RISK MANAGEMENT AND

INSURANCE
1 Session 1
COURSE OBJECTIVES
🞆 Understand the meaning and application of the following concepts:
- Peril
- Risk
- Hazard
- Uncertainty

🞆 Understand different types of risks:

- Pure & Speculative risks
- Fundamental & Particular risks
- Static & Dynamic risks

🞆 Identifying hazards:
- Physical,
- Moral
- Morale hazale
- Understand the risk management process 2
COURSE OBJECTIVES

🞆 Appreciate the position of insurance in the overall risk

management process, i.e., as a methodology of risk
transfer
🞆 Differentiate between insurable and uninsurable risks
🞆 Current trends in risk transfer – ARM mechanisms
(insurance related and securities related)
🞆 Assignment: Identify different risks that an individual
or organization face and which of these can be insured
and which cannot be insured.
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 Goals of the
organization

RISK

ACTIONS 4
WHAT IS RISK?
🞆 Etymology of the word risk:
1661, risque, from Fr. risque, from It. risco, 
riscio (modern rischio), from riscare 
"run into danger" 

⚫ A situation involving exposure to danger

⚫ The possibility that something unpleasant or unwelcome will
happen
⚫ A person or thing regarded as a threat or likely source of danger
⚫ A possibility of harm or damage against which something is
insured
⚫ The possibility of financial loss 5
AND THEN, WHAT IS PERIL?
🞆 A peril is the cause of the risk. A peril is the immediate
specific event causing the loss and giving rise to risk.
For example, when a building burns, fire is the peril.

⚫ When a building burns, fire is the peril.

⚫ When a person dies, death is the peril.
⚫ When an individual is injured in an accident, the accident is
the peril.
⚫ When a person becomes ill from a disease, the disease is the
peril.

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DO YOU KNOW, WHAT IS HAZARD?
🞆 A hazard is the source of danger. The hazard is the
underlying factor behind the peril that leads to the
probability of a particular loss to the insurer. It is the
active ingredient that could create a peril, which could
then lead to a particular loss event

⚫ In the first instance, faulty wiring could be the hazard.

⚫ In the second instance, falling from a ladder could be the
hazard
⚫ In the third instance, road rage could be the hazard
⚫ In the fourth instance, smoking could have been the hazard
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LET’S NOW UNDERSTAND RISK AND
PERIL

RISK PERIL
When a building burns, fire is the Faulty wiring could be the hazard.
peril.

When a person dies, death is the Falling from a ladder could be the
peril. hazard

When an individual is injured in an Road rage could be the hazard

accident, the accident is the peril.

When a person becomes ill from a Smoking could have been the
disease, the disease is the peril hazard

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AND, WHAT IS UNCERTAINTY?
🞆 Uncertainty is when the outcome can be either positive
or negative. Risk is only when the outcome is only
negative. A lottery is an uncertainty.

What is the difference between risk and

uncertainty?

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WHAT ARE TYPES OF RISKS - PURE AND
SPECULATIVE RISKS?
A category of risk in which loss is the only possible
PURE RISKS outcome; there is no beneficial result. Pure risk is
related to events that are beyond the risk-taker's
control and, therefore, a person cannot consciously
take on pure risk.

SPECULATIVE
A category of risk that, when undertaken, results in
RISKS an uncertain degree of gain or loss. All speculative
risks are made as conscious choices and are not just
a result of uncontrollable circumstances. 10
TYPES OF RISKS – FUNDAMENTAL AND
PARTICULAR RISKS
FUNDA-
Fundamental risks affect the entire economy or
MENTAL large numbers of people or groups within the
economy.

PARTICULAR Particular risks are risks that affect only individuals

and not the entire 
community.
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TYPES OF RISKS – STATIC AND DYNAMIC
RISKS

Static risks, which can be either pure or speculative

STATIC stem from an unchanging society that is in stable
equilibrium.  Examples of pure static risks include
random events like lightning, windstorms, and
death.

DYNAMIC Dynamic risks can be either pure or speculative.

These are produced because of changes in society.
Examples of sources of dynamic risks include
urban unrest, complex technology, terrorism etc. 12
WHAT ARE TYPES OF HAZARDS
PHYSICAL Physical hazard can be described as being of a
physical nature – quite self-explanatory. Petroleum
storage, faulty wires, poor fire protection system

MORAL Moral hazards are those tendencies individuals

have that increase the chance of suffering a peril.
Eg smoking, not investing in risk management

A morale hazard is that way that hazards could

MORALE develop into a loss situation. A morale hazard
stems from an individual’s state of mind such as
road rage. It is usually a temporary lapse in
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judgement.
WHAT IS THE RISK MANAGEMENT
FUNCTION?
🞆 A group of actions that are integrated within the wider context
of a company organisation, which are directed toward
assessing and measuring possible risk situations as well as
elaborating the strategies necessary for managing them.
🞆 Types of risks faced by an organisation
⚫ Risks inherent to the external context
⚫ Risks inherent to operative environment
⚫ Risks inherent to financial management
🞆 Each of these risks may lead to direct and/or indirect damage
to the organisation, with economic implications that may also
be considerable in the short, medium and long term
🞆 Risk Management is not only about the value already created
by the organisation but also future opportunities to create value 14
DO WE KNOW THE PHASES OF RISK
MANAGEMENT?
🞆Context definition
🞆Risk identification
🞆Risk assessment
🞆Risk treatment
🞆 Communication
🞆 Planning
🞆 Checking and supervision
🞆 Process review
Will focus on the highlighted areas only
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WHAT IS CONTEXT DEFINITION
🞆 Context implies:
⚫ Identifying the areas of risk that must be considered
🞆Market
🞆Product/Service
🞆Manufacturing / supply process
🞆External references such as suppliers, vendors, banks, unions,
government, regulation, laws applicable etc.)
⚫ Congruently defining an identification and assessment
activity schedule;
⚫ Organising the necessary resources, starting by defining
duties and responsibilities.

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HOW DO WE DO RISK IDENTIFICATION
🞆 The process of identifying potential risks must, in any
case, work for the type of organisation and, therefore,
for the type of product/service offered and the type of
market in which the organisation itself operates; it
normally refers to:
⚫ the objectives, which the organisation has set for itself;
⚫ the scenarios, which the organisation may find it must face in
carrying out its business;
⚫ the procedures or practice, which the organisation adopts for
management and operational purposes.

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HOW DO WE PERFORM RISK
ASSESSMENT
🞆 For each risk identified in the previous stage, analyse
⚫ Probability of the event
⚫ Severity of the event
🞆 Once each risk is evaluated on the basis of the above risk
matrix, we arrive at the risk profile of the organisation

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 RISK TREATMENT UNDER DIFFERENT
SCENARIOS
High Probability and low High probability and high
HIGH

severity severity

Retain Avoid
PROBABILITY

Ignore/ Insure
Manage
Low probability and high severity
Low Probability and low severity
LOW

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LOW SEVERITY HIGH

WHAT ARE CHARACTERISTICS OF AN
INSURABLE RISK
⚫ Large number of similar exposure units
⚫ Accidental and unintentional loss
⚫ No catastrophic loss
⚫ Determinable and measurable loss
⚫ Calculable chance of loss
⚫ Economically feasible premium

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LARGE NUMBER OF SIMILAR
EXPOSURE UNITS
🞆 Enable the insurer to predict loss based on the law of
large numbers
🞆 Exposure units = item, person, etc…
🞆 If exposure units are dissimilar and the insurer treats
them indifferently, there will be “adverse selection”
problem.
🞆 If “large number” is violated, the insurer will not be
confident in their estimations, and thus, high risk charge
must be added in the premium.

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WHAT ARE ACCIDENTAL AND
UNINTENTIONAL LOSSES
🞆 The loss should be fortuitous and outside of the insured’s
control.
🞆 The law of large number is based on the random
occurrence of events. Thus, if non-random (intentional
or non-accidental) loss is insured, the prediction on the
probability of a loss would be highly inaccurate.
🞆 If intentional loss is paid, moral hazard would be
substantially increased, and premium would rise as a
result.

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NO CATASTROPHIC LOSS – LETS
DISCUSS
🞆 No excessive possibility of catastrophe for the group as a
whole.
🞆 Catastrophic event could imperil the insurer’s solvency.
🞆 The pooling (loss sharing) mechanism of insurance
breaks down and becomes unworkable if catastrophic
loss occurs.
🞆 In certain cases, insurers are forced to provide coverage
for catastrophic losses.
🞆 Terrorism coverage

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REMEDY FOR CATASTROPHIC LOSSES
🞆 Reinsurance
🞆 Geographical dispersion
🞆 CAT Bonds (Catastrophic bonds)

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WHAT ARE DETERMINABLE AND
MEASURABLE LOSSES
🞆 A loss must be definite in time, place, and amount.
🞆 It enables an insurer to determine if the loss is covered
under the policy, and if it is covered, how much should
be paid.
🞆 Easy to determine and measure
⚫ Most property losses
⚫ Life insurance cases
🞆 Difficult to determine and measure
⚫ Disability income benefits
⚫ Pain and suffering

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WHAT IS CALCULABLE CHANCE OF
LOSS
🞆 The insurer must be able to calculate both the average
frequency and severity of future losses with some accuracy.
🞆 It is necessary so that a proper insurance premium can be
charged.
🞆 Easy to calculate chance of loss
⚫ Fire accidents
⚫ Auto accidents
🞆 Difficult to calculate chance of loss
⚫ Floods
⚫ Wars
⚫ Cyclical unemployment
⚫ Terrorism 26
DO WE KNOW WHAT IS ECONOMICALLY
FEASIBLE PREMIUM
🞆 The insured must be able to pay the premium.
🞆 The premium paid must be substantially less than the
potential loss.
⚫ Would you like to buy an insurance policy covering losses to
your Reynolds pen?
🞆 To have economically feasible premium, the chance of
loss should be relatively low.
⚫ A life insurance policy on a man age 99.

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WHAT ARE SOME NEW RISKS RISING IN
DYNAMIC WORLD
🞆 Cyber risks
🞆 Terrorism
🞆 Environmental risks
🞆 Directors and Officers Liability
🞆 Professional Liability
🞆 Pandemic
🞆 Political risk
🞆 Product Liability
🞆 Supply Chain
🞆 Trade Credit
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🞆 Work force
LET’S TALK ABOUT FUNCTIONS OF
INSURANCE
🞆 Spread of risk by the individual – purchasing insurance.
🞆 Spread of risk by the insurer – volume, diversity of type and
diversity of location.
🞆 Security - provides peace of mind to the insured.
🞆 Credit - protects both the insured’s and lenders financial
interests.
🞆 Capital – the economy is stimulated by the insurer’s
investment of the premium collected from the insured’s.
🞆 Employment – provides direct employment for people and
support many insurance related businesses.
🞆 Loss Prevention – by lobbying for safer products and
practices, fire prevention, safe driving, and crime and fraud 29
prevention.
APPROACH TO ALTERNATE RISK
TRANSFER
Closer to Insurance Closer to Securities
Self Insurance Securitization
Large deductible plans Contingent Surplus Notes
Retention groups Contingency equity put (Cat E Puts)
Captives Insurance derivatives
Multi-line Multi-Year programmes Weather derivatives
Time and Distance (financial Standard asset protection and residual
reinsurance) value

Catex

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