affected. High subjective risk often results in conservative and prudent conduct, while low subjective risk may result in less conservative conduct. Thus, in the preceding example, the driver may have, been previously arrested for drunk driving and is aware that he or she has consumed too much alcohol. The driver may then compensate for the mental uncertainty by getting someone else to drive him or her home or bytaking a cab. In contrast, another driver in the same situation may perceive the risk of being arrested for drunken driving as slight. This second driver may drive in a careless and reckless manner; a low subjectiverisk results in less conservative driving behaviour.
Chance of loss
Chance of loss is closely related to the concept of risk. Chance of loss is defined as the probability that anevent will occur. Like risk, the term probability has both objective and subjective aspects.
Objective probability refers to the long run frequency of an event based on the assumption of an infinitenumber of observations and of no change in the underlying conditions. Objective problem can bedetermined in two ways. First, they can be determined by deductive reasoning. These probabilities are calleda priori probabilities. For example, the probability of getting a head from the toss of a perfectly balancedcoin is 1/2, since there are two sides and only one is a head. Likewise, the probability of scoring a “4” with asingle die is 1/6, since there are six sides and only one side has four dots on it.Second, objective probabilities can be determined by inductive reasoning, rather than by deduction. For example, the probability that a person aged ten will die before age twenty cannot be logically deduced.However, by careful analysis of past mortality experience, life insurers can estimate the probability of deathand sell a ten year term insurance policy.
Subjective probability is the individual’s personal estimate of the chance of loss. Subjective probability neednot coincide with objective probability. For example, some persons may bet on a favourite horse since they believe it is their lucky day. Accordingly, they may overestimate the small objective probability of winning.A wide variety of factors has been found to influence subjective probability, including the individual’s age,education, sex, intelligence, and use of alcohol. With respect to the latter, studies have shown that alcoholcauses persons to overestimate their physical skills and abilities.
Chance of Loss Distinguished from Risk
One should not confuse chance of loss with objective risk. They are not the same thing. As stated earlier,chance of loss is the probability that an event will occur. Objective risk is the relative variation of actual lossfrom expected loss. The chance of loss may be identical for two different groups, but objective risk may bequite different. For example, assume that a fire insurer has 10,000 homes insured in Mumbai and 10,000houses insured in Delhi. Also assume that the chance of loss in each city is 1 percent. Thus, on an average,100 homes should burn annually in each city. However, if the annual variation in losses ranges from 75 to125 in Mumbai, but only from 90 to 110 in Delhi, objective risk is greater in Mumbai even though thechance of loss in both cities is the same.
PERIL AND HAZARD
The terms “peril” and “hazard” should not be confused with the concept of risk discussed earlier. Let us firstconsider the meaning of peril.
Peril is defined as the cause of loss. Thus, if a house burns because of a fire, the peril, or cause of, loss, isthe fire. If a car is totally destroyed in an accident with another motorist, accident (collision) is the peril, or cause of loss. Some common perils that result in the loss or destruction of property include fire, cyclone,storm, landslide, lightning, earthquakes, theft, and burglary.
A hazard is a condition that creates or increases the chance of loss. There are three major types of hazards:Physical hazard; Moral hazard; Morale hazard.