2. CONCEPT OF RISK
• Risk is a situation in which some kind of loss
is possible. Risk is a part of life.
• Insurance protects against risk, in the sense
that people who buy insurance are
financially compensated in case of loss.
• Purchasing insurance does not remove risk.
It merely provides compensation for the loss
and spreads the cost of sharing the risk.
3. CONCEPT OF RISK
• Because insurance is intangible, you do not
actually see what you are getting which
some people cannot bring themselves to
spend money on something they cannot see
and might not need.
• Risk is intangible too, until you experience a
loss, or survive a close call.
4. CONCEPT OF RISK
• Dealing with risk
– There are several ways to handle risk.
• Avoid risk for example, decided not to smoke
• Reduce risk, by limiting the number of
cigarettes you smoke if you are a smoker
• Ignore risk
• Transfer risk
5. PROBABILITY THEORY
• A Priori Probability
– Determined when the total number of possible
events are known.
– Example: the probability of getting a six on a
roll of dice is 1/6.
– This concept has a limited practical
application in the study of risk because
situations where a number of possible outcome
are known are very rare.
6. PROBABILITY THEORY
• Empirical Probability
– Determined on the basis of historical data
– Example: road accidents.
– The underlying concept that makes it possible
for empirical probability to be measured
accurately is that as the number of
observations increases, the predicted loss
tends to approach the actual loss (the law of
large numbers)
7. PROBABILITY THEORY –
Empirical Probability
• Law of large numbers is a concept with the
following requirements:
– Large number of similar loss exposures
– Loss exposures must be independent
– Random occurrence of losses.
8. PROBABILITY THEORY
• Judgemental Probability
– Determined based on the judgement of the
person predicting the outcome.
– It is used when there is lack of historical data
or credible statistics.
– Example: Astronaut program by Malaysia.
The insurance company in Malaysia uses
judgemental probability due to lack of credible
statistics.
9. RELATED CONCEPT
• Hazard
• Loss – A condition that increases
– A reduction or the chance of loss
disappearance of – Physical Hazard
• Physical condition that
economic value increases the condition of
loss
• Peril – Moral Hazard
– Is a cause of loss • A character defect in an
individual that increases
the chance of loss
– Morale Hazard
• A character defect in an
individual that increases
the chance of loss with the
knowledge that insurance
exists
10. BASIC CATEGORIES OF RISKS
• Fundamental and Particular Risks
– Fundamental risk
• Affects the entire economy or large number of
persons/groups within the economy
• Affects the society in general and cannot be controlled
• Example: flood or inflation
– Particular risk
• Those future outcomes that we can partially control
• Arises from individual decisions
• Example: to further study or to drive a car
11. BASIC CATEGORIES OF RISKS
• Pure and Speculative Risks
– Pure Risk
• There are possibility of loss or no loss
• Example: to pass or to fail the exam
– Speculative Risk
• Possibility of loss, no loss or profit
• Example: investment
12. TYPES OF PURE RISKS
• PERSONAL RISKS
• PROPERTY RISKS
• LIABILITY RISKS
13. TYPES OF PURE RISKS
• Personal Risks
– Risk of premature death
• Significant losses: loss of human value and additional
expenses
– Risk of old age
• Significant loss: insufficient income during retirement
– Risk of poor health
• Significant losses: Expensive medical charges and loss of
earned income
– Risk of unemployment
• Significant losses: loss of earned income and depletion of
accumulation financial assets.
14. TYPES OF PURE RISKS
• Direct Loss
– Damage to property by a peril.
– Example: house destroyed by fire
• Indirect loss
– Loss in consequence of a direct loss
– Example: loss of profit
• Extra expenses
– Extra costs incurred as a result of the loss
– Example: owner have to rent another building to
continue operation/ living.
15. TYPES OF PURE RISKS
• Liability risks
– Anybody is exposed to liability risk as you can
be held legally liable if you do something that
results in bodily injury or property damage to
someone else.
– A court of lay may order you to pay
substantial damage to the person whom you
have injured.
