introduction to risk management and insurance, 7e - dorfman

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Instructor’s Manual with Transparency Mastersto Accompany Introduction to Risk Management and Insurance, 7E - Dorfman

© 2002 by Prentice Hall, Inc.A Simon & Schuster CompanyUpper Saddle, NJ 07458

Introduction to Risk Management and Insurance, 7E - DorfmanChapter 1:Fundamentals and Terminology

2Instructor’s Manual with Transparency Mastersto Accompany Introduction to Risk Management and Insurance, 7E - Dorfman


OVERVIEW OF COURSE

LIFE CONTINGENCIES

CONTRACTS & PERSONAL INSURANCE

SOCIAL PROGRAMS

COMMERCIAL INS. & ADVANCED RISK MANAGEMENT

TERMINOLOGY PRINCIPLES INSURANCE AND RISK MANAGEMENT

COMPANIES(MACRO)

COMPANIESOCCUPATIONS CONSUMERS Government



Insurance Benefits to Society

Stability of familiesAids planning ability to businessesFacilitates credit transactionsAnti-monopoly deviceReduces credit costsIncreases efficiency of capital



Costs to Society

The costs of operating the insurance mechanism Commissions Overhead of the company Exaggerated claims Intentional losses (moral) General indifference about the way we treat

our property, etc. (morale)

Does not include losses that would have occurred anyway



The Problem of ArsonIllustration of Loss Costs

What is Arson?What is Arson-for-Profit?What are the costs?Who really pays for Arson?Should insurance companies be substituted for the role of public law enforcement authorities?



INTRODUCTIONDefinitions and terms

Insurance Two main elements

1) Financial intermediation2) Contractual relationship

Loss (definition of) Types of losses

Direct Loss Indirect Loss

Chance of Loss Number expected / Total exposed = Fraction




Peril - The cause of a loss or contingency that causes a loss “Named peril” or Specified peril contracts ”Open-peril" contracts

burden of proof

Hazard Something that increases the probability of

loss or increases the severity when a loss occurs physical, moral, morale




Proximate cause of the loss Also known as Doctrine of proximate

cause First insured peril in an unbroken

chain of events leading to the loss - all is paid.




Risk - many definitions - the term is used in a variety of ways1) To describe that there is a possibility of loss2) To identify the probability of loss3) To identify the cause of loss - peril4) To identify conditions that increase

frequency of severity of loss - hazard5) To identify the property or person exposed6) To identify the potential $ amount of loss7) To describe the variation in potential losses –

the ability to predict



Objective Risk - relative variation from expected

Degree of risk – the ability to predictNot the same thing as probability of lossLaw of large numbersCoefficient of variation = s/x = % of variation expected relative to the mean

OBJECTIVE RISK V. THE PROBABILITY OF LOSS




OBJECTIVE RISK V THE PROBABILITY OF LOSSBINOMIAL DISTRIBUTION

Numbe r Probability S tandard Expe cte d Coe ficie ntIn Pool of the e ve nt 1-P De viation Value of Variation

N P Q S QRT(NPQ) NP CV10,000 0.000 1.000 0.0000 0 0.000010,000 0.010 0.990 9.9499 100 0.099510,000 0.100 0.900 30.0000 1000 0.030010,000 0.200 0.800 40.0000 2000 0.020010,000 0.300 0.700 45.8258 3000 0.015310,000 0.400 0.600 48.9898 4000 0.012210,000 0.500 0.500 50.0000 5000 0.010010,000 0.600 0.400 48.9898 6000 0.008210,000 0.700 0.300 45.8258 7000 0.006510,000 0.800 0.200 40.0000 8000 0.005010,000 0.900 0.100 30.0000 9000 0.003310,000 1.000 0.000 0.0000 10000 0.0000




Obje c tive Ris k v. Pro ba bility o f Lo s s

P ro ba bility o f Lo s s

0.00000.01000.02000.03000.04000.05000.06000.07000.08000.09000.1000



OBJECTIVE RISK V. THE NUMBER OF EXPOSURES

OBJECTIVE RISK V THE NUMBER OF EXPOSURESBINOMIAL DISTRIBUTION

Numbe r Probability S tandard Expe cte d Coe ficie ntIn Pool of the e ve nt 1-P De viation Value of Variation

N P Q S QRT(NPQ) NP CV10 0.030 0.970 0.5394 0.3 1.7981

100 0.030 0.970 1.7059 3 0.56861,000 0.030 0.970 5.3944 30 0.1798

10,000 0.030 0.970 17.0587 300 0.0569100,000 0.030 0.970 53.9444 3000 0.0180

1,000,000 0.030 0.970 170.5872 30000 0.0057



OBJECTIVE RISK V. THE NUMBER OF EXPOSURES

Obje c tive Ris k v Numbe r o f Expo s ure s

Numbe r o f Expo s ure s

0.00000.20000.40000.60000.80001.00001.20001.40001.60001.8000



Risk - types

Subjective Risk - individual’s mental attitude concerning lossPure Risk - exposure that can only result in a loss or no change (two possible outcomes)Speculative Risk - exposure that can only result in a loss, no change, or gain (three possible outcomes)



Risk Management

Logical process used by firms and individuals to deal with exposures to loss.Involves pre-loss planning concerning the use of post-loss resources to minimize overall costs.Continuous process that identifies exposures and decides how to deal efficiently with them.Post-loss activities puts the plans into action.



Insurance works well when:

Many individuals purchaseFew people collect Keeps rates affordable



Mathematical Basis for insurance - Example

Houses in pool 10,000 Avg. value of each $ 80,000 Total property value $ 800 million Predicted losses = 1.5% of value $12 million Predicted Loss per house $ 1,200 Rate per $100 of value $ 1.50



Mathematical Basis for insurance - Example continued

Insurance Premium Cost of losses $ 1.50 Admin. costs .45 Reserves for unexpected losses .10 Investment Earnings (0.07) Rate per $100 value $ 1.98



Concepts:

Cash flow underwritingLoss ratioExpense ratioCombined ratioSalvage



Insurance Benefits to Society

Stability of familiesAids planning ability to businessesFacilitates credit transactionsAnti-monopoly deviceReduces credit costsIncreases efficiency of capital



Costs to Society

The costs of operating the insurance mechanism Commissions Overhead of the company Exaggerated claims Intentional losses (moral) General indifference about the way we treat

our property, etc. (morale)

Does not include losses that would have occurred anyway



The Problem of ArsonIllustration of Loss Costs

What is Arson?What is Arson-for-Profit?What are the costs?Who really pays for Arson?Should insurance companies be substituted for the role of public law enforcement authorities?

introduction to risk management and insurance, 7e - dorfman

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