Addis Ababa University

College of Business and Economics

Department of Accounting and Finance
Individual Assignment

Unit Title:- Risk Management &

Insurance
NAME ……………. DESTA TIBEBE CHEFIK
ID NO…………..…..BEE/7247/11
SECTION…………. ONE (1)

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  Risk is defined in financial terms as the chance that an outcome or investment's
actual gains will differ from an expected outcome or return. Risk includes the
possibility of losing some or all of an original investment.

1. Objective Probability vs. Subjective Probability?

Objective probability refers to the long-run relative frequency of an event based on

the assumptions of an infinite number of observations and of no change in the
underlying conditions.

 For example, as the number of homes under observation increases, the

greater is the degree of accuracy in predicting the proportion of homes that
will burn.

Subjective probability is the individual’s personal estimate of the chance of loss.

For example assume that a property insurer has 20000 houses insured over a long period
and ,on average, 1percent, 200 houses burn each year. However,it woud be rare for exactly
200 house may burn. Thus, there is a variation of 20 house form the expected number of
200, or a variation of percent. This relative varition of actual loss from expected loss is
known as objective risk.

 For example, a customer who was drinking heavily in a bar may foolishly
attempt to drive home. The driver may be uncertain whether he will arrive
home safely without being arrested by the police for drunk driving. This
mental uncertainty is called subjective risk.

2. Risk and uncertainty?

Uncertainty refers to a state of mind characterized by doubt, based on the lack of

knowledge about what will or what will not happen in the future.

 The existence of risk is :-

A/ A condition of circumstance in which there is apossibility of loss

B/ Creats uncertanity on the part of indviduals when that risk is recognized.

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Example you use the hammer to do the job the hammer is the hazard but using it and injure
you self is the risk.

Uncertainty being a perceptual phenomenon implies different degrees to a different

person.

 E.g. A situation where an individual has to appear for the first in the newly
introduced insurance examination.

An individual student had undergone training in insurance.

Risk traditionally has been defined regarding uncertainty. Based on this concept, the risk is
denied here as uncertainty concerning the occurrence of a loss.

 E.g. the risk of lung cancer for smokers is present because uncertainty is
present.

The risk of flunking a college course is present because uncertainty is present.

3. Risk, Peril and hazard?

Risk it is defined in different terms by several authors with some differences in the
wordings used.

Peril is defined as the cause of the loss.

For example :-volcanic eruptions

Choking or falling objects

 E.g. In an auto accident, the collision is the peril.

Hazard is a condition that increases the chance of loss arising from a peril.

For example: - a slick wods during a snow storm leaving car doors unlocked.

4. What are the four major types of hazard?

1. Physical hazards: objective factors capable of increasing the probabilities of the

unfavorable event (e.g. Quality of packing of the goods. Bad quality packing creates more
losses, an over-aged vessel or a vessel in a bad shape or a vessel in an unseaworthy
condition presents higher risks and is more affiliated with accident)

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2. Moral hazards: dishonesty or character flaws of an individual that increase the
likelihood of the unfavorable event (e.g. Carelessness is the cause of most of the accidents
and when the insured behaves carelessly, an unsatisfactory moral)

3. Morale hazard: a situation of carelessness, negligence, dereliction of duty, indifference

faced with danger (e.g. he or she might be carless in locking the doors and window when
leaving home.)

4. Legal Hazard refers to characteristics of the legal system or regulatory environment

that increase the frequency or severity of loss.

5. Pure vs. Speculative risks?

Pure risk is a situation in which there are only the possibilities of loss or no loss there is
no possibility of gain. it can be categorized as personal, property or legal risk. (E.g. risk of
unemployment changes without the economy so it difficult to predict what unemployment
will be to the coming year.)

Speculative risk is a situation in which either profit or loss is possible, most of them are
uninsurable because they are undertaken willingly for the hope of profit. (E.g. Investments
benefit society, and starting a business helps to create jobs.)

6. Personal risk Property risk Liability risk?

1. Personal risks are risks that directly affect and individual or family. They involve the
possibility of a loss or reduction in income, extra expenses or depletion of financial assets,
due to:

 Poor health (catastrophic medical bills loss of earned income)

 Insufficient income during retirement
 Premature death of family head

For example

 Achievement economically risk

2. Property risks:- involve the possibility of losses associated with the destruction or theft
of property.

For example natural disasters such as fooled, earthquake and storm.

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  E.g. the immovable like land and building being damaged due to flood, earthquake
or fire, the movables like appliances and personal assets being destroyed due to the
fire or stolen.

Direct loss is a financial loss that results from the physical damage, destruction, or theft
of the property

Indirect loss or consequential loss is a financial loss that results indirectly from the
occurrence of direct physical damage.

3. Liability risks involve the possibility of being held legally liable for bodily injured or
property damage to someone else.

For example, the financial loss arising from the non- performance or standard performance
in a contract, in engineering or construction contracts.