CONCEPT OF RISK

 Risk is the possibility of unfavorable result following from any occurrence.

 Risk is the danger of loss from an unforeseen situation.
 Risk is the subject matter of insurance. Risk can be reduces by insurance.
 Risk is the chance that an investment’s actual outcome will differ from the
expected outcome.
 Risk is the condition where there is a possibility of an adverse deviation
from the desired outcome that is expected or hoped for; there is no need
that the possibility be measureable, only that must exist. LIC
 Business risks include changing demand, price falls, change in taste, market
condition, competition, invention, natural calamities etc.
 The degree of risk is the likelihood of occurrence of an event. It is a
measure of accuracy with which the outcome of a chance can be predicted.

Elements of risk
1. The outcome is uncertain.
2. Out of the possible outcomes, one is unfavorable or not liked by the
analyst.

Risk vs. Uncertainty

 Risk is the situation under which the decision outcomes and their
probabilities of outcomes are known to the decision maker.
Uncertainty refers to a situation where the outcome is not certain or
unknown. It is a state of mind characterised by doubt, based on the lack of
knowledge about what will or what will not happen in future. It is the
situation under which the decision outcomes and their probabilities of
outcomes are not known to the decision maker.
 Risk can be measureable but uncertainty is neither measurable nor
predictable.
 PERIL
 A peril refers to the cause of loss or the contingency that may cause a loss.
 It is a potential event or factors that cause a loss.
 Perils may be general or specific e.g. fire may affect assets like building,
machinery, equipment, automobiles and humans. Collusion may cause
damage to the automobiles resulting in financial loss.
 Example: Fire, Flood,Earth-quake, Lightening, Land-Slide etc.
 Risk of fire can be reduced by installing smoke-detectors or fire –
extinguisher in the office.
 Insurance does not prevent the losses due to peril. Insurance only tries to
reduce the impact of the financial loss to the owner or beneficiary of the
asset.
 Insurance tries to put the person in the same position, which he or she was,
before the fire occurred in the office.
HAZARDS
 Hazard is a condition that increases the severity or chances ofloss.
 It is something, which accelerates the peril.
 Economic slowdown is a peril that may cause a loss to the business,
but it is also a hazard that may cause a heart attack or mental shock
to the proprietor of the business.
 If there is fire in an explosive manufacturing unit, the explosives will
result in a rapid spread of fire, destroying everything in a short
time.
Classification of Hazards
1. Physical hazard: It consists of those physical conditions that increase the
chance of loss from any peril. The probability of danger is greater here.
Examples:
 Existence of dry forests- a hazard affecting the peril of fire
 Stocking of crackers in a commercial complex- a hazard affecting the
peril of fire
 Petrol is more hazardous than edible oil for a fire-peril.
 Loose wiring or open live wires in a house, can result in short-circuits
and fire have physical hazards, relating to fire insurance.
  Individuals, having a history of Tuberculosis, have physical hazards,
relating to life insurance.
2. Moral hazard: It refers to an increase the probability of loss that result
from dishonesty inthe character of the insured. The intention is malafide
(cheating the insurer and making profit out of insurance)
Examples:
 Putting fire to a factory running in losses
 Deliberately indulging into automobile collusion or damaging it
 Tendency on the part of the doctor to go for unnecessary testing,
since the loss will be reimbursed by the insurer.
 The mental attitude of a careless or accident-prone person
because of the existence of insurance contract.
 Taking life insurance, by fraudulently suppressing the fact that
he/she is suffering from critical illness.
3. Societal hazard: It refers to theincrease in the frequency and severity of
loss arising from legal doctrines or societal customs and structure.
Examples:
 The construction or the possibility of demolition of buildings in
unauthorized/public places.

TYPES OF RISK
1. Static risk – Such risk is more or less predictable and is not affected by the
economic conditions. They can be covered by insurance.
2. Dynamic risk – Such risk arises from the changes in the economy or the
environment. The economic variables like inflation, income level, price
level, technology changes etc are the causes of such risk. They are not
covered by insurance.
3. Fundamental risk – Such risk affects the economy or its participants on a
macro basis. The risks factor may be socio economic or political or natural
calamities.
4. Particular risk – Such risk is confined to individual entity or small groups.
Robbery, fire etc. are risks that are particular in nature.
5. Pure risk – Here the situations are those where there is a possibility of loss
or no loss. There is no gain to the individual or to the organization.
6. Speculative risk – It is defined as situation in which either a profit or loss is
possible. These are not insurable.
7. Business risk (Internal) – Such risk arises from events taking place within
the business enterprise. Internal factors giving rise to such risk. It includes
human factors,technological factors and physical factors.
8. Business risk (External) – Such risk arises due to events occurring outside
the business organization. External factors giving rise to such risk includes
economic factors, natural factors and political factors.
9. Business risk (Controllable) – Such risk arises during the ordinary course of
business and which can be forecasted and the probability of occurrence can
be determined. Such risk need no necessarily be prevented, but the
financial loss can be minimized.
10.Business risk (Uncontrollable) – Such risk would have detrimental financial
impact but cannot be controlled.
11.Personal risk–The risk of unemployment, accident, sickness, retirement
affect individuals and the occurrence may seriously disturb future
expenditure plans.
12.Property risk – All business and individuals that own, rent or use property
that are exposed to risk that the property may be damaged, destroyed or
stolen.
13.Liability risk – It is concerned with those losses resulting from the
unintentional injury of other person or damages to their property through
negligence or carelessness. Risks relating to third party liability risk are
within its scope.
14.Financial risk - Such risks lead to losses. They can be quantified or
measured in monetary terms. For example changes in the value of assets
like shares or property etc.Such risk have an impact on the earnings of the
firm. It includes credit risk, foreign exchange risk, interest rate risk etc.
15.Non-financial Risks: Such risks cannot be quantified or measured in
monetary terms. For example mental agony or loss of reputation etc.
CLASSIFICATION OF RISK
 STATIC RISK DYNAMIC RISK
1. They are more or less 1. The occurrence of such losses is
predictable, their frequency and not easily predictable.
possibility can be studied and
forecasted.
2. They occur even if there is no 2. They result from changes in
change in economic economic environment.
environment.
3. They can be managed/covered 3. They are not covered by insurance.
by insurance.
4. They are not a source of gain to 4. They are the best indicators of
society. progress to society.
5. Examples: 5. Examples:
Destruction of an asset or changes in the price level, consumers
change in its possession as a wants,fashisons, techonology,change in
result of dishonesty or failure of government, income level etc.
a person

PURE RISK SPECULATIVE RISK

1. It denotes those situations where
there is a possibility of complete
loss or no loss at all.
2. It is generally prevalent in
situations such as natural
disasters, fire, deaths etc.
3. They are insurable being
predictable.
4. Law of large numbers can be
applied more easily for such risk.
Examples:
Fire, Earth-quake, death of a
person
1. It exists when there is uncertainty
about an event that could
produce either a profit or loss.
2. Risk pulling is not possible.
3. These risks are not insurable.
4. Law of large numbers cannot be
applied more easily for such risk.
Examples:
Betting, Horse-racing, speculating in
stock markets
 FUNDAMENTAL RISK/GROUP RISK
1. It involves those losses which
affect large number of people or
the economy at large (Macro
basis).
2. The major factors affecting such
risk are changes of economic,
social, cultural and political
environment etc.
Examples:
Unemployment, war, inflation, natural
calamities etc.
PARTICULAR RISK/INDIVIDUAL RISK
1. It is the risk confines to individual
events or small groups (Micro
basis).
2. It affects only the person
concerned.
Examples:
Burning of a house, robbery in a bank