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RISK MANAGE MENT F OR ENT ERPRISES

AND I NDI VI DUALS


Chapter 1
The Nature of Risk: Losses
and Opportunities
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Learning Objectives
Build the definition of risk as a consequence of
uncertainty and within a continuum of decision-
making roles.
Learn about the three maior types oI 'risk
attitudes.
Learn what a risk professional means by exposure.
Learn several different ways to split risk exposures
according to the risk types involved.
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Learning Objectives
Learn how enterprise-wide risk approaches
combine risk categories.
Learn the terminology used by risk professionals
to note different risk concepts.
Learn about causes of lossesperils and the
hazards, which are the items increasing the chance
of loss.
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The Notion and Definition of Risk
The notion of risk is inextricably linked to the
notion of uncertainty.
Uncertainty is having two potential outcomes for
an event or situation.
Uncertainty about which of several possible
outcomes will occur circumscribes the meaning of
risk.
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The Notion and Definition of Risk
Risk is the uncertainty about a future outcome,
particularly the consequences of a negative
outcome.
Our perception of risk arises from our perception
of and quantification of uncertainty.
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Table 1.1 - Examples of Consequences
That Represent Risks
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The Role of Risk in Decision Making
Risk encompasses the potential provision of both
an opportunity for gains as well as the negative
prospect for losses.
Risk permeates the spectrum of decision making
from goals of value maximization to goals of
insolvency minimization.
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Attitudes Toward Risks
Risk averse refers to shying away from risks and
preferring to have as much security and certainty
as is reasonably affordable.
Risk seeker is someone who will enter into an
endeavor as long as a positive long run return on
the money is possible, however unlikely.
Risk neutral attitude is seen when one`s risk
preference lies between the extremes of risk averse
and risk seeking.
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Types of RisksRisk Exposures
Pure versus speculative risk exposures
Pure risk: Risk that features some chance of loss and
no chance of gain.
Speculative risk: Risk that features a chance to either
gain or lose.
Some risks can be transferred to a third party, while
some require risk transfers that use capital markets,
known as hedging or securitizations.
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Personal loss exposures (personal pure risk)
Property loss exposures (property pure risk)
Liability loss exposures (liability pure risk)
Liability loss is loss caused by a third party who is
considered at fault.
Types of RisksRisk Exposures
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Catastrophic loss exposure and fundamental or
systemic pure risk
Fundamental risk or systemic risk are risks that are
pervasive to and affect the whole economy, as opposed
to accidental risk for an individual.
Types of RisksRisk Exposures
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Table 1.3 - Examples of Risk Exposures by the
Diversifiable and Nondiversifiable Categories
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Enterprise Risks
The opportunities in the risks and the fear of losses
encompass the holistic risk or the enterprise risk of
an entity.
Enterprise risk management (ERM) is one of
today`s key risk management approaches.
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Perils and Hazards
Perils: The causes of loss.
Natural perils: Causes of losses over which people
have little control.
Human perils: Causes of losses that lie within
individuals` control.
Economic perils: Causes of losses resulting from the
state of the economy.
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Table 1.4 - Types of Perils by Ability to
Insure
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Hazards: Conditions that increase the cause of
loss; they may increase the probability of losses,
their frequency, their severity, or both.
Physical hazards: Tangible environmental conditions
that affect the frequency and/or severity of loss.
I ntangible hazards: Attitudes and nonphysical
cultural conditions can affect loss probabilities and
severities of loss.
Hazards are critical as our ability to reduce their
effects will reduce both overall costs and
variability.
Perils and Hazards
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Summary
Risk is a consequence of uncertainty, and can be
emotional, financial, or reputational.
The three risk attitudes include being risk averse,
risk neutral, and a risk seeker.
The main categories of risks include pure versus
speculative, diversifiable versus nondiversifiable,
and idiosyncratic versus systemic risk.
Perils are the causes of loss while hazards are
conditions that increase the cause of loss.