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Chapter 1





Textbook

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Get motivated
if you had a bad time last year
https://www.youtube.com/watch?v=MRQizP
cZWBI

http://www.youtube.com/watch?v=0yetHqW
ODp0
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Source: Internet
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4 http://www.youtube.com/watch?v=obq5gJrO3z0 Then
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FIERY BALLOON ACCIDENT KILLS 19 TOURISTS IN
EGYPT
By MAGGIE MICHAEL
Feb. 26, 2013 9:11 PM EST
LUXOR, Egypt (AP) The terror lasted less than two minutes:
Smoke poured from a hot air balloon carrying sightseers on a
sunrise flight over the ancient city of Luxor, it burst in a flash
of flame and then plummeted about 1,000 feet to earth. A
farmer watched helplessly as tourists trying to escape the
blazing gondola leaped to their deaths.
Nineteen people were killed Tuesday in what appeared to be
the deadliest hot air ballooning accident on record. A British
tourist and the Egyptian pilot, who was badly burned, were the
sole survivors.
http://bigstory.ap.org/article/official-least-19-foreign-tourists-
die-egypt-hot-air-balloon-crashes-near-luxor
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How do you see the activity now?

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Risk and Its Treatment
Different Definitions of Risk
Chance of Loss
Peril and Hazard
Classification of Risk
Major Personal Risks and Commercial Risks
Burden of Risk on Society
Techniques for Managing Risk

Outcome
Understand the terms above and how they are
related to our daily lives and learn the
technique for risk management)

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How do you see Risk?
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Definition of RISK
webster.com
1: possibility of loss or injury : peril

2: someone or something that creates or suggests a hazard

3a : the chance of loss or the perils to the subject matter of an
insurance contract; also : the degree of probability of such loss
b : a person or thing that is a specified hazard to an insurer c :
an insurance hazard from a specified cause or source <war
risk>

4: the chance that an investment (as a stock or commodity)
will lose value

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Different Definitions of Risk
Risk: ___________ concerning the occurrence of a _______
Expected loss
Riskier => greater frequency or severity of loss (any
examples?)
Riskier => The expected loss will be higher
E.g. higher risk of Earthquake: Japan, higher risk of car
accident: drunk driving
Variability of loss (around expected value)
Riskier => more difficult to predict
E.g. Price change of stock vs price change of bonds

Loss Exposure: Any situation or circumstance in which a loss
is __________, regardless of whether a loss occurs.

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Different Definitions of Risk
Objective Risk vs. Subjective Risk
Objective risk is defined as the relative variation of actual
loss from expected loss
It can be statistically calculated using a measure of dispersion,
such as the standard deviation
Remember any graphs of normal distribution & standard
deviation?
How does the risk change with a larger units of exposure?
Objective risk declines as the number of exposure
increases
claims: on average 10 out of 10,000 cases insured
(from experience)
Actual claims can be say, 8 or 12 =>
_______variation
How can we reduce the variation?

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Subjective risk is defined as uncertainty based on a
persons mental condition or state of mind (hot air balloon
=> more ________ now! How about travelling by plane
after the disappearance of the Malaysia Airlines Flight 17))
Two persons in the same situation may have different
perceptions of risk (you may have no fear if you are
being gun pointed if.)
High subjective risk often results in conservative
behavior
Think about buying stocks
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Chance of Loss
Chance of loss: The probability that an event will occur

Objective Probability vs. Subjective Probability
Objective probability refers to the long-run relative
frequency of an event assuming an ________ number of
observations and ____change in the underlying conditions
It can be determined by deductive or inductive
reasoning
E.g. probability of getting a head from coin tossing
vs probability of a person having car accident in a
year.
Subjective probability is the individuals personal estimate
of the chance of loss
A persons perception of the chance of loss may differ
from the objective probability
E.g. before and after global financial crisis
2012 Mayan Calendar Doomsday, End-of-the-World
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Peril and Hazard
A peril is defined as the cause of the loss
In an auto accident, the __________ is the peril
A hazard is a condition that increases the chance of loss
Physical hazards are physical conditions that increase the
chance of loss

Moral hazard is dishonesty or character defects in an
individual, that increase the chance of loss

Attitudinal Hazard (Morale Hazard) is carelessness or
indifference to a loss, which increases the frequency or
severity of a loss

Legal Hazard refers to characteristics of the legal system or
regulatory environment that increase the chance of loss

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Questions (take out a paper)
Given the following scenario, state which is the
hazard, the peril, and the exposure, respectively?
You recently moved from Beijing to Taiwan and
bought a home. A typhoon destroys your home.

True or False? Twin towers burn to the ground
resulting in a complete loss. The fact that the
construction material is steel is the peril involved in
this loss.

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Classification of Risk
Pure and Speculative Risk
A __________is one in which there are only the possibilities
of loss or no loss
earthquake
A __________is one in which both profit or loss are possible
gambling
Diversifiable Risk and Nondiversifiable Risk
A diversifiable risk affects only individuals or small groups
(car theft). It is also called nonsystematic or particular risk.
A nondiversifiable risk affects the entire economy or large
numbers of persons or groups within the economy
(hurricane). It is also called systematic risk or fundamental
risk.
Government assistance may be necessary to insure
_____________ risks.
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Classification of Risk
Enterprise risk encompasses all major risks faced by a
business firm, which include: pure risk, speculative risk,
strategic risk, operational risk, and financial risk
Financial Risk refers to the uncertainty of loss because of
adverse changes in commodity prices, interest rates, foreign
exchange rates, and the value of money.
Enterprise Risk Management combines into a single unified
treatment program all major risks faced by the firm:
Pure risk
Speculative risk
Strategic risk
Operational risk
Financial risk
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Major Personal Risks and Commercial Risks
Personal risks involve the possibility of a loss or
reduction in income, extra expenses or depletion of
financial assets:
Premature death of family head
Insufficient income during retirement
Most workers are not saving enough for a
comfortable retirement
More Americans Say 80 Is The
New Retirement Age Forbes
http://www.youtube.com/watch?v=8t1cBn7Vnns
Poor health (catastrophic medical bills and loss of
earned income)
Involuntary unemployment
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Insight
About half of all personal bankruptcy cases are (at
least in part) due to medical reasons
2000-2007 June: 5 million families filed for
bankruptcy due to medical reasons
20% of people who reported having medical bill
problems considered filing for bankruptcy (bills too
expensive)
More than half of adults with inadequate insurance:
didnt fill in prescription, skipped recommended
tests, treatment or didnt go to doctor for medical
advices. $$ problem

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Exhibit 1.1 Reported Total Savings and
Investments among Those Responding, by Age
(not including value of primary residence or defined benefit plans)
What can you tell from the figures above?
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Major Personal Risks and
Commercial Risks
_________involve the possibility of losses
associated with the destruction or theft of property:
Physical damage to home and personal property from fire,
tornado, vandalism, or other causes
Direct loss vs. indirect loss
A direct loss is a financial loss that results from the physical
damage, destruction, or theft of the property, such as fire
damage to a home
An indirect loss results indirectly from the occurrence of a direct
physical damage or theft loss, such as the additional living
expenses after a fire to a home. These additional expenses would
be a ___________________
e.g. Fire at Fa Yuen Street killed 9 and injured 34 (Nov. 2011)
Rally over 'photo ban' shuts retailer Dolce & Gabbana in Tsim Sha Tsui, Jan 10, 2012
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http://www.youtube.com/watch?fea
ture=player_embedded&v=VdeyQa
QNckA
http://www.youtube.com/watch?v=
00ZmGa8Q42E
http://www.youtube.com/watch?v=
O4rSiUPGt3A
Amazon testing drones for deliveries
Write down the types of risk involved
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Probably you would like to avoid amazons drone delivery
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Major Personal Risks and
Commercial Risks
___________involve the possibility of being held
liable for bodily injury or property damage to
someone else
There is no maximum upper limit with respect to the
amount of the loss
A lien can be placed on your income and financial assets
Defense costs can be enormous
Have you ever played golf, remote control (rc) toys, etc ?
Women killed by rc-aeroplane in Mainland.
Man got hit by a golf ball.
Man paralyzed by rc-helicopter accident in H.K.
The owner of the heli that hit him was only fined HK$5000 (US$642).
A civil suit then followed and the victim was awarded HK $8.8M (U$1.13 M).

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Brain surgery for man hit by wayward toy copter

PatsyMoy and CarolChung

Monday, January 14, 2008,, http://www.thestandard.com.hk

A 44-year-old man underwent emergency brain surgery after he was hit by a remote-
controlled toy helicopter yesterday. Law Kwok-wah was rushed by ambulance to Queen
Elizabeth Hospital with a 20-centimeter-long wound to the back of his head. Law, who
works in a travel company, was said to have over 10 years of experience flying toy
helicopters and had won in local competitions. Police said the accident happened at
1.48pm when Law and his friend, surnamed Wong and over 40 years old, were flying a
remote-control helicopter at an open space on Chun Wang Street in Tseung Kwan O.
Police said the man was a friend of the toy owner. Law asked to try the toy and
accidentally hit a button on
the remote control, causing the helicopter to crash into his head.
The blades of the 1.5-meter-long helicopter broke off in the accident. The helicopter,
weighing six kilograms, can fly up to 90 kilometers an hour. Police are still investigating.
The Civil Aviation Department said it will follow up the case, adding that licensing is not
required for helicopters weighing less than seven kilograms. The accident happened at a
government site with a warning sign prohibiting flying remote-control toys. But some
aficionados said they simply ignored the warning due to lack of other places in urban
districts for their activities. A Mr Tong, who has been flying remote-control helicopters
for the past three years, estimated there were 50,000 to 80,000 players in Hong Kong.


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5000
()26 05:05


5000

45




http://www.daddyhobby.com 06-02-2009
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9/11/2004
The High Court ordered the Incorporated Owners Association of Albert House
in Aberdeen to wind up, ten years after a fatal canopy collapse there, in which
a woman was killed and 13 others injured. It could not repay more than
25 million dollars in compensation and legal fees within a reasonable
period.





Be aware of the above case when you become a property owner
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encumbrance

2500

622
10


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9481
113

6
3000

136
200115%


:


http://www.gaforum.org/archive/index.php/t-101471.html
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Indirect loses
20080818
http://hk.apple.nextmedia.com
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25

..
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Major Personal Risks and
Commercial Risks
Commercial Risks
Firms face a variety of pure risks that can have serious
financial consequences if a loss occurs:
Property risks, such as damage to buildings, furniture and
office equipment
Liability risks, such as suits for defective products, pollution of
the environment, and sexual harassment
Loss of business income, when the firm must shut down for
some time after a physical damage loss
Other risks to firms include crime exposures, human resource
exposures, foreign loss exposure, intangible property
exposures, and government exposures
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Have you heard about the BP oil spill 2010? Not yet settled in 2014

What is the direct loss?
Indirect losses?
A US judge has given final approval to
BPs $7.8bn (4.8bn) part settlement with
businesses and individuals who suffered
losses following its disastrous Gulf of
Mexico oil spill.
The settlement resolves most private
individuals claims for economic loss and
property damage, but it doesnt cover
lawsuits brought by the US government or
those brought by the states of Alabama and
Louisiana.
http://www.telegraph.co.uk 22 Nov 2012
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Burden of Risk on Society
The presence of risk results in three major
burdens on society:
In the absence of insurance, individuals would
have to maintain large emergency funds
The risk of a liability lawsuit may discourage
innovation, depriving society of certain goods
and services
Risk causes worry and fear
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Techniques for Managing Risk
There are five major methods for managing risk
1. Avoidance
2. Loss control
Loss prevention refers to activities to reduce the
_________of losses
Loss reduction refers to activities to reduce the
__________of losses
3. Retention
An individual or firm retains all or part of a given risk
Active retention means that an individual is consciously aware
of the risk and deliberately plans to retain all or part of it
Passive retention means risks may be unknowingly retained
because of ignorance, indifference, or laziness
Self Insurance is a special form of planned retention by which
part or all of a given loss exposure is retained by the firm
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Techniques for Managing Risk
4. Noninsurance transfers
A risk may be transferred to another party by several methods:
A transfer of risk by contract, such as through a service contract
or a hold-harmless clause in a contract
Hedging is a technique for transferring the risk of unfavorable
price fluctuations to a speculator by purchasing and selling
futures contracts on an organized exchange
Incorporation of a business firm transfers to the creditors the risk
of having insufficient assets to pay business debts
5. Insurance
For most people, insurance is the most practical method for
handling a major risk
What techniques do you think BP employed?
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Concept check
Fog that increases the chance of an
automobile accident is an example of a

A) speculative risk.
B) peril.
C) physical hazard.
D) moral hazard.

Why not peril?


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Concept check
the cause of a loss is called________
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Chapter 1 CASE APPLICATION
Mike is a college senior who is majoring in BBA.
He owns a high-mileage 2000 Ford with current
market value of $2,500.
The current replacement value of his personal
property in a rented apartment totals $10,000.
He wears disposable contact lenses, which cost
$300 for a six-month supply.
He also has a waterbed in his rented apartment
that has leaked water in the past.
As avid runner, Mike run five miles daily in a
nearby public park that has reputation of being
extremely dangerous due to drug dealers.
Mikes parents both work to help him pay for his
tuition.
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Mikes Methods of Handling
Risks
For each of the following risks and loss
exposures, identify an appropriate RM
technique that could have been used to
deal with the exposure.

Physical damage to the 2000 Ford due to
a collision with another motorist.

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Mikes Methods of Handling
Risks
Liability lawsuit against Mike arising out of
the negligent operation of his car.



Total loss of personal property due to a
fire in the kitchen of his rented apartment.


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Mikes Methods of Handling
Risks
Disappearance of one contact lens.




Waterbed leak that cause property damage to
the apartment.

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Mikes Methods of Handling
Risks
Physical assault on Mike by gang members who are
dealing drugs in the park where he runs.


Loss of tuition assistance from Mikes father who is
killed by a drunk driver in an auto accident.