Solution Manual for Principles of Risk
Management and Insurance 13th Edition by
George Rejda and Michael McNamara
,CHAPTER 1 — RISK AND ITS TREATMENT
REVIEW QUESTIONS AND ANSWERS
1. Define risk. How does it differ from uncertainty?
Answer:
Risk is uncertainty concerning the occurrence of a loss. It refers to situations where the outcome
is unknown but measurable. Uncertainty, on the other hand, is a broader concept — it exists
when the probabilities of outcomes are not known or cannot be measured.
For example, the risk of a car accident can be statistically estimated, but uncertainty about future
government policies cannot. In short, risk is measurable uncertainty, while uncertainty may
be unquantifiable.
2. Explain the difference between objective risk and subjective risk.
Answer:
Objective risk is the measurable variation between actual and expected loss, often expressed
statistically (e.g., using standard deviation).
Subjective risk depends on an individual’s mental state or perception. For example, two people
driving the same car in the same conditions may perceive different levels of danger.
Thus, objective risk is statistical and measurable, while subjective risk is psychological and
varies among individuals.
3. Distinguish between chance of loss and objective risk.
Answer:
The chance of loss is the probability that a loss will occur, while objective risk measures the
,degree of variation between expected and actual losses.
Two risks may have the same chance of loss but different objective risks if one shows greater
variability. For example, both cities might have a 1% fire loss chance, but if losses vary more
widely in one city, that city has greater objective risk.
4. Define peril and hazard. What is the difference between the two?
Answer:
A peril is the cause of loss (e.g., fire, theft, storm).
A hazard is any condition that increases the frequency or severity of a loss.
In short, perils cause loss, while hazards make the occurrence or severity of that loss more likely.
5. Explain the following types of hazards: physical hazard, moral hazard, attitudinal
hazard, and legal hazard.
Answer:
Physical hazard: A tangible condition that increases loss likelihood (e.g., icy roads,
faulty wiring).
Moral hazard: Dishonesty or fraudulent behavior, such as filing a false insurance claim.
Attitudinal hazard: Carelessness or indifference to loss, such as leaving doors unlocked.
Legal hazard: Laws or court decisions that increase the frequency or severity of loss,
such as large jury awards.
6. Distinguish among pure risk, speculative risk, diversifiable risk, and nondiversifiable
risk.
Answer:
Pure risk: Involves only loss or no loss (e.g., illness, theft).
Speculative risk: Involves possible gain or loss (e.g., gambling, investments).
, Diversifiable risk: Affects individuals or small groups and can be reduced by
diversification (e.g., car theft).
Nondiversifiable risk: Affects large groups or the economy and cannot be diversified
away (e.g., inflation, war, natural disasters).
7. Define enterprise risk. What are the major types of enterprise risk that firms face?
Answer:
Enterprise risk is all the major risks faced by a business, including pure, speculative, strategic,
financial, and operational risks.
Enterprise Risk Management (ERM) integrates these risks into a unified system, allowing firms
to identify interdependencies and reduce total volatility.
Major types include:
Strategic risk (e.g., competition)
Operational risk (e.g., supply chain failure)
Financial risk (e.g., interest rate changes)
Compliance/legal risk (e.g., regulatory penalties)
8. Identify the major personal risks and briefly explain the financial consequences of each.
Answer:
1. Premature death: Loss of family income and financial hardship for dependents.
2. Poor health: Medical bills, loss of income, and potential long-term disability.
3. Unemployment: Reduced standard of living and inability to meet obligations.
4. Insufficient retirement income: Dependence on others or poverty in old age.
Each can cause severe economic insecurity if not mitigated through insurance or savings.
Management and Insurance 13th Edition by
George Rejda and Michael McNamara
,CHAPTER 1 — RISK AND ITS TREATMENT
REVIEW QUESTIONS AND ANSWERS
1. Define risk. How does it differ from uncertainty?
Answer:
Risk is uncertainty concerning the occurrence of a loss. It refers to situations where the outcome
is unknown but measurable. Uncertainty, on the other hand, is a broader concept — it exists
when the probabilities of outcomes are not known or cannot be measured.
For example, the risk of a car accident can be statistically estimated, but uncertainty about future
government policies cannot. In short, risk is measurable uncertainty, while uncertainty may
be unquantifiable.
2. Explain the difference between objective risk and subjective risk.
Answer:
Objective risk is the measurable variation between actual and expected loss, often expressed
statistically (e.g., using standard deviation).
Subjective risk depends on an individual’s mental state or perception. For example, two people
driving the same car in the same conditions may perceive different levels of danger.
Thus, objective risk is statistical and measurable, while subjective risk is psychological and
varies among individuals.
3. Distinguish between chance of loss and objective risk.
Answer:
The chance of loss is the probability that a loss will occur, while objective risk measures the
,degree of variation between expected and actual losses.
Two risks may have the same chance of loss but different objective risks if one shows greater
variability. For example, both cities might have a 1% fire loss chance, but if losses vary more
widely in one city, that city has greater objective risk.
4. Define peril and hazard. What is the difference between the two?
Answer:
A peril is the cause of loss (e.g., fire, theft, storm).
A hazard is any condition that increases the frequency or severity of a loss.
In short, perils cause loss, while hazards make the occurrence or severity of that loss more likely.
5. Explain the following types of hazards: physical hazard, moral hazard, attitudinal
hazard, and legal hazard.
Answer:
Physical hazard: A tangible condition that increases loss likelihood (e.g., icy roads,
faulty wiring).
Moral hazard: Dishonesty or fraudulent behavior, such as filing a false insurance claim.
Attitudinal hazard: Carelessness or indifference to loss, such as leaving doors unlocked.
Legal hazard: Laws or court decisions that increase the frequency or severity of loss,
such as large jury awards.
6. Distinguish among pure risk, speculative risk, diversifiable risk, and nondiversifiable
risk.
Answer:
Pure risk: Involves only loss or no loss (e.g., illness, theft).
Speculative risk: Involves possible gain or loss (e.g., gambling, investments).
, Diversifiable risk: Affects individuals or small groups and can be reduced by
diversification (e.g., car theft).
Nondiversifiable risk: Affects large groups or the economy and cannot be diversified
away (e.g., inflation, war, natural disasters).
7. Define enterprise risk. What are the major types of enterprise risk that firms face?
Answer:
Enterprise risk is all the major risks faced by a business, including pure, speculative, strategic,
financial, and operational risks.
Enterprise Risk Management (ERM) integrates these risks into a unified system, allowing firms
to identify interdependencies and reduce total volatility.
Major types include:
Strategic risk (e.g., competition)
Operational risk (e.g., supply chain failure)
Financial risk (e.g., interest rate changes)
Compliance/legal risk (e.g., regulatory penalties)
8. Identify the major personal risks and briefly explain the financial consequences of each.
Answer:
1. Premature death: Loss of family income and financial hardship for dependents.
2. Poor health: Medical bills, loss of income, and potential long-term disability.
3. Unemployment: Reduced standard of living and inability to meet obligations.
4. Insufficient retirement income: Dependence on others or poverty in old age.
Each can cause severe economic insecurity if not mitigated through insurance or savings.
