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Risk Management & Insurance

Chapter One: General Concepts of Risk
1.1. General
The word risk is certainly used frequently in everyday conversation and seems to be well
understood by those using it.
What is your understanding of the word risk? What impression does it give you when somebody
mentions the word to you?
Before you go to the next paragraph, ask yourself these questions and try to answer them. And
later on, you will compare your answer with the definitions given in this note.
To most people risk implies some form of uncertainty about an outcome in a given situation. An
event might occur and, if it does, the outcome might not be favorable. The word risk then implies
both doubt about the future and the fact that the outcome could leave us in a worse
situation than we are in at the moment. In the other words risk is variability from expected.
If you want to go out during the evening, a family member could say to you, “Take care, it is
risky.” What is the message being sent? You are being warned that a bad event (such as robbery,
assault, etc.) could occur to you. You can easily see from this that the word risk has some bad
test.
It is interesting to contrast risk with the use of the word chance. Like risk chance also implies
some doubt. But unlike risk, in the case of chance, the expected outcome is favorable. We talk
about the risk of an accident, the risking of losing our job, but we talk about the chance of
winning a lottery, the chance of getting a scholarship, etc.
 Risk refers to the possible occurrence of an unfavorable event.
 Chance refers to the possible occurrence of a favorable event.
This is how people understand risk. But as students of risk management and insurance, you do
not need to stop with this simple analysis of risk. Rather, you need to explore more the concepts
incorporated in it.
The understanding of the word risk is made more difficult by the variety of ways in which it is
used in the world of risk management and insurance. In this Module, in other materials, and in
everyday business conversations, you will come across with the word risk to mean different
things. Below are some possible ways of using the word.
 Risk as a cause: This is when the word risk is used to refer to the cause of an outcome.
For example, when we say” There is a possible risk of theft”, we are referring to the possible

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loss of our property by theft, but we use the word risk to imply that the cause of this loss of
property is theft.
 Risk as a cause is used to refer to the cause of an outcome.
 Risk as a likelihood
We often talk about the risk of something happening, meaning the probability or likelihood of its
occurring. This is sometimes modified by referring to the high or low risk of some event: for
example, when do you think is the risk of getting robbed high? When you sleep leaving your
door open or when you sleep after properly closing your door?
During the former surely: This example reveals that there are levels of risk or degrees of
likelihood of its happening.
 Risk as a likelihood refers to the probability or likelihood of something happening.
 Risk as an object
The word risk can also be used to refer to the object or person at risk. If a group of engineers go
to visit a building, which is on the verge of cracking, they can say, ‘let’s go and see the risk. In
this case, the word ‘risk’ is used to refer to the object at risk, i.e. the building.
 Risk as a loss
Suppose someone you do not really trust asks you to lend him money. You decide to give him
but you feel that you are taking a risk. In this case, you are using the word risk as a loss.
 Risk as a loss refers to cases when we put ourselves in a situation where there is some doubt
about loss from the future outcome.
 Risk as a verb
Finally, the word risk is used not only as a noun but also as a verb. A girl could risk walking
alone during the night, someone could risk swimming in a river where there is crocodile, etc. In
this instance the word risk is used as a verb implying an act of placing oneself in a situation
where a loss could occur.
 When the word risk is used as a verb it refers to the act of positively or willingly placing
oneself in a situation where a loss could occur.
1.2. The Meaning of Risk
Different text books, writers, authors, and practitioners have tried to define risk in various ways
and it is difficult to pick one of these definitions and make it a universally accepted one. That is
why it is indicated in the above overview, that we need to know a relatively proper definition of
risk.
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Definition1. Risk is a condition in which there is a possibility of an adverse deviation

from a desired outcome that is expected or hoped for.
Definition2. Risk is the objectified uncertainty as to the occurrence of an undesired event.
Definition3. Risk simply is uncertainty about loss.
Have you read the above definitions properly? Have you noticed that in spite of the differences
in wording, the essence in most of the definitions is similar?
That is why your instructor gave you only three definitions. This does not mean, however, that
we would stick rigidly to one or two definitions. As a single definition would not sufficiently
capture the comprehensive flavor of risk, we would analyze its meaning by considering the
concepts embodied in various definitions: you can note from the above definitions that risk
refers to the possibility of an undesired event. Risk materializes when something you do not
want to happen occurs or when something you want to happen fails to happen. It is simply a
negative deviation from your expectation.
For insurance purposes, risk refers to uncertainty about financial loss. A person driving a car
might face a car accident, a factory building may be burnt and production in the factory could
be stopped. But loss is not always associated with accident. If a firm could not get enough
market for its products, it would suffer loss (we will discuss the different types of risks in the
following unit.)
The first important point you note from the above examples and the proceeding definitions is that
risk is associated with bad and harmful incidents. You can see this clearly from the first
definition given above. In that definition, risk is defined as an adverse deviation from
expectations. Risk is understood as occurrence of a bad situation. The second definition, too,
conveys this message as risk is defined as undesired event.
 Risk has a bad taste.
You get the second important point from the second definition.
 Risk is an objective concept.
Risk is something measurable. There is every possibility to quantitatively measure the bad
occurrence we are talking about. Hence, risk is something objective (we will discuss this at
length in the following section.)
In the third definition the fact that risk is negative deviation from expected or loss is
underscored. This loss could either be financial or non-financial. A death of a close relative

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could be an example of a non-financial loss while loss of a car by theft could be an example of
financial loss.
 Risk refers to a possibility that a loss might occur.
Form the discussion made so far it is possible to conclude that risk refers to the uncertainty
human beings face in life that a bad incident entailing loss could possibility occur.
1.3. Risk and Related terms
 Risk and Uncertainty - Overview
In the first section you have dealt at length with the concept of risk and you’ve seen that risk
refers to uncertainties in life. The word uncertainty is already used several times in this
material.
But you are not yet very clear as to what uncertainty actually means and how it differs from the
word risk. Getting clear idea here, therefore, would help you much to have a proper
understanding of the concept of risk.
What do we mean by uncertainty? Are risk and uncertainty similar?
Even though risk and uncertainty are closely related and most of the time used interchangeably,
they are not one and the same.
Think of times when you felt certain about something. When you feel certain, it seems you are
free from doubt. Certainty refers to the state of being doubtless about something. Its antonym
uncertainty is doubt about our ability to predict the future outcome of current actions. Clearly the
term uncertainty describes a state of mind. It has something to do with subjective beliefs. It
arises when someone has doubt or cannot be certain about the outcome of events.
A writer by the name Peffer distinguishes risk and uncertainty as follows:
 Risk is a combination of hazards and is measured by probability; uncertainty is measured
by the degree of belief. Risk is a state of the world. Uncertainty is a state of the mind.
You can see from the above definition that risk is an objective concept that can be measured.
We can measure risk by using statistical techniques (you will study more about risk measurement
in the 2nd chapter).
When we say uncertainty is subjective, does it mean that the intensity of uncertainty differs
among people? Of course! Since uncertainty depends on the knowledge and attitude of a
person, individuals facing the same situation can show differing levels of uncertainties. Two
people working on the same business could feel uncertain about future loss of their job with
varying degrees.

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 Individuals facing the same situation could experience differing levels of uncertainties.
In discussing the concept of uncertainty, we can take the rather philosophical view and say that
uncertainty is, like beauty, in the eyes of the beholder.
This could possibly trigger a question in your mind.
Does this mean that there is no real uncertainty in the natural order of things in our world?
Some people could argue saying that there is no uncertainty i.e. they might say that uncertainty
does not exist in the natural order of things. Other people, on the other hand, could respond to
this by saying that there are a number of outcomes which are uncertain. For example, if
somebody practices unsafe sex, there is uncertainty as to whether or not the person will be
affected with HIV virus, when someone drives on a risky road, he/she will feel uncertain as to
whether an accident will occur or not.
We quite often say there is a risk of rain, the risk of being in an accident, the risk of getting
HIV/AIDS, etc.; we use these phrases almost suggesting that the event may or may not happen.
The fact is that the event will or will not happen, there is no doubt about that. What we want to
express when using these phrases is that there is some doubt as to whether the event will occur or
not. The information we have about the future is imperfect and this leads us to the doubt, and
hence uncertainty which we express.
The analysis in the above paragraph supports the view that uncertainty is in the eyes of the
beholder. But be careful in that you should not go too far down that road and make the same
conclusions about risk, too.
Are we to say that risk only exists when an individual recognizes that they have some doubt
about the future?
To say that risk only exists when it is recognized by an individual would discount certain
situations where we would all agree risks are present, even if not recognized by anyone.
Consider someone who has no idea about HIV/AIDS. This person has not heard a word about the
dangers of AIDS. If this person goes to town and practices unprotected sex with a prostitute,
does it mean that there is no risk of getting infected with the virus because he was not aware of
the danger? Not really!
Most of us would agree that there is a clear risk of contacting the virus even in the absence of
awareness about the danger
But is that true, too, in the case of uncertainty?

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Writers in risk management and insurance have predicted different answers for this question.
Some argue that uncertainty, like risk, exists whether or not the person is aware of it. Others
argue that uncertainty being a subjective feeling exists only with awareness.
 Uncertainty exists only with awareness; it is a state of mind. Risk, however, exists
whether or not a person is aware of it. It is a state of world.
Let’s finish this section by mentioning the four situations. Crowe and Horn described in their
book “The meaning of risk” in an article to show the difference between risk and uncertainty.
A) The first situation is when both risk and uncertainty are present. Suppose someone cuts
his hand with a blade that an HIV positive person has used. This person would experience
uncertainty and indeed there is a risk of getting infected.
B) The second situation is when both risk and uncertainty are absent. We all know that the
earth is not flat but egg shaped. But there is no possibility of falling off the edge of the earth. As
a result we neither experience risk nor uncertainty.
C) The third situation is when risk is present while uncertainty is absent. A good example
for this could be a person driving a car whose brake has a problem. The person does not
experience uncertainty as he is totally unaware of the problem. The risk of accident, however, is
clearly present.
D) Finally there are situations when risk is absent but uncertainty is present. For illustration
consider the following example.
While listening to the news, a woman finds out that one of the five buses that go to Dessie has
overturned. She knew her husband was in one of these buses though she does not know which
one he specifically took.
In this case, there is no risk as risk refers to future outcomes. In the above example, since the
incident has already occurred, there is no adverse deviation from expectation that will happen in
the future. Whether the man is in the bus or not, the incident has already happened. But there is
uncertainty as it relates to past, present and future situations. The women would be worried sick
until she finds out that her husband is safe.
 Risk and Probability - Overview
In the last section you’ve studied the difference between risk and uncertainty. Another area of
confusion you might encounter in risk and insurance discussions relates to concepts of risk and
probability. Risk and probability are used confusedly and students of risk and insurance

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encounter problems related to this in introductory courses. It is important that you be clear on
their differences as you will be doing that in this section.
Make sure that when you’ve worked through this section, you’ve achieved the following
 Probability Defined
What is probability? Have you ever purchased a lottery?
What is the probability that you win the lottery?
I am not asking you the chance of winning the lottery. As far as the chance is concerned, there
are two outcomes. You will either win or lose. Probability is a bit different from this. The
probability of winning a lottery depends on the number of people buying the lottery. If you
are one of the 100,000 people who have bought the lottery the probability that you win is
1/100,000.
Thus probability refers to the chance of occurrence of one particular event.
We use the word probability to refer to the likelihood of occurrence of a given event;
specifically it is a mathematical rate expressing the chance that a certain event will occur.
 Risk and probability distinguished
When you read materials on risk management and insurance, you might come across some
definitions which more or less treat risk and probability similarly. Look at the following
definition of risk, which simply defines risk as a chance of loss.
Nobody blames you if this definition confuses you with what we’ve said about probability in the
previous sub-section. The distinction gets more blurred as one explores their relationship.
The agreed up on conclusion is that risk and probability are two concepts which are different
but related. The probability of a certain outcome is the number of times that outcome would
occur, assuming finite number of observations and no change in underling conditions. Risk,
however, refers to deviations from expectations. This statement deserves a little bit more
elaboration.
 When do we assign probability to events?
Generally, probabilities are assigned to events that are expected to happen in the future. In the
case of probability there might be a number of possible events that will take place under a given
set of conditions; and that events may occur in equal or different chances of occurrence.
Consider these extreme situations. Sometimes you will be 100% certain that a certain event is
going to take place, i.e. there is perfect foresight as to the occurrence of the event probability in
this case is 1.

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For example, if you have 10 fifty Birr notes in your wallet, what is the probability that a
randomly selected note will be a fifty Birr note?
The probability is 1. You are very certain that whichever note you pick, it is going to be a fifty
Birr note. In this situation there is no risk involved. Even if you pay your bill without looking,
there is no risk of paying a 100 Birr note by mistake.
The other extreme situation is when probability is zero. This happens when event is certainly
not going to take place. Consider the above situation again.
What is the probability that a randomly selected note will be a 100 Birr note?
The probability is zero. Since you do not have any one hundred birr note there is no chance that a
randomly selected note will be a 100 Birr note. In this case, too, risk is absent. A risk of giving
someone a 100 Birr note by mistake (when you actually want to give 50 Birr) is absent as you do
not have a 100 Birr note in your wallet in the first place.
In between these two extreme possibilities, there could be several occurrences of the events with
the corresponding probabilities of occurrence. In these situations, since we cannot exactly tell
which of the many possible events will take place, we will be in an uncertain situation, and this
creates risk.
 When probability of occurrence of a given event is either zero or one, there is no risk
involved.
The association between risk and probability can be described as follows.
 Event certainly to take Place, P=1 → Risk=0
 Event will not certainly take place; P=0 → Risk=0
 As you discuss above, risk is absent when probability is zero (0) and one (1). But in
between these two extreme situations, though the probability could differ, risk is present.
What else do you note from the above description? Is risk necessarily high when probability is high?

People wrongly think that risk is necessarily high when probability is high. But this is not
always true rather the above analysis shows that risk is zero when probability is as high as one.
 Risk, Peril and Hazard
So far we’ve looked at the notion of risk by comparing it with concepts of uncertainty and
probability. One final thing we should do before completing this unit is to look into the
relationship of risk peril and hazard. As it is the case with uncertainty and probability, these

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words are also used confusedly with risk. In this brief section, we will make clear to you the
distinction between risk, peril & hazard.
What do we mean by the words peril and hazard?
Are they used interchangeably with risk?
The word risk is often used to mean both the event which will give rise to some loss and the
factors which might influence the outcome of a loss.
What sense does it make to you when somebody mentions to you a risk of a plane explosion?
What you understand from this statement is the risk of human and property damage due to
explosion of the plane otherwise the risk of explosion by itself does not really make much sense.
A plane explosion could cause human and property damage.
Thus when we mention the phrase” the risk of plane explosion” we are highlighting the
explosion as a cause for possible human and property damage. This explosion, say, could
possibly be created due to engine failure.
When you think of a cause of risk, you should consider two aspects of it. The explosion is the
cause of the human and property damage and the fact that the plane has an engine problem
increased the possibility that the plane might explode.
Are you able to separately see these two aspects of risk?
If you do then you are beginning to see the difference between peril and hazard. Peril is the
prime or specific cause of a loss while hazard refers to those factures which might influence
the outcome specifically, hazard refers to those conditions that may create or increase the
chance of loss arising from a given peril. In our example the peril is the plane explosion, which
is the cause of human and material loss suffered, while the engine problem is the hazard.
Can you think of some examples of peril?
You might have thought of fire, storm, theft, collision, explosion, flood, and others as possible
examples of peril. Thus, peril refers to the prime source of a specific loss. Most of the time is
beyond the control of anyone involved in the situation.
Hazards unlike perils do not cause risk by themselves. But, considering a given peril, hazards can
increase or decrease the effect. In other words a hazard affects the magnitude and frequency of a
loss caused by a given peril. The more hazardous conditions are the higher the chances of
losses are.
 Peril is a specific cause of loss while hazard is a condition that creates or increases the
chance of a loss

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There are various types of hazards but risk and insurance writers focus mostly on four major
types of hazards discussed below.
i. Physical hazard
Physical hazard refers to a physical condition that increases the chance of a loss. It relates to
the physical properties of the item exposed to risk.
Surely, a house located near a river bank is more exposed to risk of flood than another house
located far away from the river. Note that in this case we are referring specifically to the physical
property of the house. The house that is physically proximate to the river happens to be more
prone to risk of flood due to its physical characteristics.
? Can you give some examples of physical hazards?
 The nature of construction of a building;
A building made up of bricks is stronger than the one made up of wood
 Security protection of a shop or factory
A supermarket that has a well-designed security system is less susceptible to theft-than the
one with no security protection system.
 Occupancy of building
What the building occupies also matters in consideration of hazard. For instance, a building
that occupies chemicals is more exposed to fire risk than the one occupying furniture.
 Working condition
A person who works in mining fields is more exposed to risk than a person working in an
office.
 Physical hazard refers to a physical condition that increases the chance of a loss
ii. Moral hazard
Moral hazard is associated with human nature, qualities, reputation, attitudes, etc. More
specifically, it is dishonesty or character defects in an individual that increase the frequency or
severity of a loss. It originates from deliberate evil tendencies in the character of individuals.
What examples of moral hazard can you think of?
You may have thought of the following as possible answers:
 Faking an accident to collect money from an insurance company;
 Dishonest act of an individual;
 Fraudulence, etc.

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Moral hazard is very important for insurance consideration. It is present in all forms of insurance
and is difficult to control. Insurance companies make attempts to control moral hazard by
carefully examining the person to be insured through a process called underwriting. You will
study about this process in the third and fourth chapters.
 Moral hazard concerns the human aspect which may influence the outcome. It relates
to evil tendencies in the character of individual.
iii. Morale hazard
It is helpful to make distinction between moral and morale hazards. Unlike moral hazard which
refers to dishonesty of individuals, morale hazard originates from an act of carelessness
leading to the occurrence of a loss. It occurs due to lack of concern, carelessness, or indifference
to a loss.
Have you come across people who smoke cigarettes in a gas station disregarding the no
smoking sign?
This is an example of morale hazard. Other examples include leaving car keys in an unlocked
car, which increase the chance of theft; leaving a house door unlocked that allows a burglar to
enter, etc.
 Morale hazard refers to carelessness or lack of concern to occurrences of losses.
iv. Legal hazard
Legal hazard refers to characteristics of the legal system or regulatory environment that
increases the frequency or severity of government laws that may change quite often based on
new developments. And this could possibly influence the outcome of a loss.
Consider this example for illustration purposes. At present, there is no insurance coverage for
HIV/AIDS related deaths under their health insurance policies this law would increase the
frequency of severity of loss to insurance companies.
In the above paragraphs you’ve studied about risk peril and hazard and by now, you are clear as
to what risk, peril, and hazard actually mean.
But is it possible to establish a specific cause effect relationship between these concepts?
Yes, though it does not always work that way, we can conclude that peril which is a prime cause
of risk, is by itself caused or influenced by hazard. Accordingly, it is possible to establish the
following relationship.
Hazard peril risk

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But be careful! as it is stated above, this relationship is not always true. Sometimes a given
hazard by itself can cause risk. And sometimes you might face difficulty distinguishing between
a peril and a hazard. Consider a situation where a fire is in progress in a given locality and due to
the confusion created in the area, two cars collided.
How do you regard the fire? as a peril or as a hazard? may be both. Concerning the loss of a
building which caught fire, the peril that causes of the risk is surely the fire. But when it comes
to the collision of the cars the fire is rather a hazard than a peril. The risk of losing those cars by
the accident is caused by collision (which is the peril. But this peril is affected by the hazard
situation created i.e. the fact that there was fire in the vicinity.)
You might sometimes, encounter these types of overleaping but in most cases, ‘the hazard leads
to peril and peril leads to risk’ step works.
1.4. General Classifications of Risk Overview
Even though many classes of risk have been identified in insurance related literature, it seems
there is some agreement as to which of these classifications are the major ones. This Section
presents five of these major classifications of risk. This will enable you to differentiate between
pure and speculative, financial and non-financial, fundamental and particular, static and dynamic
and diversifiable and non-diversifiable risks.
 Pure and speculative risks
Pure and speculative Risks Distinguished
The distinction between pure and speculative risks rests on whether or not gain is involved. Pure
risk exists when there is a chance of loss but not of chance of gain. Hence there are two
possible outcomes in the case of pure risks: loss or no loss. In any case there is no possibility of
gain in the case of pure risk.
For example, if Mr. A’ car collides with another car, the owner will suffer financial loss. If no
collision occurs the owner would neither suffer loss nor gain anything. Since there is no
possibility of gain, the owner’s financial position remains unchanged.
 Pure risk refers to a situation in which only a loss or no loss would occur.
What about speculative risks?
In the case of speculative risks, there exists both a chance of gain as well as a chance of loss. For
example when someone makes an investment there is an expectation of profit out of the
investment. The investor speculates that the investment venture entered into could bring gain to
him/her. In fact there is a possibility that a person may just get back his money (breakeven) or

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experience loss. That is what makes the venture risky after all. The point, anyway, is that in the
case of speculative risk there is a possibility of gain or loss.
 Speculation risk refers to a situation where there is a chance of loss or gain.
However distinct pure and speculative risks may look theoretical in real business world, both of
them could exist. The distinction made between them to a large extent is semantic or trival. In
actual facts a given risk has both pure and speculative elements.
An owner of a residential building, for instance, faces the risk that the value of the building at the
end of a year might be grater or smaller than its current value. This risk can be caused, among
other things, due to partial damage of the building by fire or due to possible general decline in
prices of buildings.
One can say that the fire risk is pure risk while decline in price of the building is not. What you
can clearly see from the example is that both of them are examples of the total risk the owner of
the building faces.
But do not take me wrong! I am not in any way implying that there is no need to distinguish
between the two concepts. Though the distinguishing line between pure and speculative risks
may be fuzzy, we will keep on treating them separately as this is the case in the whole business
world.
 Pure risks are normally insurable while speculative risks are not.
Why do you think is insurance unavailable for speculative risks?
The reason is easy to see. Speculative risks are entered into voluntarily, in the hope that there
will be gain. If it is known that an insurance company would cover the risk of loss, regardless of
the effort made by the individual facing the risk, the person would exert very little effort, if any,
to avoid the risk of loss. If a business man knows that any loss he might experience is insurable,
he will not bother much to be profitable.
As it is mentioned above, however, these days it is difficult to be dogmatic about the non-
insurable nature of speculative risks. Practice tells us that insurance is becoming available to
those risks which are normally considered speculative risks. Credit insurance is a good example
in this case. Credit insurance is an arrangement that creditors make with insurance companies so
that the latter would cover the resultant loss should the debtor default.
 Further Classification of Pure Risks.
Pure risks are further classified into three categories.
a. Personal risks

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As the name itself indicates personal risk refers to the possibility of loss to a person. It is chiefly
concerned with death, and the time of it occurrence. And apart from death incapacity through
accident, injury, illness or old age loss of earning power is considered to personal a risk.
Personal loss refers to possibility of loss to a person.
b. Property Risk
Property risk refers to a possible loss of physical property due to various causes. Look at the
possible pure risks which may result in loss of physical property by fire, theft, explosion,
windstorm, flood and any other peril is categorized under property risk.
In addition to direct losses, property risk can also result in indirect losses commonly known as
consequential losses. For example, as a consequence of interruption of operation due to various
reasons a firm could lose income; hence the name consequential loss.
 By property loss we mean a physical property loss suffered due to various causes.
c. Liability Risk
Liability risk is occasioned by the operation of the law of liability and may be termed third
party risk. It materializes when someone intentionally or unintentionally inflicts damage to other
persons or their property. In this case the person would legally be obliged to pay for the damage
he/she has inflicted.
Liability risk arises when damage is inflicted on a third party or on her/his property.
Can you give an example of liability risk?
Cakes a given pastry makes available for sale may create health problems on consumers due to
sanitation problems and people may die because of this. If the consumers go to a court of law
demanding compensation, the pastry would face liability risk which is specifically referred to as
product liability.
 Financial and Non – financial Risk
The second classification of risk groups risk into financial and non-financial category. This
classification is self-explanatory by itself. Financial risks result in losses that can be expressed in
financial terms whereas non- financial risks do not have financial implications.
Can you think of some risks which are measured financially?
Financial risk can easily be seen in the case of material damage to property, theft of property or
loss of business profit following a fire accident. In each of these cases the effect of the risk can
be expressed in terms of money.
Is personal injury a financial risk?

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Personal injuries are also financial risks as it is possible to measure the loss associated with
personal injuries in terms of a court award of damages or based on negotiations made between
the injured person and the person who inflicted the damage. The point is if a given risk can be
measured in financial terms, it would automatically be categorized as financial risk. But there are
situations where this kind of measurement is not possible.
Can you measure the agony one fells following the death of a close relative in terms of money?
What is the financial loss of losing a father? Is it measurable financially?
The above two cases are examples of non- financial risks. If a car you bout for 60,000 Birr
overturns and is totally damaged, you can say that your loss is 60,000 Birr. But you cannot
assign price to people’s lives. Some writers argue that it has been possible to assign money to
people’s lives after the introduction of life insurance. But the money insurance companies pay
for relatives of the deceased person is by no means the value of the dead person and cannot
measure the value of a person’s life. It is rather a mere compensation made to the relatives so
that they can overcome financial hardships.
Non-financial risk refers to risky situation where outcome cannot be measured in terms of
money.
In this course and in real business world, the focus is more on financial risks than on non-
financial risks.
Static and Dynamic Risks
It is also possible to classify a risk based on its degree of intensity and its predictability.
Which one do you think is a more severe risk? A risk associated with changes in coffee price
international or a risk of a farmer losing his/her coffee plant due to fire accident?
Undoubtedly the former one is more severe as its effect is more serious than the latter one. This
is what we refer to as dynamic risk. Dynamic risk originates from changes in the overall
economy such as price level changes, changes in consumer tastes, changes on government
policies, technological change, political changes and the like. It is very much difficult to predict
these kinds of risk.
 Dynamic risk originates from changes in the oversell economy and its effect is felt
widely.
What about static risks?
Static risks refer to those losses that can take place even though there were no changes in the
overall economy. Consider the example that a farmer’s loss of his coffee plant could be very

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painful to the individual, but it won’t have a wider effect like the case of a major decline in the
price of coffee in the international market. Unlike dynamic risks, for static risks to happen there
should not necessarily be change in the overall economy.
Can you think of some examples of static risks?
You may have thought of many of the perils that make life uncertain. Property might get stolen,
a car may collide with another car, a person could fall and break his leg, etc.

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