, explosion wooden construction premature death accident, natural disasters, legal liability. left unoccupied loss of income Hazard Poor housekeeping additional expenses Hazard is a condition that increases the chance of loss. Motor poor braking systems property damage accident bodily injury Examples : physical, moral and morale. engine problems premature death loss of use Loss additional expenses. Loss is a reduction or disappearance of economic value. Legal liability negligence court awards carelessness legal expenses Examples : property damage, bodily tort injury, death, loss of income, unemployment, court awards.  Probability Theories The term probability refers to an area of study which measures the chance of a particular event occurring. It is also can be defined as the likelihood that the event will occur. The three common types of probabilities theories are a priori probability, empirical probability and judgemental probability.  A Priori Probability Determined when the total number of possible events is 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 outcomes are known but very rare.  Empirical Probability Determined based on historical data. Example: number of road accident and fatalities, fire, flood, critical illness and etc. This is the underlying concept that makes it possible for empirical probability to be measured accurately; as the number of observations increases, the predicted loss tends to approach the actual loss (the law of large numbers).  Judgemental Probability Determined based on the judgement of the expert person in predicting the outcome. It is used when there is lack of historical data or credible statistics. Examples : Astronaut program by Malaysia and operating a nuclear plant in Malaysia. Types of Risk Pure Risk & Speculative Risk Fundamental Risk & Particular Risk Financial Value Risk & Non-Financial Value Risk  Pure Risk & Speculative Risk Pure Risk There is only a possibility of loss or no loss. No possibility of gain or profit. Example : probability of injuries in a road accident. Pure risk also can be categorized as personal risk, property risk and liability risk. Speculative Risk There is possibility of profit or loss. Examples : financial investment and gambling. Most of the speculative risks are uninsurable since they are undertaken willingly in hope of profit or gain. Fundamental Risk & Particular Risk Fundamental Risk It affects the entire economy or a large number of persons or groups within the economy. It affects the society in general or groups of people, and it cannot be controlled even partially by any one person. Examples: weather and climate, inflation, mass unemployment, natural disasters. Particular Risk It affects individuals. Those future outcomes that we can partially control. It arises from individual decisions. Examples : to further study, to drive a car, to own property.  Financial Value Risk & Non-Financial Value Risk Financial Value Risk The outcomes can be measured in monetary terms Examples : material damage to property, theft or loss of business profit, fire, court award for damages. Non-Financial Value Risk The outcomes cannot be measured in monetary terms. Examples : selection of career, spouse, restaurant menu items and etc. Outcomes and consequences : loss of trust and reputation. Types of Pure Risk Personal Risks Property Risks Liability Risks  Personal Risks 1. Risk of premature death Loss of income, medical expenses from last illness, funeral expenses. 2. Risk of old age Insufficient income during retirement, poor health. 3. Risk of poor health Expensive medical expenses and loss of earned income. 4. Risk of unemployment Loss of earned income and depletion of accumulation financial assets. Life Expectancy in Malaysia  Property Risks 1. Direct loss Damage to property by a peril. Example : if a factory destroyed by fire, the owner loses the value of the factory. 2. Indirect loss Loss in consequence of a direct loss. Example : The business interruption due to the loss of use of the destroyed assets is indirect loss. 3. Extra expenses Extra costs or additional expenses incurred as a result of the loss. Example : The factory owner will incur additional expenses to rent another building to continue the operation.  Liability Risks The basic peril in the liability risk is the unintentional injury of other persons or damage to their property through negligence or carelessness; however, liability may result from intentional injuries or damage. Risk 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.  Risk Categories Associated with Hotel and Tourism Industry RISK CATEGORY PERILS Nature Natural disaster Weather and climate conditions Environmental conditions Crime and Safety Fraud and crime Acts of terrorism and hijacking Health Infectious diseases Malaria COVID-19 Political Factors War Political instability Economic Factors Exchange rates Rising prices Economic recession Transport Technology Information technology (IT) Reservation systems Socio-Demographic Factors Culture Law of Large Numbers The operation of the common pool is very much based on the successful application of the Law of large numbers. Definition: The law states that the larger the group of similar risks, the closer the actual losses experienced by the group will approach the expected losses. Measure of probability of the incidence of a particular result during one experiment. Also known as a law of averages.  Glossary of Terms Term Meaning Adverse deviation The dispersion of actual from expected results ; the probability of any outcome different from the one expected. Compensation The amount of paid by an insurance company to the insured when the covered damages occur i.e. wages, salaries, awards, fees, commissions, financial returns of any kind. Frequency of loss How often the incident of claims on a policy occurred during a given period. Hazard A condition that increases the likelihood and severity of loss. Insured peril An event that can cause damage or loss to a property but is covered by an insurance policy that pays for the loss or damage if it occurs. Insurer A company that providing insurance products to public. Law of large number The law that states that the larger the number of the contributors, the better the prediction or probability of risk exposures, which provides the underwriter a more accurate pricing mechanism.  Glossary of Terms Term Meaning Liability A debt or responsibility; an obligation that may arise by a contract made or by a tort committed. Likelihood A probability or chance of something. Loss A reduction or disappearance of economic value. Peril A cause of loss. Proximate cause One of the fundamentals of insurance. The immediate or actual or active or efficient cause of loss under an insurance policy. The doctrine of proximate cause is based on the maxim causa proxima non remota spectator which means that the proximate cause and not the remote cause must be looked at. Risk The likelihood of an event happening and the severity of the negative consequences. Severity of loss How severe was the loss when it occurred (in term of size of loss) during a period given.  Thank You “Adventure without risk is Disneyland” -Douglas Coupland-