CHAPTER 1

THE NATURE OF RISKS

LEARNING OBJECTIVES
Upon completion of this chapter, you should be able to
:
Define some common terminology
Describe the concept of risk, perils,hazard and loss
Explain different types of probabilities theories
Discuss calssification risk
Distinguish different types of pure risk
Overview
Concept Of Risk
Concepts Of Peril, Hazards And Loss
Probability Theories
Classifications Of Risks
Types Of Pure Risks
CONCEPT OF RISK
Possibility of adverse Risk threatens or
deviation from a Risk implies negative limits the ability of a
desired outcome that consequences and community or non-
is expected or hoped results profit organization to
for achieve its mission

Unpredictable and
World is full of risks
unexpected events
 Possibility of
an
unfortunate
occurrence
 Risks implies;

•Some form of Uncertainty

Possibility of
about an outcome in a given
Unpredictable
Loss situation.

Definition •Both doubt about future

of RISKS

•Outcome will leave us in a

worse position

Combination Uncertainty
of Hazards of loss
Risk & Chance

RISK CHANCE
Some doubt or
Uncertainty about an
uncertainty about the
outcome of an event.
outcome of an event

The outcome normally

NEGATIVE
Eg; The outcome normally a
Bukit Antarabangsa POSITIVE.
Condominium Residents
Smoker
CONCEPTS OF PERIL, HAZARD AND LOSS

LOSS A reduction or
PERIL
disappearance Is a cause of
of economic loss
value
CONCEPTS OF PERIL, HAZARD AND LOSS
Moral Hazard
A character defect in
an individual that
increases the chance
of loss
Morale Hazard
Physical Hazard A character defect in
an individual that
Physical condition
increases the chance
that increases the
of loss with the
condition of loss
knowledge that
insurance exists

Hazard
A condition
that increases
the chance of
loss
Relationship between Hazard, Peril and Loss
Hazard Peril Loss
Explosive Explosion Property Damage

Poor Break Motor Accident Loss of use

Poor Health Illness Medical Expenses

Carelessness Negligence Court

 PROBABILITY THEORIES
A Priori Probability
• Determined when the total
number of possible events
are known.
• Example: the probability of
getting a six on a roll of
dice is 1/6.
• This concept has a limited
practical application in the
study of risk because
situations where a number
of possible outcome are
known are very rare.
Empirical Probability
• Determined on the basis of
historical data.
• Example: road accidents.
• The underlying concept
that makes it possible for
empirical probability to be
measured accurately is that
as the number of
observations increases, the
predicted loss tends to
approach the actual loss
(the law of large numbers)
Judgmental Probability
• Determined based on the
judgment of the person
predicting the outcome.
• It is used when there is
lack of historical data or
credible statistics.
• Example: Astronaut
program by Malaysia. The
insurance company in
Malaysia uses judgmental
probability due to lack of
credible statistics.
CLASSIFICATIONS OF RISKS
Fundamental and Particular risk

Fundamental
risk Particular
Affects the entire risk
economy or large Those future
number of outcomes that we
persons/groups can partially control
within the economy

Affects the society in Arises from

general and cannot individual decisions
be controlled Example: to further
Example: Tsunami, study or to drive a
earthquake car
Pure and Speculative Risks

Speculative
Pure Risk
There are Risk
Possibility of
possibility of
loss, no loss
loss or no
or profit
loss

Example: to
Example:
pass or to fail
investment
the exam
Financial and Non Financial Risks

Non
Financial
Financial
Risks
Outcome can be
Risks Outcome cannot
measured by be measured by
monetary terms monetary terms

Example; Property Example: Choice

damages can be of career will
measured in terms affect ones quality
of loss of profit of life.
TYPES OF PURE RISKS

Personal Property
Risks Risks

Liability
Risks
TYPES OF PURE RISKS
Personal Risks
• Risk of premature death
• Significant losses: loss of human value and additional
expenses
• Risk of old age
• Significant loss: insufficient income during retirement
• Risk of poor health
• Significant losses: Expensive medical charges and loss of
earned income
• Risk of unemployment
• Significant losses: loss of earned income and depletion of
accumulation financial assets.
Property Risk
• Direct Loss
• Damage to property by a peril.
• Example: house destroyed by fire
• Indirect loss
• Loss in consequence of a direct loss
• Example: loss of profit
• Extra expenses
• Extra costs incurred as a result of the loss
• Example: owner have to rent another building to continue
operation/ living.
TYPES OF PURE RISKS
Liability risks
• Risks of being sued because of neglect,
malpractice, or causing willful injury either
to another person or to someone else's
property.
• Possibility of financial loss if you are found
liable, or the financial loss incurred just
defending yourself, even if you are not found
liable.
▫END