Chapter 1 & 9 Review: Risk Management & Insurance Contracts

Chapter 1 Review: Understanding Risk

Key Risk Management Terms

Types of Risk

• Systemic Financial Risk: Risk that affects the entire economy or system, not just individuals.
• Risk: Uncertainty about a future outcome, particularly a negative one.
• Pure Risk: Risk with the possibility of loss but no chance of gain.
• Speculative Risk: Risk with the possibility of both gain and loss.
• Fundamental Risk: Risks that are pervasive to the whole economy, also known as "systemic" risk.
• Diversifiable Risks: Risks that can be mitigated by having a broad mix of risk exposures.

Risk Attitudes

• Risk Averse (Avoider): Prefers to avoid risks and seeks security.
• Risk Seeker (Taker): Enjoys taking risks.
• Risk Neutral: Preference lies between risk averse and risk seeker.

Risk Management Techniques

• Diversification: Investing in a variety of assets to balance potential positive and negative outcomes.
• Hedging: Activities taken to reduce or eliminate risk.
• Risk Retention: When a firm keeps the risk (also known as "self-insuring").

Types of Loss

• Product Liability: When a manufacturer may be held liable for harm caused by its product, even if responsibly produced.
• Indirect Loss: A non-physical loss, such as loss of business, resulting from a "pure" risk.
• Property Loss: Loss or damage to property, also a result of a "pure" risk.
• Liability Loss: Loss caused by a third party who is considered to be at fault.

Other Important Terms

• Risk Manager: Individual who manages specific risks.
• Uncertainty: Having two or more potential outcomes for an event.
• ERM (Enterprise Risk Management): The simultaneous consideration and management of all risks within an organization.

Chapter 9: Insurance Contracts

3.1 Contracts of Adhesion

• Insurance policies are contracts of adhesion, meaning insureds have limited input in the policy's terms.
• Insureds can either accept or reject the contract as offered by the insurer.
• Interpretation of contracts of adhesion favors the insured in cases of ambiguity and considers the insured's reasonable expectations.
• The expectations principle guides interpretation based on how an insured would understand the contract.

3.2 Indemnity Concept

• Indemnity means the insurer pays no more (and no less) than the actual loss suffered by the insured.
• This principle prevents insureds from profiting from losses, which would negatively impact society and the insurance industry.
• Several legal principles and policy provisions support the doctrine of indemnity.