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Vocabulary Pure risk is a chance of loss with no chance for gain. In contrast, a speculative risk may result in either gain or loss . Economic risk may result in gain or loss because of changing economic conditions .
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Vocabulary • Pure risk is a chance of loss with no chance for gain. • In contrast, a speculative risk may result in either gain or loss. • Economic risk may result in gain or loss because of changing economic conditions. • Insurance is a method for spreading individual risk among a large group of people to make losses more affordable for all. • An insurable risk is a pure risk that is faced by a large number of people and for which the amount of the loss can be predicted. • An insurable interest is any financial interest in life or property such that, if the life or property were lost or harmed, the insured would suffer financially. • A personal risk is the chance of loss involving your income and standard of living. • The chance of loss or harm to personal or real property is called property risk. • A liability risk is the chance of loss that may occur when your errors or actions result in injuries to others or damages to their property. • Under the policy, the insurer agrees to assume an identified risk for a fee, called the premium, usually paid at regular intervals by the owner of the policy (the policyholder). • Indemnificationmeans putting the policyholder back in the same financial condition he or she was in before the loss occurred.
Pure Risk • Pure risk is a chance of loss with no chance for gain. Pure risks are random (can happen to anyone) and result in loss (not gain). Examples of pure risk include the following: - Accidents resulting in physical injury and damage to property - Illnesses that people get throughout life, as a part of aging - Acts of nature, resulting in damage to persons and property Everyone should have a plan in place in the event of a pure risk because the consequences are often serious and can even be catastrophic, affecting both your life and your lifestyle.
Speculative Risk In contrast, a speculative risk may result in either gain or loss. For example, if you buy gold, futures, options, or commodities, you could either make or lose money. Because speculative risks are not “accidental”or random, and may result in either gain or loss, you cannot protect yourself from losses in a traditional manner. While hedging(making an investment to help offset against loss) is a technique used to help reduce losses from such risky acts, it does not reduce the risk itself.
Economic Risk We all face risks due to the current state of the economy. Economic risk may result in gain or loss because of changing economic conditions. For example, when the business cycle is in a period of recovery or growth, most people and businesses are realizing gains in their financial position.
Insurance is a method for spreading individual risk among a large group of people to make losses more affordable for all. • An insurable risk is a pure risk that is faced by a large number of people and for which the amount of the loss can be predicted. • An insurable interest is any financial interest in life or property such that, if the life or property were lost or harmed, the insured would suffer financially. • There are three major insurable risks: personal, property, and liability.
Personal Risk • A personal risk is the chance of loss involving your income and standard of living. You can protect yourself from personal risks by buying life, health, and disability insurance. Property Risk • The chance of loss or harm to personal or real property is called property risk. For example, your home, car, or other possessions could be damaged or destroyed by fire, theft, wind, rain, accident, and other hazards. Liability Risk • A liability risk is the chance of loss that may occur when your errors or actions result in injuries to others or damages to their property. For example, you could accidentally cause injury or damage to others or their property by your conduct while driving a car.
Spreading the Risk An insurance company, or insurer, is a business that agrees to pay the cost of potential future losses in exchange for regular fee payments. When people buy insurance, they join a risk-sharing group by purchasing a written insurance contract (a policy). Under the policy, the insurer agrees to assume an identified risk for a fee, called the premium, usually paid at regular intervals by the owner of the policy (the policyholder).
Spreading the Risk cont. Insurance is not meant to enrich—only to compensate for actual losses incurred. This principle is called indemnification. Indemnificationmeans putting the policyholder back in the same financial condition he or she was in before the loss occurred. • Insurers set premiums based on statistical probability. • The higher the probability of a loss occurring, the higher the premium for insuring against it.
Vocabulary • Risk management is an organized strategy for controlling financial loss from pure risks and insurable risks. • It begins with risk assessment, or understanding the types of risk you will face and their potential consequences. Handle Risks • Risk shifting, also called risk transfer, occurs when you buy insurance to cover financial losses caused by damaging events, such as fire, theft, injury, or death. • Risk avoidance lowers the chance for loss by not doing the activity that could result in the loss. • Risk reduction lowers the chance of loss by taking measures to lessen the frequency or severity of losses that may occur. • Risk assumption is the process of accepting the consequences of risk. To help cushion your financial burden, you could establish a monetary fund to cover the cost of a loss. • A deductible is the specified amount of a loss that you must pay.
RISK MANGAMENT IS A PROCESS Risk management is an organized strategy for controlling financial loss from pure risks and insurable risks. In other words, as soon as you have assets, wealth, income, and anything that others could take from you, you must begin to think about how you can protect yourself from loss. Risk management is more than buying insurance for every possible peril that could occur.
RISK ASSESSMENT It begins with risk assessment, or understanding the types of risk you will face and their potential consequences. Risk assessment is a three-step process. Step 1: Identify Risks of Loss Ask yourself what financial risks you take daily, such as when you drive a car, own a house, or plan a party. Step 2: Assess Seriousness of Risks Human activities and the ownership of property reflect a certain amount of risk. Driving a car- high priority Things with a small chance of occurring- low priority Step 3: Handle Risks There are four techniques you can consider to handle risk: shifting, avoiding, reducing, or assuming risk. A good risk-management plan uses a combination of these strategies to balance risk, the cost of insurance, and your potential losses.
HANDLE RISKS Steps: 1. Risk shifting, also called risk transfer, occurs when you buy insurance to cover financial losses caused by damaging events, such as fire, theft, injury, or death. By making premium payments, you shift the risk of major financial loss to the insurance company. 2. Risk avoidance lowers the chance for loss by not doing the activity that could result in the loss. For example, instead of having a party at your house and risking damage, you could reserve a section of a restaurant. Instead of participating in a dangerous sport, you could go camping. 3. Risk reduction lowers the chance of loss by taking measures to lessen the frequency or severity of losses that may occur. For example, you may put studded snow tires on your car, install fire alarms or sprinklers in your home, or use seat belts. All these steps would lessen the financial risk of potential losses. 4. Risk assumption is the process of accepting the consequences of risk. To help cushion your financial burden, you could establish a monetary fund to cover the cost of a loss. People who self-insure plan to absorb the costs of some risks themselves. This strategy can reduce the cost of insurance. In some cases, the cost of insuring against a particular risk may be too great, or the probability that the risk will occur may be too low, to justify paying an insurance premium.
To avoid possible financial disaster, create a risk-management plan, listing the risks you identified, your assessment of their financial impacts, and the techniques that you plan to use to manage each risk.
RISK MANAGEMENT PLANSHOULD INCLUDE: 1. Potential loss of income due to the premature death, illness, accident, or unemployment of a wage earner. 2. Potential loss of income and extra expense resulting from the illness, disability, or death of a spouse or other family member. 3. Potential loss of real or personal property due to fire, theft, or other hazards. 4. Potential loss of income, savings, and property resulting from personal liability (injuring a person or damaging the property of others).
REDUCTING INSURANCE COST Insurance Plan: Increase Deductibles-A deductible is the specified amount of a loss that you must pay. The higher the deductible the less the insurance cost. Purchase Group Insurance- The premiums for group plans are usually considerably lower than for an individual plan Consider Payment Options- How you pay premiums can save you considerable money over a short period of time. Look for Discount Opportunities- Many insurance companies offer discounts for special conditions. Some will give you a better plan if you’re a non-smoker. Comparison Shop- Get quotes from several insurers
