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 CONTENTS v ii

Case Application 123

Insight 6.1: Home Owner’s Failure to Cooperate Yields Denied Claim 115
Insight 6.2: Be a Smart Consumer—Check the Claims Record of Insurers before You Buy 116

Chapter 7 Financial Operations of Insurers 128

Property and Casualty Insurers 129
Life Insurance Companies 134
Rate Making in Property and Casualty Insurance 136
Rate Making in Life Insurance 140
Summary 141 ■ Key Concepts and Terms 142 ■ Review Questions 142 ■ Application
Questions 143 ■ Internet Resources 144 ■ Selected References 144 ■ Notes 144

Case Application 141

Insight 7.1: How Profitable Is the Property and Casualty Insurance Industry? 135

Chapter 8 Government Regulation of Insurance 146

Reasons for Insurance Regulation 147
Historical Development of Insurance Regulation 148
Methods for Regulating Insurers 150
What Areas Are Regulated? 150
State versus Federal Regulation 156
Current Issues in Insurance Regulation 159
Modernizing Insurance Regulation 159
Insolvency of Insurers 162
Market Conduct Regulation 163
Summary 166 ■ Key Concepts and Terms 167 ■ Review Questions 167 ■ Application
Questions 167 ■ Internet Resources 168 ■ Selected References 168 ■ Notes 169

Case Application 165

Insight 8.1: The Pros and Cons of Credit-Based Insurance Scores 164

part three Legal Principles in Risk and Insurance

Chapter 9 Fundamental Legal Principles 170
Principle of Indemnity 171
Principle of Insurable Interest 174
Principle of Subrogation 175
Principle of Utmost Good Faith 176
Requirements of an Insurance Contract 179
Distinct Legal Characteristics of Insurance Contracts 180
Law and the Insurance Agent 181
Summary 184 ■ Key Concepts and Terms 185 ■ Review Questions 185 ■ Application
Questions 185 ■ Internet Resources 186 ■ Selected References 186 ■ Notes 186

Case Application 183

Insight 9.1: C
 orporation Lacking Insurable Interest at Time of Death Can Receive Life
Insurance Proceeds 176

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 v iii CONTENTS

Insight 9.2: Auto Insurer Denies Coverage Because of Material Misrepresentation 177
Insight 9.3: Insurer Voids Coverage Because of Misrepresentations in Proof of Loss 178

Chapter 10 Analysis of Insurance Contracts 188

Basic Parts of an Insurance Contract 189
Definition of “Insured” 191
Endorsements and Riders 193
Deductibles 193
Coinsurance 195
Coinsurance in Health Insurance 196
Other-Insurance Provisions 196
Summary 199 ■ Key Concepts and Terms 199 ■ Review Questions 200 ■ Application
Questions 200 ■ Internet Resources 201 ■ Selected References 201 ■ Notes 201

Case Application 198

Insight 10.1: W
 hen You Drive Your Roommate’s Car, Are You Covered Under Your
Policy? 192

part four Life and Health Risks

Chapter 11 Life Insurance 202

Premature Death 203
Financial Impact of Premature Death on Different Types of Families 204
Amount of Life Insurance to Own 205
Types of Life Insurance 210
Variations of Whole Life Insurance 216
Other Types of Life Insurance 224
Summary 228 ■ Key Concepts and Terms 229 ■ Review Questions 230 ■ Application
Questions 230 ■ Internet Resources 232 ■ Selected References 233 ■ Notes 233

Case Application 227

Insight 11.1: Cash-Value Life Insurance as an Investment—Don’t Ignore Two Points 215
Insight 11.2: Be a Savvy Consumer—Four Life Insurance Policies to Avoid 226

Chapter 12 Life Insurance Contractual Provisions 234

Life Insurance Contractual Provisions 235
Dividend Options 241
Nonforfeiture Options 243
Settlement Options 245
Additional Life Insurance Benefits 249
Summary 254 ■ Key Concepts and Terms 255 ■ Review Questions 256 ■ Application
Questions 256 ■ Internet Resources 257 ■ Selected References 258 ■ Notes 258

Case Application 254

Insight 12.1: Is This Death A Suicide? 237
Insight 12.2: Selection of the Best Dividend Option in a Participating Whole Life Policy 242
Insight 12.3: Accelerated Death Benefits—A Real-Life Example 252
Insight 12.4: What Is a Life Settlement? Examples of Actual Cases 253

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 CONTENTS ix

Chapter 13 Buying Life Insurance 259

Determining the Cost of Life Insurance 260
Rate of Return on Saving Component 263
Taxation of Life Insurance 265
Shopping for Life Insurance 267
Summary 270 ■ Key Concepts and Terms 270 ■ Review Questions 270 ■ Application
Questions 271 ■ Internet Resources 271 ■ Selected References 272 ■ Notes 272

Case Application 269

Insight 13.1: Be Careful in Replacing an Existing Life Insurance Policy 263
Appendix: Calculation of Life Insurance Premiums 273

Chapter 14 Annuities and Individual Retirement Accounts 278

Individual Annuities 279
Types of Annuities 280
Taxation of Individual Annuities 287
Individual Retirement Accounts 288
Adequacy of IRA Funds 291
Summary 294 ■ Key Concepts and Terms 295 ■ Review Questions 295 ■ Application
Questions 296 ■ Internet Resources 296 ■ Selected References 297 ■ Notes 297

Case Application 1 293

Case Application 2 294
Insight 14.1: Advantages of an Immediate Annuity to Retired Workers 281
Insight 14.2: Bells and Whistles of Variable Annuities 284
Insight 14.3: Ten Questions to Answer Before You Buy a Variable Annuity 288
Insight 14.4: Will You Have Enough Money at Retirement? Monte Carlo Simulations Can
Be Helpful 292

Chapter 15 Healthcare Reform: Individual Health Insurance

Coverages 298
Defects in the Healthcare System in the United States 299
Basic Provisions of the Affordable Care Act 304
Individual Medical Expense Insurance 310
Individual Medical Expense Plans and Managed Care 312
Health Savings Accounts 313
Long-Term Care Insurance 314
Disability-Income Insurance 318
Individual Health Insurance Contractual Provisions 321
Summary 323 ■ Key Concepts and Terms 324 ■ Review Questions 324 ■ Application
Questions 325 ■ Internet Resources 325 ■ Selected References 326 ■ Notes 327

Case Application 323

Insight 15.1: H
 ealth Insurance Options for College Students under the Affordable
Care Act 307

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 x CONTENTS

Chapter 16 Employee Benefits: Group Life and Health

Insurance 328
Meaning of Employee Benefits 329
Fundamentals of Group Insurance 329
Group Life Insurance 331
Group Medical Expense Insurance 332
Managed Care Plans 334
Affordable Care Act and Group Medical Expense Insurance 336
Key Features of Group Medical Expense Insurance 338
Consumer-Directed Health Plans 339
Recent Developments in Employer-Sponsored Health Plans 340
Group Medical Expense Contractual Provisions 343
Group Dental Insurance 344
Group Disability-Income Insurance 345
Cafeteria Plans 346
Summary 348 ■ Key Concepts and Terms 349 ■ Review Questions 349 ■ Application
Questions 350 ■ Internet Resources 351 ■ Selected References 351 ■ Notes 351

Case Application 347

Insight 16.1: Basic Characteristics of the Small Business Health Options (SHOP) Marketplace
Program 338

Chapter 17 Employee Benefits: Retirement Plans 353

Fundamentals of Private Retirement Plans 354
Types of Qualified Retirement Plans 357
Defined-Benefit Plans 357
Defined-Contribution Plans 360
Section 401(K) Plan 361
Section 403(B) Plan 363
Profit-Sharing Plans 364
Retirement Plans for the Self-Employed (Keogh Plans) 364
Simplified Employee Pension (SEP) 364
Simple IRA Plan 365
Saver’s Credit 365
Funding Agency and Funding Instruments 366
Problems and Issues in Tax-Deferred Retirement Plans 367
Summary 369 ■ Key Concepts and Terms 370 ■ Review Questions 370 ■ Application
Questions 370 ■ Internet Resources 371 ■ Selected References 371 ■ Notes 372

Case Application 368

Insight 17.1: Six Common 401 (k) Mistakes 362

Chapter 18 Social Insurance 373

Social Insurance 374
Old-Age, Survivors, and Disability Insurance 376
Types of Benefits 377
Medicare 383
Problems and Issues 388
Unemployment Insurance 391
Workers Compensation 393

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 CONTENTS xi

Summary 398 ■ Key Concepts and Terms 398 ■ Review Questions 399 ■ Application
Questions 399 ■ Internet Resources 400 ■ Selected References 401 ■ Notes 402

Case Application 397

Insight 18.1: Claiming Social Security Benefits­—S­ trategies for Single Persons 380
Insight 18.2: How Would You Reduce the Long-Range Social Security Deficit? 389

part five Personal Property and Liability Risks

Chapter 19 The Liability Risk 403

Basis of Legal Liability 404
Law of Negligence 405
Imputed Negligence 407
Res Ipsa Loquitur 408
Specific Applications of the Law of Negligence 408
Current Tort Liability Problems 410
Summary 420 ■ Key Concepts and Terms 420 ■ Review Questions 421 ■ Application
Questions 421 ■ Internet Resources 422 ■ Selected References 423 ■ Notes 423

Case Application 419

Insight 19.1: Judicial Hellholes 2014–2015 413

Chapter 20 Auto Insurance 425

Overview of Personal Auto Policy 426
Part A: Liability Coverage 427
Part B: Medical Payments Coverage 433
Part C: Uninsured Motorists Coverage 434
Part D: Coverage for Damage to Your Auto 438
Part E: Duties after an Accident or Loss 445
Part F: General Provisions 446
Insuring Motorcycles and Other Vehicles 447
Summary 448 ■ Key Concepts and Terms 448 ■ Review Questions 448 ■ Application
Questions 449 ■ Internet Resources 451 ■ Selected References 451 ■ Notes 451

Case Application 447

Insight 20.1: What Do Ride Sharing and Car Sharing Mean for Personal Auto
Insurance? 430
Insight 20.2: New Study Reveals a Declining Trend in the Percentage of Uninsured
Motorists 435
Insight 20.3: Using Electronic Devices while Driving Is a Serious Problem 442

Chapter 21 Auto Insurance (Continued) 453

Approaches for Compensating Auto Accident Victims 454
Auto Insurance for High-Risk Drivers 464
Cost of Auto Insurance 465
Shopping for Auto Insurance 469
Summary 473 ■ Key Concepts and Terms 473 ■ Review Questions 474 ■ Application
Questions 474 ■ Internet Resources 474 ■ Selected References 475 ■ Notes 475

A01_REJD2578_13_SE_FM.indd 11 12/17/15 3:47 AM

 x ii CONTENTS

Case Application 472

Insight 21.1: Filing an Auto Claim with the Other Party’s Insurance Company 458
Insight 21.2: Protect Yourself: Insuring Your Teen Driver 468
Insight 21.3: More Folks Are Tweeting, Texting, and Taking Pictures While Driving: AT&T
Survey 471

Chapter 22 Homeowners Insurance, Section I  477

Homeowners Insurance 478
Analysis of Homeowners 3 Policy (Special Form) 482
Section I Coverages 483
Section I Perils Insured Against 489
Section I Exclusions 492
Section I Conditions 493
Section I and II Conditions 498
Summary 500 ■ Key Concepts and Terms 500 ■ Review Questions 500 ■ Application
Questions 501 ■ Internet Resources 502 ■ Selected References 503 ■ Notes 503

Case Application 499

Insight 22.1: Renters Insurance Checklist 481
Insight 22.2: How Do I Take a Home Inventory and Why? 494
Insight 22.3: The Big Gap between Replacement Cost and Actual Cash Value Can Empty
Your Wallet 495

Chapter 23 Homeowners Insurance, Section II  504

Personal Liability Insurance 505
Section II Exclusions 507
Section II Additional Coverages 511
Section II Conditions 512
Endorsements to a Homeowners Policy 513
Cost of Homeowners Insurance 516
Summary 520 ■ Key Concepts and Terms 521 ■ Review Questions 521 ■ Application
Questions 522 ■ Internet Resources 523 ■ Selected References 523 ■ Notes 523
Case Application 520
Insight 23.1: Dog Bites Hurt, So Do Lawsuits 506
Insight 23.2: Trying to Save Money? Avoid the Five Biggest Insurance Mistakes! 519

Chapter 24 Other Property and Liability Insurance Coverages 525

ISO Dwelling Program 526
Mobile Home Insurance 528
Inland Marine Floaters 529
Watercraft Insurance 530
Government Property Insurance Programs 531
Title Insurance 536
Personal Umbrella Policy 539

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 CONTENTS x iii

Summary 543 ■ Key Concepts and Terms 543 ■ Review Questions 544 ■ Application
Questions 544 ■ Internet Resources 545 ■ Selected References 546 ■ Notes 546

Case Application 542

Insight 24.1: Dispelling Myths about Flood Insurance 535
Insight 24.2: Title Insurance: Protecting Your Home Investment against Unknown Title
Defects 537
Insight 24.3: Umbrella Insurance Policies: Why You Might Want That Extra Protection 540

part six Commercial Property and Liability Risks

Chapter 25 Commercial Property Insurance 548

Commercial Package Policy 549
Building and Personal Property Coverage Form 551
Causes-of-Loss Forms 554
Endorsements 554
Reporting Forms 556
Business Income Insurance 557
Other Commercial Property Coverages 560
Transportation Insurance 563
Businessowners Policy (BOP) 568
Summary 570 ■ Key Concepts and Terms 571 ■ Review Questions 571 ■ Application
Questions 572 ■ Internet Resources 573 ■ Selected References 574 ■ Notes 574

Case Application 569

Insight 25.1: Three Commercial Property Endorsements That Every Client Should Have 555
Insight 25.2: Examples of Equipment Breakdown Claims: Recent Paid Claims 562

Chapter 26 Commercial Liability Insurance 576

General Liability Loss Exposures 577
Commercial General Liability Policy 578
Employment-Related Practices Liability Insurance 586
Workers Compensation Insurance 587
Commercial Auto Insurance 589
Aircraft Insurance 591
Commercial Umbrella Policy 593
Cyber Liability Insurance 594
Businessowners Policy 595
Professional Liability Insurance 595
Directors and Officers Liability Insurance 597
Summary 599 ■ Key Concepts and Terms 600 ■ Review Questions 600 ■ Application
Questions 601 ■ Internet Resources 602 ■ Selected References 602 ■ Notes 602

Case Application 598

Insight 26.1: Cyber Loss Exposure—No Longer Breaching the CGL 581
Insight 26.2: Basic Facts about Workers Compensation 588

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 xiv CONTENTS

Chapter 27 Crime Insurance and Surety Bonds 605

The ISO Commercial Crime Insurance Program 606
Commercial Crime Coverage Form (Loss-Sustained Form) 607
Financial Institution Bonds 612
Surety Bonds 613
Summary 616 ■ Key Concepts and Terms 617 ■ Review Questions 617 ■ Application
Questions 617 ■ Internet Resources 618 ■ Selected References 619 ■ Notes 619

Case Application 615

Insight 27.1: Crime Prevention Tips for Small Businesses 609

Appendix A: Personal Auto Policy 620

Appendix B: Homeowners 3 (Special Form) 634

Glossary 659

Index 678

A01_REJD2578_13_SE_FM.indd 14 12/17/15 3:47 AM

 Preface
T his text deals with risk and its management. Since
the last edition of the text appeared, several trage-
dies have occurred that clearly demonstrate the deadly
presence of risk in our society. A suicide bomber
entered a market near Baghdad, detonated a bomb,
and killed 11 people. Malaysia Flight 360 mysteri-
ously disappeared with 239 passengers aboard, caus-
ing an enormous amount of pain and suffering to the
surviving families. A deadly earthquake struck Nepal,
a low-income country in Asia, which killed more than
8,600 people and destroyed or damaged tens of thou-
sands of houses. Meanwhile, in the United States, a
gunman killed nine members of a Bible study group in
an historical African American church in Charleston,
South Carolina, and a student enrolled at Umpqua
Community College in Oregon killed nine people and
himself in a tragic and senseless shooting.
In addition to reporting events making national
headlines, the media routinely report on tragic events
at the local level that clearly show the destructive
presence of risk. A runner is hit by a car while jogging;
a tornado touches down and destroys most of a small
town; a house fire leaves a family homeless; a drunk
driver fails to stop at a red light and smashes into
another motorist; a plant explosion kills two people and
injures several employees; and a blinding snowstorm
and ice-packed interstate highway cause a chain-like
accident and collision damage to 10 cars. To say that
we live in a risky and dangerous world is an enormous
understatement.
This thirteenth edition of Principles of Risk Man-
agement and Insurance discusses these issues and
other insurance issues as well. As in previous editions,
the text is designed for a beginning undergraduate
course in risk management and insurance with no pre-
requisites. This edition provides an in-depth treatment
of major risk management and insurance topics. Top-
ics discussed include basic concepts of risk and insur-
ance, introductory and advanced topics in traditional
risk management and enterprise risk management,
A01_REJD2578_13_SE_FM.indd 15
functional and financial operations of insurers, legal
principles, life and health insurance, property and
liability insurance, employee benefits, and social
insurance. In addition, the Affordable Care Act is dis-
cussed in depth. Once again, Principles of Risk
­Management and Insurance places primary emphasis
on insurance consumers and blends basic risk man-
agement and insurance principles with consumer
­considerations. With this user-friendly text, students
can apply basic concepts immediately to their own
personal risk management and insurance programs.
KEY CONTENT CHANGES IN
THE THIRTEENTH EDITION
Thoroughly revised and updated, this edition pro-
vides an in-depth analysis of current insurance indus-
try issues and practices, which readers have come
to expect from Principles of Risk Management and
Insurance. Key content changes in this edition include
the following:
•• Capital retention approach eliminated. In
­Chapter 11, the capital retention approach for
determining the amount of life insurance has
been eliminated. This method generally is not
discussed in the online websites of life insur-
ers. In contrast, the needs approach is heavily
stressed in the available online calculators.
•• Healthcare reform. Chapter 15 has an in-depth
discussion and update of the broken healthcare
delivery system in the United States, which led to
enactment of the Affordable Care Act.
•• Update on the Affordable Care Act. Chapters 15
and 16 provide an update on the Affordable Care
Act (ACA) and its impact on individual and group
health insurance coverages. Primary attention is
devoted to provisions that have a major financial
impact on individuals, families, and employers.
Chapter 18 summarizes the possible desirable and
xv
12/17/15 3:47 AM
 xvi P r e f a ce
undesirable effects of the ACA on both workers
compensation programs and ­employers.
•• Current developments in employer-sponsored
group health insurance plans. Employers con-
tinue to grapple with the rapid increase in group
health insurance premiums and to seek new so-
lutions for holding down costs. Chapter 16 dis-
cusses current trends in group health insurance
to contain higher healthcare costs and premiums.
•• Change in sequence of homeowners and auto
insurance chapters. In previous editions, home-
owners insurance was discussed prior to auto
insurance. This thirteenth edition reverses the se-
quence of homeowners and auto insurance chap-
ters. Auto insurance is discussed first because it
is more relevant and interesting to students than
homeowners insurance. In addition, discussion
of liability coverage in the Personal Auto Policy
(now Chapter 20) logically follows the general
discussion of the liability risk treated in the previ-
ous chapter (Chapter 19).
•• Legalization of medical marijuana and opiate
overuse in workers compensation. The medical
use of marijuana has been legalized in at least 20
states and the District of Columbia. The increased
use of medical marijuana and opiate overuse, and
their impact on workers compensation programs,
are important issues discussed in Chapter 18.
•• Cyber-liability insurance. Computer hackers have
been successful in accessing the credit card records
and other personal information of millions of cus-
tomers of major retail firms. Cyber-liability insur-
ance covers damages arising from the failure of a
data holder to protect private information from
being accessed by an unauthorized party. Chapter
26 discusses some basic concepts in cyber-liability
insurance.
•• New Insurance Services Office (ISO) Forms. The
latest revisions of the ISO Commercial Property
form, the Commercial General Liability form,
and the Commercial/Government Crime Forms
are discussed in these pages. The text also covers
the new Auto Dealers Coverage form.
•• New Insight boxes. A number of new and timely
Insight boxes appear. Insights are valuable learn-
ing tools that provide real-world applications of
a concept or principle discussed in the text.
•• Technical accuracy. As in previous editions,
numerous experts have reviewed the text for
A01_REJD2578_13_SE_FM.indd 16
technical accuracy, especially in areas where
changes occur rapidly. This new edition presents
technically accurate and up-to-date material.
Instructor Resources
At the Instructor Resource Center, www.pearsonhigh-
ered.com/irc, instructors can easily register to gain
access to a variety of instructor resources available
with this text in downloadable format. If assistance is
needed, our dedicated technical support team is ready
to help with the media supplements that accompany
this text. Visit http://247.pearsoned.com for answers
to frequently asked questions and toll-free user sup-
port phone numbers.
The following supplements are available with this
text:
•• Companion Website
–– Internet exercises
–– A multiple choice practice quiz for each chapter
•• Instructor’s Resource Manual & Test Bank
•• TestGen® Computerized Test Bank
•• PowerPoint Presentations
•• Student Study Guide
ACKNOWLEDGMENTS
A market-leading text is never written alone. We owe
an enormous intellectual debt to numerous risk man-
agement and insurance professors, risk management
experts, insurance industry personnel, and other
professionals for their kind and gracious assistance.
These experts provided supplementary materials,
made valuable comments, answered technical ques-
tions, or provided other help. As a result, this new
edition is a substantially improved educational prod-
uct. Our experts include the following:
•• Steve Avila, Ball State University
•• Burton T. Beam, Jr., The American College (­ retired)
•• Patricia Born, Florida State University
•• Nick Brown, Chief Executive Officer, Global
Aerospace
•• Leon Chen, Minnesota State University, ­Mankato
•• Ann Costello, University of Hartford
•• Edward Graves, The American College (retired)
•• Jane Henderson, LIMRA
•• Robert Klein, Georgia State University
12/17/15 3:47 AM

•• Yu-Luen Ma, Illinois State University
•• Rebecca A. McQuade, Director of Risk Manage-
ment, PACCAR, Inc.
•• William H. Rabel, The University of Alabama
•• Bill Rives, The Ohio State University
•• Fred Travis, University of Missouri-Columbia
•• Johnny Vestal, Texas Tech University
•• Eric Wiening, Insurance and Risk Management
Author/Educator/Consultant
•• Millicent W. Workman, Research Analyst, Inter-
national Risk Management Institute, Inc. (IRMI),
and Editor, Practical Risk Management
The views expressed in the text are those solely of the
authors and do not necessarily reflect the viewpoints
A01_REJD2578_13_SE_FM.indd 17
x v ii
P r e f a ce
or positions of the reviewers whose assistance we
gratefully acknowledge.
Finally, the fundamental objective underlying
this thirteenth edition remains the same as in the first
edition: We have attempted to write an intellectually
stimulating and visually attractive textbook from
which students can learn and professors can teach.
George E. Rejda, Ph.D., CLU
Emeritus Professor of Finance, University of
Nebraska—Lincoln
Michael J. McNamara, Ph.D., CPCU, CLU, ARM
Mutual of Enumclaw/Field Distinguished Professor
of Insurance, Washington State University
12/17/15 3:47 AM
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A01_REJD2578_13_SE_FM.indd 18 2/29/16 7:12 PM

 Risk and Its
Chapter

1 Treatment

“When we take a risk, we are betting on an outcome that

will result from a decision we have made, though we do not
know for certain what the outcome will be.”
Peter L. Bernstein
Against the Gods: The Remarkable Story of Risk

Lear n in g Ob je c tive s

After studying this chapter, you should be able to

■■ Explain the historical definition of risk.
■■ Explain the meaning of loss exposure.
■■ Understand the following types of risk:
– Pure risk
– Speculative risk
– Diversifiable risk
– Nondiversifiable risk
– Enterprise risk
– Systemic risk
■■ Identify the major pure risks that are associated with great economic insecurity.
■■ Show how risk is a burden to society.
■■ Explain the major techniques for managing risk.

M01_REJD2578_13_SE_C01.indd 1 16/12/15 1:08 am

 J ason, age 24, is a senior at a large Midwestern university. He has a part-time job
as a cashier in a liquor store located near the university campus. Around mid-
night, on a Saturday night, an intoxicated customer entered the store, grabbed a bot-
tle of wine, and attempted to leave without paying. When Jason blocked his exit, the
enraged customer pulled a knife and stabbed Jason repeatedly in the chest and neck,
severing a major artery. Jason died while being transported to a local hospital.
Jason’s tragic and untimely death shows that we live in a risky, dangerous, and vio-
lent world. The news media report daily on similar tragic events that clearly illustrate
the widespread presence of a risk in our society. Examples abound—two terrorists
armed with assault weapons stormed into the newsroom of a satirical magazine kill-
ing 12 people; a drunk driver on a crowded expressway changed lanes suddenly and
severely injured four people; a tornado touched down and wiped out a small town; a
river overflows, and thousands of acres of farm crops are lost; and an executive is
found guilty of defrauding his company of several millions of dollars. In addition, peo-
ple often experience personal tragedies and financial setbacks that seldom make the
news headlines but nevertheless cause great economic insecurity—the unexpected
death of a family head; catastrophic medical bills that wipe out a family’s savings; the
loss of a good-paying job and long-term unemployment during a severe business
recession; and total disability from an accident of sickness that results in a significant
loss of earnings.
This chapter discusses the nature and treatment of risk in our society. Topics dis-
cussed include the meaning of risk, the major types of personal risks that affect indi-
viduals and families, major commercial risks that affect business firms, the burden of
risk on society, and the major methods for managing risk.

Definitions of Risk Employees in the insurance industry often use the

There is no single definition of risk. Economists,
behavioral scientists, risk theorists, statisticians, actu-
aries, and historians each have their own concept of
risk.
term risk in a different manner to identify the prop-
erty or life that is being considered for insurance. For
example, in the insurance industry, it is common to
hear statements such as “That driver is a poor risk”
or “That building is an unacceptable risk.”

Traditional Definition of Risk Risk Distinguished from Uncertainty

Risk traditionally has been defined in terms of uncer-
tainty. Based on this concept, risk is defined as uncer-
tainty concerning the occurrence of a loss. For
example, the risk of being killed in an auto accident
is present because uncertainty is present. The risk of
lung cancer for smokers is present because uncertainty
is present. The risk of flunking a required college
course is present because uncertainty is present.
2
In the economics and finance literature, authors and
actuaries often make a distinction between risk and
uncertainty. According to the American Academy of
Actuaries, the term risk is used in situations where the
probabilities of possible outcomes are known or can
be estimated with some degree of accuracy, whereas
uncertainty is used in situations where such probabili-
ties cannot be estimated.1 For example, the probability

M01_REJD2578_13_SE_C01.indd 2 16/12/15 1:08 am


of dying at each attained age can be estimated with
considerable accuracy. In contrast, the probability of
destruction of your home by a meteorite from outer
space is only a guess and generally cannot be
­accurately estimated. As such, many authors have
developed their own concept of risk, and numerous
definitions of risk exist in the professional
literature.2
Loss Exposure
Because risk is an ambiguous term and has different
meanings, many authors and corporate risk managers
use the term loss exposure to identify potential losses.
A loss exposure is any situation or circumstance in
which a loss is possible, regardless of whether a loss
actually occurs. Examples of loss exposures include
manufacturing plants that may be damaged by an
earthquake or flood, defective products that may
result in lawsuits against the manufacturer, possible
theft of company property because of inadequate
security, and potential injury to employees because of
unsafe working conditions.
Finally, when the definition of risk includes the
concept of uncertainty, some authors make a careful
distinction between objective risk and subjective risk.
Objective Risk
Objective risk (also called degree of risk) is defined as
the relative variation of actual loss from expected loss.
For example, assume that a property insurer has
10,000 houses insured over a long period and, on
average, 1 percent, or 100 houses, burn each year.
However, it would be rare for exactly 100 houses to
burn each year. In some years, as few as 90 houses
may burn; in other years, as many as 110 houses may
burn. Thus, there is a variation of 10 houses from the
expected number of 100, or a variation of 10 percent.
This relative variation of actual loss from expected
loss is known as objective risk.
Objective risk declines as the number of expo-
sures increases. More specifically, objective risk varies
inversely with the square root of the number of cases
under observation. In our previous example, 10,000
houses were insured, and objective risk was 10/100,
or 10 percent. Now assume that 1 million houses are
insured. The expected number of houses that will
burn is now 10,000, but the variation of actual loss
M01_REJD2578_13_SE_C01.indd 3
D e f initi o ns o f R is k 3
from expected loss is only 100. Objective risk is now
100/10,000, or 1 percent. Thus, as the square root of
the number of houses increased from 100 in the first
example to 1,000 in the second example (10 times),
objective risk declined to one-tenth of its former level.
Objective risk can be statistically calculated by
some measure of dispersion, such as the standard
deviation or the coefficient of variation. Because
objective risk can be measured, it is an extremely use-
ful concept for an insurer or a corporate risk manager.
As the number of exposures increases, an insurer can
predict its future loss experience more accurately
because it can rely on the law of large numbers. The
law of large numbers states that as the number of
exposure units increases, the more closely the actual
loss experience will approach the expected loss experi-
ence. 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. The law of large numbers is discussed in
greater detail in Chapter 2.
Subjective Risk (Perceived Risk)
Subjective risk (perceived risk) is defined as uncer-
tainty based on a person’s mental condition or state
of mind. Another name for subjective risk is perceived
risk; some authors use the term in their discussion of
the perception of risk by individuals. For example,
assume that a driver with several convictions for
drunk driving is drinking heavily in a neighborhood
bar and foolishly attempts to drive home. The driver
may be uncertain whether he will arrive home safely
without being arrested by the police for drunk driv-
ing. This mental uncertainty or perception is called
subjective risk.
The impact of subjective risk varies depending on
the individual. Two persons in the same situation can
have a different perception of risk, and their behavior
may be altered accordingly. If an individual experi-
ences great mental uncertainty concerning the occur-
rence of a loss, that person’s behavior may be affected.
High subjective risk often results in conservative and
prudent behavior, whereas low subjective risk may
result in less conservative behavior. For example,
assume that a motorist previously arrested for drunk
driving is aware that he has consumed too much alco-
hol. The driver may then compensate for the mental
uncertainty by getting someone else to drive the car
16/12/15 1:08 am
 4 C H A P T E R 1 / R is k and I ts T reat m ent
home or by taking a cab. Another driver in the same
situation may perceive the risk of being arrested as
slight. This second driver might drive in a more care-
less and reckless manner; a low subjective risk results
in less conservative driving behavior.
Chance of Loss
Chance of loss is closely related to the concept of risk.
Chance of loss is defined as the probability that an
event will occur. Like risk, probability has both objec-
tive and subjective aspects.
Objective 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. Objective probabilities can
be determined in two ways. First, they can be deter-
mined by deductive reasoning. These probabilities are
called a priori probabilities. For example, the proba-
bility of getting a head from the toss of a perfectly
balanced coin is 1/2 because there are two sides, and
only one is a head. Likewise, the probability of rolling
a 6 with a single die is 1/6, since there are six sides and
only one side has six dots.
Second, objective probabilities can be determined
by inductive reasoning rather than by deduction. For
example, the probability that a person age 21 will die
before age 26 cannot be logically deduced. However,
by a careful analysis of past mortality experience, life
insurers can estimate the probability of death and sell
a five-year term life insurance policy issued at age 21.
Subjective Probability
Subjective probability is the individual’s personal esti-
mate of the chance of loss. Subjective probability need
not coincide with objective probability. For example,
people who buy a lottery ticket on their birthday may
believe it is their lucky day and overestimate the small
chance of winning. A wide variety of factors can influ-
ence subjective probability, including a person’s age,
gender, intelligence, education, and the use of alcohol
or drugs.
In addition, a person’s estimate of a loss may dif-
fer from objective probability because there may be
M01_REJD2578_13_SE_C01.indd 4
ambiguity in the way in which the probability is per-
ceived. For example, assume that a slot machine in a
casino requires a display of three lemons to win. The
person playing the machine may perceive the proba-
bility of winning to be quite high. But if there are 10
symbols on each reel and only one is a lemon, the
objective probability of hitting the jackpot with three
lemons is quite small. Assuming that each reel spins
independently of the others, the probability that all
three will simultaneously show a lemon is the product
of their individual probabilities (1/10 * 1/10 * 1/10 =
1/1,000). This knowledge is advantageous to casino
owners, who know that most gamblers are not trained
statisticians and are therefore likely to overestimate
the objective probabilities of winning.
Chance of Loss versus Objective Risk
Chance of loss can be distinguished from objective
risk. Chance of loss is the probability that an event
that causes a loss will occur. Objective risk is the rela-
tive variation of actual loss from expected loss. The
chance of loss may be identical for two different
groups, but objective risk may be quite different. For
example, assume that a property insurer has 10,000
homes insured in Los Angeles and 10,000 homes
insured in Philadelphia and that the chance of a fire
in each city is 1 percent. Thus, on average, 100 homes
should burn annually in each city. However, if the
annual variation in losses ranges from 75 to 125 in
Philadelphia, but only from 90 to 110 in Los Angeles,
objective risk is greater in Philadelphia even though
the chance 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.
Peril
Peril is defined as the cause of loss. If your house
burns because of a fire, the peril, or cause of loss, is
the fire. If your car is damaged in a collision with
another car, collision is the peril, or cause of loss.
Common perils that cause loss to property include
fire, lightning, windstorm, hail, tornado, earthquake,
flood, burglary, and theft.
16/12/15 1:08 am

Hazard
A hazard is a condition that creates or increases the
frequency or severity of loss. There are four major
types of hazards:
■■ Physical hazard
■■ Moral hazard
■■ Attitudinal hazard (morale hazard)
■■ Legal hazard
Physical Hazard A physical hazard is a physical con-
dition that increases the frequency or severity of loss.
Examples of physical hazards include icy roads that
increase the chance of an auto accident, defective wir-
ing in a building that increases the chance of fire, and
a defective lock on a door that increases the chance of
theft.
Moral Hazard Moral hazard is dishonesty or char-
acter defects in an individual that increase the fre-
quency or severity of loss. Examples of moral hazard
in insurance include faking an accident to collect ben-
efits from an insurer, submitting a fraudulent claim,
inflating the amount of a claim, and intentionally
burning unsold merchandise that is insured. Murder-
ing the insured to collect the life insurance proceeds is
another important example of moral hazard.
Moral hazard is present in all forms of insurance,
and it is difficult to control. Dishonest individuals
often rationalize their actions on the grounds that
“the insurer has plenty of money.” This view is incor-
rect because the insurer can pay claims only by col-
lecting premiums from other insureds. Because of
moral hazard, insurance premiums are higher for
everyone.
Insurers attempt to control moral hazard by the
careful underwriting of applicants for insurance and
by various policy provisions, such as deductibles,
waiting periods, exclusions, and riders. These provi-
sions are examined in Chapter 10.
Attitudinal Hazard (Morale Hazard) Attitudinal
hazard is carelessness or indifference to a loss, which
increases the frequency or severity of a loss. Examples
of attitudinal hazard include leaving car keys in an
unlocked car, which increases the chance of theft;
leaving a door unlocked, which allows a burglar to
enter; and changing lanes suddenly on a congested
expressway without signaling, which increases the
M01_REJD2578_13_SE_C01.indd 5
C lassi f icati o n o f R is k 5
chance of an accident. Careless acts like these increase
the frequency and severity of loss.
The term morale hazard has the same meaning as
attitudinal hazard. Morale hazard is a term that
appeared in earlier editions of this text to describe
someone who is careless or indifferent to a loss. How-
ever, the term attitudinal hazard is more widely used
today and is less confusing to students and more
descriptive of the concept being discussed.
Legal Hazard Legal hazard refers to characteristics
of the legal system or regulatory environment that
increase the frequency or severity of losses. Examples
include adverse jury verdicts or large damage awards
in liability lawsuits; statutes that require insurers to
include coverage for certain benefits in health insur-
ance plans, such as coverage for alcoholism; and regu-
latory action by state insurance departments that
prevents insurers from withdrawing from a state
because of poor underwriting results.
Classification of Risk
Risk can be classified into several distinct classes. The
most important include the following:
■■ Pure and speculative risk
■■ Diversifiable risk and nondiversifiable risk
■■ Enterprise risk
■■ Systemic risk
Pure Risk and Speculative Risk
Pure risk is defined as a situation in which there are
only the possibilities of loss or no loss. The only pos-
sible outcomes are adverse (loss) and neutral (no loss).
Examples of pure risks include premature death, job-
related accidents, catastrophic medical expenses, and
damage to property from fire, lightning, flood, or
earthquake.
In contrast, speculative risk is defined as a situa-
tion in which either profit or loss is possible. For
example, if you purchase 100 shares of common
stock, you would profit if the price of the stock
increases but would lose if the price declines. Other
examples of speculative risks include betting on a
horse race, investing in real estate, and going into
business for yourself. In these situations, both profit
and loss are possible.
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 6 C H A P T E R 1 / R is k and I ts T reat m ent
It is important to distinguish between pure and
speculative risks for three reasons. First, private insur-
ers generally concentrate on pure risks and do not
emphasize the insurance of speculative risks. How-
ever, there are exceptions. Some insurers will insure
institutional portfolio investments and municipal
bonds against loss. Also, enterprise risk management
(discussed later) is another important exception where
certain speculative risks can be insured.
Second, the law of large numbers can be applied
more easily to pure risks than to speculative risks. The
law of large numbers is important because it enables
insurers to predict future loss experience. In contrast,
it is generally more difficult to apply the law of large
numbers to speculative risks to predict future loss
experience. An exception is the speculative risk of
gambling, where casino operators can apply the law
of large numbers in a most efficient manner.
Finally, society may benefit from a speculative
risk even though a loss occurs, but is harmed if a
pure risk is present and a loss occurs. For example,
a firm may develop new technology for producing
inexpensive computers. As a result, some competi-
tors may be forced into bankruptcy. Despite the
bankruptcy, society benefits because the computers
are produced at a lower cost. However, society nor-
mally does not benefit when a loss from a pure risk
occurs, such as a flood or earthquake that destroys
a town or area.
Diversifiable Risk and Nondiversifiable Risk
Diversifiable risk is a risk that affects only individuals
or small groups and not the entire economy. It is a risk
that can be reduced or eliminated by diversification.
For example, a diversified portfolio of stocks, bonds,
and certificates of deposit (CDs) is less risky than a
portfolio that is 100 percent invested in common
stocks. Losses on one type of investment, say stocks,
may be offset by gains from bonds and CDs. Likewise,
there is less risk to a property and liability insurer if
different lines of insurance are underwritten rather
than only one line. Losses on one line can be offset by
profits on other lines. Because diversifiable risk affects
only specific individuals or small groups, it is also
called nonsystematic risk or particular risk. Examples
include car thefts, robberies, and dwelling fires. Only
individuals and business firms that experience such
losses are affected, not the entire economy.
M01_REJD2578_13_SE_C01.indd 6
In contrast, nondiversifiable risk is a risk that
affects the entire economy or large numbers of per-
sons or groups within the economy. It is a risk that
cannot be eliminated or reduced by diversification.
Examples include rapid inflation, cyclical unemploy-
ment, war, hurricanes, floods, and earthquakes
because large numbers of individuals or groups are
affected. Because nondiversifiable risk affects the
entire economy or large numbers of persons in the
economy, it is also called as fundamental risk.
The distinction between a diversifiable and non-
diversifiable (fundamental) risk is important because
government assistance may be necessary to insure
nondiversifiable risks. Social insurance and govern-
ment insurance programs, as well as government
guarantees or subsidies, may be necessary to insure
certain nondiversifiable risks in the United States.
For example, the risks of widespread unemployment
and flood are difficult to insure privately because the
characteristics of an ideal insurable risk (discussed in
Chapter 2) are not easily met. As a result, state
unemployment compensation programs are neces-
sary to provide weekly income to workers who
become involuntarily unemployed. Likewise, the fed-
eral flood insurance program makes property insur-
ance available to individuals and business firms in
flood zones.
Enterprise Risk
Enterprise risk is a term that encompasses all major
risks faced by a business firm. Such risks include pure
risk, speculative risk, strategic risk, operational risk,
and financial risk. We have already explained the
meaning of pure and speculative risk. Strategic risk
refers to uncertainty regarding the firm’s financial
goals and objectives; for example, if a firm enters a
new line of business, the line may be unprofitable.
Operational risk results from the firm’s business oper-
ations. For example, a bank that offers online banking
services may incur losses if “hackers” break into the
bank’s computer.
Enterprise risk also includes financial risk, which
is becoming more important in a commercial risk
management program. Financial risk refers to the
uncertainty of loss because of adverse changes in com-
modity prices, interest rates, foreign exchange rates,
and the value of money. For example, a food com-
pany that agrees to deliver cereal at a fixed price to a
16/12/15 1:08 am
Another random document with
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 Then the educator should “time” himself in forming habits? How
long may it take to cure a bad habit, and form the contrary good
one?
Perhaps a month or six weeks of careful incessant treatment may
be enough.
But such treatment requires an impossible amount of care and
watchfulness on the part of the educator?
Yes; but not more than is given to the cure of any bodily disease
—measles, or scarlet fever, for example.
Then the thoughts and actions of a human being may be
regulated mechanically, so to speak, by setting up the right nerve
currents in the brain?
This is true only so far as it is true to say that the keys of a piano
produce music.
But the thoughts, which may be represented by the fingers of the
player, do they not also run their course without the consciousness
of the thinker?
They do; not merely vague, inconsequent musings, but thoughts
which follow each other with more or less logical sequence,
according to the previous training of the thinker.
Would you illustrate this?
Mathematicians have been known to think out abstruse problems
in their sleep; the bard improvises, authors “reel off” without
premeditation, without any deliberate intention to write such and
such things. The thoughts follow each other according to the habit of
thinking previously set up in the brain of the thinker.
Is it that the thoughts go round and round a subject like a horse in
a mill?
No; the horse is rather drawing a carriage along the same high
road, but into ever new developments of the landscape.
In this light, the important thing is how you begin to think on any
subject?
 Precisely so; the initial thought or suggestion touches as it were
the spring which sets in motion a possibly endless succession or
train of ideas; thoughts which are, so to speak, elaborated in the
brain almost without the consciousness of the thinker.
Are these thoughts, or successive ideas, random, or do they
make for any conclusion?
They make for the logical conclusion which should follow the
initial idea.
Then the reasoning power may be set to work involuntarily?
Yes; the sole concern of this power is, apparently, to work out the
rational conclusion from any idea presented to it.
But surely this power of arriving at logical rational conclusions
almost unconsciously is the result of education, most likely of
generations of culture?
It exists in greater or less degree according as it is disciplined and
exercised; but it is by no means the result of education as the word
is commonly understood: witness the following anecdote:[17]
“When Captain Head was travelling across the Pampas of South
America, his guide one day suddenly stopped him, and, pointing high
into the air, cried out, ‘A lion!’ Surprised at such an exclamation,
accompanied with such an act, he turned up his eyes, and with
difficulty perceived, at an immeasurable height, a flight of condors
soaring in circles in a particular spot. Beneath this spot, far out of
sight of himself or guide, lay the carcass of a horse, and over this
carcass stood, as the guide well knew, a lion, whom the condors
were eyeing with envy from their airy height. The sight of the birds
was to him what the sight of the lion alone would have been to the
traveller, a full assurance of its existence. Here was an act of thought
which cost the thinker no trouble, which was as easy to him as to
cast his eyes upward, yet which from us, unaccustomed to the
subject, would require many steps and some labour.”
Then is what is called “the reason” innate in human beings?
 Yes, it is innate, and is exercised without volition by all, but gains
in power and precision, according as it is cultivated.
If the reason, especially the trained reason, arrives at the right
conclusion without any effort of volition on the part of the thinker, it is
practically an infallible guide to conduct?
On the contrary, the reason is pledged to pursue a suggestion to
its logical conclusion only. Much of the history of religious
persecutions and of family and international feuds turns on the
confusion which exists in most minds between that which is logically
inevitable and that which is morally right.
But according to this doctrine any theory whatever may be shown
to be logically inevitable?
Exactly so; the initial idea once received, the difficulty is, not to
prove that it is tenable, but to restrain the mind from proving that it is
so.
Can you illustrate this point?
The child who lets himself be jealous of his brother is almost
startled by the flood of convincing proofs that he does well to be
angry, which rush in upon him. Beginning with a mere flash of
suspicion in the morning, the little Cain finds himself in the evening
possessed of irrefragable proofs that his brother is unjustly preferred
to him: and
“All seems infected that the infected spy
As all looks yellow to the jaundiced eye.”

But supposing it is true that the child has cause for jealousy?
Given, the starting idea, and his reason is equally capable of
proving a logical certainty, whether it is true or whether it is not true.
Is there any historical proof of this startling theory?
Perhaps every failure in conduct, in individuals, and in nations, is
due to the confusion which exists as to that which is logically right,
as established by the reason, and that which is morally right, as
established by external law.
 Is any such distinction recognised in the Bible?
Distinctly so; the transgressors of the Bible are those who do that
which is right in their own eyes—that is, that of which their reason
approves. Modern thought considers, on the contrary, that all men
are justified in doing that which is right in their own eyes, acting “up
to their lights,” “obeying the dictates of their reason.”
For example?
A mother whose cruel usage had caused the death of her child
was morally exonerated lately in a court of justice because she acted
“from a mistaken sense of duty.”
But it is not possible to err from a mistaken sense of duty?
Not only possible, but inevitable, if a man accept his “own reason”
as his lawgiver and judge. Take a test case, the case of the
superlative crime that has been done upon the earth. There can be
no doubt that the persons who caused the death of our Lord and
Saviour Jesus Christ acted under a mistaken sense of duty. “It is
expedient that one man die for the people, and that the whole nation
perish not,” said, most reasonably, those patriotic leaders of the
Jews; and they relentlessly hunted to death this Man whose
ascendency over the common people and whose whispered claims
to kingship were full of elements of danger to the subject race. “They
know not what they do,” He said, Who is the Truth.
All this may be of importance to philosophers; but what has it to
do with the bringing up of children?
It is time we reverted to the teaching of Socrates. “Know thyself,”
exhorted the wise man, in season and out of season; and it will be
well with us when we understand that to acquaint a child with himself
—what he is as a human being—is a great part of education.
It is difficult to see why; surely much harm comes of morbid
introspection?
Introspection is morbid or diseased when the person imagines
that all which he finds within him is peculiar to him as an individual.
To know what is common to all men is a sound cure for unhealthy
self-contemplation.
How does it work?
To recognise the limitations of the reason is a safeguard in all the
duties and relations of life. The man who knows that loyalty is his
first duty in every relation, and that if he admit doubting, grudging,
unlovely thoughts, he cannot possibly be loyal, because such
thoughts once admitted will prove themselves to be right and fill the
whole field of thought, why, he is on his guard, and writes up “no
admittance” to every manner of mistrustful fancy.
That rule of life should affect the Supreme relationship?
Truly, yes; if a man will admit no beginning of mistrustful surmise
concerning his father and mother, his child and his wife, shall he do
so of Him who is more than they, and more than all, the “Lord of his
heart”? “Loyalty forbids” is the answer to every questioning of His
truth that would intrude.
But when others, whom you must needs revere, question and tell
you of their “honest doubt”?
You know the history of their doubt, and can take it for what it is
worth—its origin in the suggestion, which, once admitted, must
needs reach a logical conclusion even to the bitter end. “Take heed
that ye enter not into temptation,” He said, Who needed not that any
should tell Him, for He knew what was in men.
If man is the creature of those habits he forms with care or allows
in negligence, if his very thoughts are involuntary and his
conclusions inevitable, he ceases to be a free agent. One might as
well concede at once that “thought is a mode of motion,” and cease
to regard man as a spiritual being capable of self-regulation!
It is hardly possible to concede too wide a field to biological
research, if we keep well to the front the fact, that man is a spiritual
being whose material organs act in obedience to spiritual
suggestion; that, for example, as the hand writes, so the brain thinks,
in obedience to suggestions.
 Is the suggestion self originated?
Probably not; it would appear that, as the material life is sustained
upon its appropriate food from without, so the immaterial life is
sustained upon its food,—ideas or suggestions spiritually conveyed.
May the words “idea” and “suggestion” be used as synonymous
terms?
Only in so far as that ideas convey suggestions to be effected in
acts.
What part does the man himself play in the reception of this
immaterial food?
It is as though one stood on the threshold to admit or reject the
viands which should sustain the family.
Is this free-will in the reception or rejection of ideas the limit of
man’s responsibility in the conduct of his life?
Probably it is; for an idea once received must run its course,
unless it be superseded by another idea, in the reception of which
volition is again exercised.
How do ideas originate?
They appear to be spiritual emanations from spiritual beings; thus,
one man conveys to another the idea which is a very part of himself.
Is the intervention of a bodily presence necessary for the
transmission of an idea?
By no means; ideas may be conveyed through picture or printed
page; absent friends would appear to communicate ideas without the
intervention of means; natural objects convey ideas, but, perhaps,
the initial idea in this case may always be traced to another mind.
Then the spiritual sustenance of ideas is derived directly or
indirectly from other human beings?
No; and here is the great recognition which the educator is called
upon to make. God, the Holy Spirit, is Himself the supreme Educator
of mankind.
 How?
He openeth man’s ear morning by morning, to hear so much of
the best as the man is able to bear.
Are the ideas suggested by the Holy Spirit confined to the sphere
of the religious life?
No; Coleridge, speaking of Columbus and the discovery of
America, ascribes the origin of great inventions and discoveries to
the fact that “certain ideas of the natural world are presented to
minds, already prepared to receive them, by a higher Power than
Nature herself.”
Is there any teaching in the Bible to support this view?
Yes; very much. Isaiah, for example, says that the ploughman
knows how to carry on the successive operations of husbandry, “for
his God doth instruct him and doth teach him.”
Are all ideas which have a purely spiritual origin ideas of good?
Unhappily, no; it is the sad experience of mankind that
suggestions of evil also are spiritually conveyed.
What is the part of the man?
To choose the good and refuse the evil.
Does this doctrine of ideas as the spiritual food needful to sustain
the immaterial life throw any light on the doctrines of the Christian
religion?
Yes; the Bread of Life, the Water of Life, the Word by which man
lives, the “meat to eat which ye know not of,” and much more, cease
to be figurative expressions, except that we must use the same
words to name the corporeal and the incorporeal sustenance of man.
We understand, moreover, how suggestions emanating from our
Lord and Saviour, which are of His essence, are the spiritual meat
and drink of His believing people. We find it no longer a “hard
saying,” nor a dark saying, that we must sustain our spiritual selves
upon Him, even as our bodies upon bread.
 What practical bearing upon the educator has this doctrine of
ideas?
He knows that it is his part to place before the child daily
nourishment of ideas; that he may give the child the right initial idea
in every study, and respecting each relation and duty of life; above
all, he recognises the divine co-operation in the direction, teaching,
and training of the child.
How would you summarise the functions of education?
Education is a discipline—that is, the discipline of the good habits
in which the child is trained. Education is a life, nourished upon
ideas; and education is an atmosphere—that is, the child breathes
the atmosphere emanating from his parents; that of the ideas which
rule their own lives.
What part do lessons and the general work of the schoolroom
play in education thus regarded?
They should afford opportunity for the discipline of many good
habits, and should convey to the child such initial ideas of interest in
his various studies as to make the pursuit of knowledge on those
lines an object in life and a delight to him.
What duty lies upon parents and others who regard education
thus seriously, as a lever by means of which character may be
elevated, almost indefinitely?
Perhaps it is incumbent upon them to make conscientious
endeavours to further all means used to spread the views they hold;
believing that there is such “progress in character and virtue”
possible to the redeemed human race as has not yet been realised,
or even imagined. “Education is an atmosphere, a discipline, a
life.”[18]

FOOTNOTES:
[17] From Archbishop Thompson’s Laws of Thought.
[18] Matthew Arnold.
 CHAPTER XXIV

WHENCE AND WHITHER

Part I
“The P.N.E.U. goes on,” an observer writes, “without puff or fuss, by
its own inherent force;” and it is making singularly rapid progress. At
the present moment not less than ten thousand children of thinking,
educated parents, are being brought up, more or less consciously
and definitely, upon the line of the Union. Parents who read the
Parents’ Review, or other literature of the Society, parents who
belong to our various branches, or our other agencies, parents who
are influenced by these parents, are becoming multitudinous; and all
have one note in common,—the ardour of persons working out
inspiring ideas.
It is hardly possible to over-estimate the force of this league of
educated parents. When we think of the part that the children being
brought up under these influences will one day play in the leading
and ruling of the land, we are solemnised with the sense of a great
responsibility, and it behoves us to put to ourselves, once again, the
two searching queries by which every movement should, from time
to time, be adjudged,—Whence? and Whither?
Whence? The man who is satisfied with his dwelling-place has no
wish to move, and the mere fact of a “movement” is a declaration
that we are not satisfied, and that we are definitely on our way to
some other ends than those commonly accepted. In one respect
only we venture boldly to hark back. Exceedingly fine men and
women were brought up by our grandfathers and grandmothers,
even by our mothers and fathers, and the wise and old amongst us,
though they look on with great sympathy, yet have an unexpressed
feeling that men and women were made on the old lines of a stamp
which we shall find it hard to improve upon. This was no mere
chance result, nor did it come out of the spelling-book or the
Pinnock’s Catechisms which we have long ago consigned to the
limbo they deserve.
The teaching of the old days was as bad as it could be, the
training was haphazard work, reckless alike of physiology and
psychology; but our grandfathers and grandmothers had one saving
principle, which, for the last two or three decades, we have been, of
set purpose, labouring to lose. They, of the older generation,
recognised children as reasonable beings, persons of mind and
conscience like themselves, but needing their guidance and control,
as having neither knowledge nor experience. Witness the queer old
children’s books which have come down to us; before all things,
these addressed children as reasonable, intelligent and responsible
(terribly responsible!) persons. This fairly represents the note of
home-life in the last generation. So soon as the baby realised his
surroundings, he found himself a morally and intellectually
responsible person. Now one of the secrets of power in dealing with
our fellow beings is, to understand that human nature does that
which it is expected to do and is that which it is expected to be. We
do not mean, believed to do and to be, with the fond and foolish faith
which Mrs. Hardcastle bestowed on her dear Tony Lumpkin.
Expectation strikes another chord, the chord of “I am, I can, I ought,”
which must vibrate in every human breast, for, “’tis our nature to.”
The capable, dependable men and women whom we all know were
reared upon this principle.
But now? Now, many children in many homes are still brought up
on the old lines, but not with quite the unfaltering certitude of the old
times. Other thoughts are in the air. A baby is a huge oyster (says
one eminent psychologist) whose business is to feed, and to sleep,
and to grow. Even Professor Sully, in his most delightful book,[19] is
torn in two. The children have conquered him, have convinced him
beyond doubt that they are as ourselves, only more so. But then he
is an evolutionist, and feels himself pledged to accommodate the
child to the principles of evolution. Therefore, the little person is
supposed to go through a thousand stages of moral and intellectual
development, leading him from the condition of the savage or ape to
that of the intelligent and cultivated human being. If children will not
accommodate themselves pleasantly to this theory, why, that is their
fault, and Professor Sully is too true a child-lover not to give us the
children as they are, with little interludes of the theory upon which
they ought to evolve. Now we have absolutely no theory to advance,
and are, on scientific grounds, disposed to accept the theories of the
evolutionary psychologists. But facts are too strong for us. When we
consider the enormous intellectual labour the infant goes through
during his first year in accommodating himself to the conditions of a
new world, in learning to discern between far and near, solid and flat,
large and small, and a thousand other qualifications and limitations
of this perplexing world, why, we are not surprised that John Stuart
Mill should be well on in his Greek at five; that Arnold at three should
know all the Kings and Queens of England by their portraits; or that a
musical baby should have an extensive repertoire of the musical
classics.
We were once emphasising the fact that every child could learn to
speak two languages at once with equal facility, when a gentleman in
the audience stated that he had a son who was a missionary in
Bagdad, married to a German lady, and their little son of three
expressed all he had to say with equal fluency in three languages—
German, English, and Arabic, using each in speaking to those
persons whose language it was. “Nana, which does God love best,
little girls or little boys?” said a meditative little girl of four. “Oh, little
girls, to be sure,” said Nana, with a good-natured wish to please.
“Then if God loves little girls best, why was not God Himself a little
girl?” Which of us who have reached the later stages of evolution
would have hit upon a more conclusive argument? If the same little
girl asked on another occasion, watching the blackbirds at the
cherries: “Nana, if the bees make honey, do the birds make jam?” it
was by no means an inane question, and only proves that we older
persons are dull and inappreciative of such mysteries of nature as
that bees should make honey.
 This is how we find children—with intelligence more acute, logic
more keen, observing powers more alert, moral sensibilities more
quick, love and faith and hope more abounding; in fact, in all points
like as we are, only much more so, but absolutely ignorant of the
world and its belongings, of us and our ways, and, above all, of how
to control and direct and manifest the infinite possibilities with which
they are born.
Our conception of a child rules our relations towards him. Pour
s’amuser is the rule of child-life proper for the “oyster” theory, and
most of our children’s books and many of our theories of child-
education are based upon this rule. “Oh! he’s so happy,” we say, and
are content, believing that if he is happy he will be good; and it is so
to a great extent; but in the older days the theory was, if you are
good you will be happy; and this is a principle which strikes the
keynote of endeavour, and holds good, not only through the childish
“stage of evolution,” but for the whole of life, here and hereafter. The
child who has learned to “endeavour himself” (as the Prayer Book
has it) has learned to live.
If our conception of Whence? as regards the child, as of—
“A Being, breathing thoughtful breath,
A traveller betwixt life and death,”—

is old, that of our grandfathers; our conception of the aims and

methods of education, is new, only made possible within the very last
decades of the century; because it rests one foot upon the latest
advances in the science of Biology and the other upon the potent
secret of these latter days, that matter is the all-serviceable agent of
spirit, and that spirit forms, moulds, is absolute lord, over matter, as
capable of affecting the material convolutions of the brain as of
influencing what used to be called the heart.
Knowing that the brain is the physical seat of habit, and that
conduct and character, alike, are the outcome of the habits we allow:
knowing, too, that an inspiring idea initiates a new habit of thought,
and, hence, a new habit of life; we perceive that the great work of
education is to inspire children with vitalising ideas as to the relations
of life, departments of knowledge, subjects of thought: and to give
deliberate care to the formation of those habits of the good life which
are the outcome of vitalising ideas.
In this great work we seek and assuredly find the co-operation of
the Divine Spirit, whom we recognise, in a sense rather new to
modern thought, as the Supreme Educator of mankind in things that
have been called secular, fully as much as in those that have been
called sacred. We are free to give our whole force to these two great
educational labours, of the inspiration of ideas and the formation of
habits, because, except in the case of children somewhat mentally
deficient, we do not consider that the “development of faculties” is
any part of our work; seeing that the children’s so-called faculties are
already greatly more acute than our own.
We have, too, in our possession, a test for systems that are
brought under our notice, and can pronounce upon their educational
value. For example, a little while ago, the London Board Schools
held an exhibition of work; and great interest was excited by an
exhibit which came from New York representing a week’s work in a
school. The children worked for a week upon “an apple.” They
modelled it in clay, they painted it in brushwork, they stitched the
outline on cardboard, they pricked it, they laid it in sticks (the
pentagonal form of the seed vessel). Older boys and girls modelled
an apple-tree and made a little ladder on which to run up the apple-
tree and gather the apples, and a wheel-barrow to carry the apples
away, and a great deal more of the same kind. Everybody said, “How
pretty, how ingenious, what a good idea!” and went away with the
notion that here, at last, was education. But we ask, “What was the
informing idea?” The external shape, the internal contents of an
apple,—matters with which the children were already exceedingly
well acquainted. What mental habitudes were gained by this week’s
work? They certainly learned to look at the apple, but think how
many things they might have got familiar acquaintance with in the
time. Probably the children were not consciously bored, because the
impulse of the teachers enthusiasm carried them on. But, think of
it—
“Rabbits hot and rabbits cold,
Rabbits young and rabbits old,
 Rabbits tender and rabbits tough,”—

no doubt those children had enough—of apples anyway. This “apple”

course is most instructive to us as emphasising the tendency in the
human mind to accept and rejoice in any neat system which will
produce immediate results, rather than to bring every such little
course to the test of whether it does or does not further either or both
of our great educational principles.
Whither? Our “whence” opens to us a “whither” of infinitely
delightful possibilities. Seeing that each of us is labouring for the
advance of the human race through the individual child we are
educating, we consider carefully in what directions this advance is
due, and indicated, and we proceed of set purpose and, endeavour
to educate our children so that they shall advance with the tide. “Can
ye not discern the signs of the times?” A new Renaissance is coming
upon us, of unspeakably higher import than the last; and we are
bringing up our children to lead and guide, and, by every means help
in the progress—progress by leaps and bounds—which the world is
about to make. But “whither” is too large a question for the close of a
chapter.

FOOTNOTES:
[19] “Studies of Childhood,” by Professor Sully (Longmans,
10s. 6d.).
 CHAPTER XXV

WHENCE AND WHITHER

Part II
The morphologist, the biologist, leave many without hesitation in
following the great bouleversement of thought, summed up in the
term evolution. They are no longer able to believe otherwise than
that man is the issue of processes, ages long in their development;
and what is more, and even more curious, that each individual child,
from the moment of his conception to that of his birth, appears in his
own person to mark an incredible number of the stages of this
evolutionary process. The realisation of this truth has made a great
impression on the minds of men. We feel ourselves to be part of a
process, and to be called upon, at the same time, to assist in the
process, not for ourselves exactly, but for any part of the world upon
which our influence bears; especially for the children who are so
peculiarly given over to us. But there comes, as we have seen, a
point where we must arise and make our protest. The physical
evolution of man may admit of no doubt; the psychical evolution, on
the other hand, is not only, not proven, but the whole weight of
existing evidence appears to go into the opposite scale.
The age of materialism has run its course: we recognise matter as
force, but as altogether subject force, and that it is the spirit of a man
which shapes and uses his material substance, in its own ways to its
own ends. Who can tell the way of the spirit? Perhaps this is one of
the ultimate questions upon which man has not yet been able to
speculate to any purpose; but when we consider the almost
unlimited powers of loving and of trusting, of discriminating and of
apprehending, of perceiving and of knowing, which a child
possesses, and compare these with the blunted sensibilities and
slower apprehension of the grown man or woman of the same
calibre, we are certainly not inclined to think that growth from less to
more, and from small to great, is the condition of the spiritual life:
that is, of that part of us which loves and worships, reasons and
thinks, learns and applies knowledge. Rather would it seem to be
true of every child in his degree, as of the divine and typical Child,
that He giveth not the Spirit by measure to him.
It is curious how the philosophy of the Bible is always well in
advance of our latest thought. “He grew in wisdom and in stature,”
we are told. Now what is wisdom—philosophy? Is it not the
recognition of relations? First, we have to understand relations of
time and space and matter, the natural philosophy which made up so
much of the wisdom of Solomon; then, by slow degrees, and more
and more, we learn that moral philosophy which determines our
relations of love and justice and duty to each other: later, perhaps,
we investigate the profound and puzzling subject of the inter-
relations of our own most composite being,—mental philosophy. And
in all these and beyond all these we apprehend slowly and feebly the
highest relation of all, the relation to God, which we call religion. In
this science of the relations of things consists what we call wisdom,
and wisdom is not born in any man,—apparently not even in the Son
of man Himself. He grew in wisdom, in the sweet gradual
apprehension of all the relations of life: but the power of
apprehending, the strong, subtle, discerning spirit, whose function it
is to grasp and understand, appropriate and use, all the relations
which bind all things to all other things—this was not given to Him by
measure; nor, we may reverently believe, is it so given to us.
That there are differences in the measures of men, in their
intellectual and moral stature, is evident enough; but it is well that we
should realise the nature of these differences, that they are
differences in kind and not in degree; depending upon what we glibly
call the laws of heredity, which bring it to pass that man in his various
aspects shall make up that conceivably perfect whole possible to
mankind. This is a quite different thing from the notion of a small and
feeble measure of heart and intellect in the child, to grow by degrees
into the robust and noble spiritual development which, according to
the psychical evolutionist, should distinguish the adult human being.
These are quite practical and simple considerations for every one
entrusted with the bringing up of a child, and are not to be set aside
as abstract principles, the discussion of which should serve little
purpose beyond that of sharpening the wits of the schoolmen. As a
matter of fact, we do not realise children, we under-estimate them; in
the divine words, we “despise” them, with the best intentions in the
world, because we confound the immaturity of their frames, and their
absolute ignorance as to the relations of things, with spiritual
impotence: whereas the fact probably is, that never is intellectual
power so keen, the moral sense so strong, spiritual perception so
piercing, as in those days of childhood which we regard with a
supercilious, if kindly, smile. A child is a person in whom all
possibilities are present—present now at this very moment—not to
be educed after years and efforts manifold on the part of the
educator: but indeed it is a greater thing to direct and use this wealth
of spiritual power than to develop the so-called faculties of the child.
It cannot be too strongly urged that our education of children will
depend, nolens volens, upon the conception we form of them. If we
regard them as instruments fit and capable for the carrying out of the
Divine purpose in the progress of the world, we shall endeavour to
discern the signs of the times, perceive in what directions we are
being led, and prepare the children to carry forward the work of the
world, by giving them vitalising ideas concerning, at any rate, some
departments of that work.
Having settled it with ourselves that we and the children alike live
for the advancement of the race, that our work is immediately with
them, and, through them, mediately for all, and that they are
perfectly fitted to receive those ideas which are for the inspiration of
life, we must next settle it with ourselves in what directions we shall
set up spiritual activities in the children.
We have sought to establish our whence in the potency of the
child, we will look for our whither in the living thought of the day,
which probably indicates the directions in which the race is making
progress. We find that all men everywhere are keenly interested in
science, that the world waits and watches for great discoveries; we,
too, wait and watch, believing that, as Coleridge said long ago, great
ideas of Nature are imparted to minds already prepared to receive
them by a higher Power than Nature herself.
At a late meeting of the British Association, the President
lamented that the progress of science was greatly hindered by the
fact that we no longer have field naturalists—close observers of
Nature as she is. A literary journal made a lamentable remark
thereupon. It is all written in books, said this journal, so we have no
longer any need to go to Nature herself. Now the knowledge of
Nature which we get out of books is not real knowledge; the use of
books is, to help the young student to verify facts he has already
seen for himself. We, of the P.N.E.U., are before all things, Nature-
lovers; we conceive that intimate acquaintance with every natural
object within his reach is the first, and possibly, the best part of a
child’s education. For himself, all his life long, he will be soothed
by—
“The breathing balm,
The silence and the calm,
Of mute insensate things.”

And for science, he is in a position to do just the work which is

most needed; he will be a close loving observer of Nature at first
hand, storing facts, and free from all impatient greed for inferences.
Looking out on the realm of Art again, we think we discern the
signs of the times. Some of us begin to learn the lesson which a
prophet has been raised up to deliver to this generation. We begin to
understand that mere technique, however perfect—whether in the
rendering of flesh tints, or marbles, or of a musical composition of
extreme difficulty—is not necessarily high Art. It is beginning to dawn
upon us that Art is great only in proportion to the greatness of the
idea that it expresses; while, what we ask of the execution, the
technique, is that it shall be adequate to the inspiring idea. But surely
these high themes have nothing to do with the bringing up of
children? Yes, they have; everything. In the first place, we shall
permit no pseudo Art to live in the same house with our children;
next, we shall bring our own facile tastes and opinions to some such
searching test as we have indicated, knowing that the children
imbibe the thoughts that are in us, whether we will or no; and, lastly,
we shall inspire our children with those great ideas which shall
create a demand, anyway, for great Art.
In literature, we have definite ends in view, both for our own
children, and for the world through them. We wish the children to
grow up to find joy and refreshment in the taste, the flavour of a
book. We do not mean by a book any printed matter in a binding, but
a work possessing certain literary qualities able to bring that sensible
delight to the reader which belongs to a literary word fitly spoken. It
is a sad fact that we are losing our joy in literary form. We are in
such haste to be instructed by facts or titillated by theories, that we
have no leisure to linger over the mere putting of a thought. But this
is our error, for words are mighty both to delight and to inspire. If we
were not as blind as bats, we should long ago have discovered a
truth very fully indicated in the Bible—that that which is once said
with perfect fitness can never be said again, and becomes ever
thereafter a living power in the world. But in literature, as in art, we
require more than mere form. Great ideas are brooding over the
chaos of our thought; and it is he who shall say the things we are all
dumbly thinking, who shall be to us as a teacher sent from God.
For the children? They must grow up upon the best. There must
never be a period in their lives when they are allowed to read or
listen to twaddle or reading-made-easy. There is never a time when
they are unequal to worthy thoughts, well put; inspiring tales, well
told. Let Blake’s “Songs of Innocence” represent their standard in
poetry; Defoe and Stevenson, in prose; and we shall train a race of
readers who will demand literature, that is, the fit and beautiful
expression of inspiring ideas and pictures of life. Perhaps a printed
form to the effect that gifts of books to the children will not be
welcome in such and such a family, would greatly assist in this
endeavour!
To instance one more point—there is a reaching out in all
directions after the conception expressed in the words “solidarity of
the race.” We have probably never before felt as now in absolute