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topic 1, Michael McCloskey. everything on powerpoint slides ...

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Probability of the loss: chance of the loss (Odds)  Ranged from 0 to 1 or 0% to 100%  Risk does not equal the probability of the loss Pure Risk vs Speculative Risk  Both involve uncertainty  Difference is the outcomes o Future states of the world (ex: alive or dead) o Speculative Risk: result in a gain or loss  3 future states of the world o gain o loss o no gain or loss  ex: investing, buying a home (value go up, go down, stay the same), college education, gambling  Basis for Enterprise Risk Management (ERM) Pure Risk: results in loss or no loss. No gain is possible  2 future states of the world o loss o no loss  ex: fire, flood, death Pure Risk: Loss known with certainty  Impossible event (No risk) has 0% chance of happening  Certain event (No risk) has 100% chance of happening  Budget, plan, and avoid the loss situation  The loss is still present BUT there is NO uncertainty about the loss  Risk does not equal Loss Static Risk vs. Dynamic Risk Static Risk: Does not change significantly over time  Always present (ex: natural disasters, sickness/death, fire) Dynamic Risk: New risk (not something people many years ago were thinking about)  Arises out of changing circumstances (ex: Terrorism, cyber security, drones, driverless cars) Diversifiable Risk vs. Non-Diversifiable Risk Diversifiable: impacts only come individuals, business, or groups (ex: risk of fire- 1000 buildings won’t burn down, one will)

Non-Diversifiable: impacts large segments of society at once (ex: earthquake- many properties will be impacted at once, natural disasters) Measurement of Risk Subjective Risk: an individual’s view of uncertainty or the situation involving risk (ex: travel on an airplane)  Depends upon the individual – measures attitude towards risk  Not easily measured  Not easy to compare among individuals  Risk lovers/takers, Risk averse (don’t want to take on any risks), Risk neutral  Influences how a firm or key decision maker will handle risky situations Objective Risk: an uncertainty containing a loss  Variation is key o Variation of actual outcomes around or about expected outcomes Expected Losses (EL): based on experience, data or other means – what we expect to happen Actual Losses (AL): losses that actually occur The problem with both of these is TIMING! We are uncertain what will happen and when it will happen Objective Risk Example: Person A: Owns 10 buildings, expects 2 fires to happen  0 is less than or equal to the number or fires but and less than or equal to four fires happening  2/10= 20% Variation of the loss 4-2=2 (4-2)/2= 100% Person B: Owns 30 buildings, expects 9 fires to happen  6 is less than or equal to the number of fires but less than or equal to twelve fires happening  9/30= 30% Variation of the loss 12-9=3 (12-9)/9= 33% Probability or chance of loss – focus on the worst possible scenario Person A faces the most risk because the variation is higher than Person B Variation of Actual Loss from Expected relative to expected loss (AL-EL)/ EL

Sources of pure risk- Personal

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Human capital o Personal pure risk- ability to generate income  Subject to life/health exposure  Injury/ illness/ death/ disability  Causes- loss of income or reduction of income, can involve medical expenses Retirement/ unemployment o Loss/ reduction in income  Retirement- possible higher medical expenses

Pure Risk- property or liability  Ownership of financial or physical assets  Theft/ damage- property pure risk  Direct losses- cost of repair, cost of replacing the assets  Indirect losses- extra expenses, loss of income Wealth losses from liability exposure- liability pure risk  Judgement from lawsuit  Legal fees Factors Affecting Risk  Peril: immediate cause of the loss (The reason) o what is going on  Ex- fire, flood, death, theft  Frequency of the loss: how often does the loss occur?  Severity of the loss: given that a loss has occurred, how bad is it in terms of money? o Severity is conditional upon frequency being positive  If frequency is 0, severity isn’t an issue  Hazard: underlying condition lying behind a loss occurrence which is either: o Increase frequency of the loss o Increases severity of the loss o Increases both frequency and severity of the loss  Physical hazard o Location- if the peril is a flood, living at the shore is a physical hazard (frequency) o Construction- if fire is the peril, a wood structure is a physical hazard (frequency and severity) o Use- a university classroom vs. a church  If the peril is a fire, does the church pose a physical hazard?  YES, the church is an older building and has more people unfamiliar with the location  Moral hazard: Acting (behavior) differently because of the existence of insurance o Frequency or severity increases because of the existence of insurance o “classic example” of fraud and dishonesty

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insurance fraud  When your car is “stolen” and you claim insurance and get money  Arson- you burn your own house down  Husband kills wife and collects insurance money o EX: health insurance  Two people have the same health  Those who have insurance consume more healthcare than those who don’t  going to the doctors more frequently than necessary WHY?  Price is fixed for someone with insurance  Lower user cost o Lower price= higher demand  Costly activity- you pay more for auto or car insurance – or more taxes o EX: Open Bar  Drinking too much and then blaming not feeling well the next morning on the open bar o Common thread  Presence of insurance  Change in behavior Morale Hazard- carelessness concerning losses Has nothing to do with the existence of insurance Financial Consequences of Risk and the burden of Risk  What does risk really cost an organization?  How does it impact the organization? o How can that impact society? Temple faces risk from Spring Fling 1. Expected Cost of Loss (anything that can happen that'll cost money) a. Financial loss -> legal fees b. Goodwill loss -> loss of reputation as a University and maybe revenue goes down, less students attend (losing business because something happens) 2. Cost to manage/ Risk Management Expenditures (What we do to prevent #1 from happening) a. Safety program, cops/ security, training b. Buying insurance 3. Residual Uncertainty -> how society as a whole loses because of risk because they’re deemed “too risky” a. Temple students lose out because Sprint Fling is canceled...