SOLUTIONS MANUAL
** All Chapters included
** Answers to Review Questions
** Answers to Case Application
** Answers to Application Questions
,Table of Contents are given below
1. Risk and Its Treatment
2. Insurance and Risk
3. Introduction to Risk Management
4. Enterprise Risk Management
5. Types of Insurers and Marketing Systems
6. Insurance Company Operations
7. Financial Operations of Insurers
8. Government Regulation of Insurance
9. Fundamental Legal Principles
10. Analysis of Insurance Contracts
11. Life Insurance
12. Life Insurance Contractual Provisions
13. Annuities and Individual Retirement Accounts
14. Individual Health Insurance Coverages
15. Employee Benefits: Group Life and Health Insurance
16. Employee Benefits: Retirement Plans
17. Social Insurance
18. The Liability Risk
19. Auto Insurance
20. Auto Insurance (Continued)
21. Homeowners Insurance, Section I
22. Homeowners Insurance, Section II
23. Other Property and Liability Insurance Coverages
24. Commercial Property Insurance
25. Commercial Liability Insurance
26. Crime Insurance and Surety Bonds
,Chapter 1
Risk and Its Treatment
Teaching Note
Welcome to Principles of Risk Management and Insurance! As you start the course, you may want to
emphasize to your students the practical nature of the material that will be covered. Individuals and
families face real-world risks—premature death, poor health, property damage, liability claims, and other
loss exposures.
In presenting the material in this chapter, keep in mind that students must master a certain amount of new
insurance terminology. Studying insurance is similar to becoming fluent in a foreign language. The student
starts by building upon a basic vocabulary when learning a new language. The same is true for insurance.
Insurance is a technical subject that requires a basic vocabulary.
It is also worthwhile to point out that there is no single definition of risk. However, risk has been
traditionally defined as uncertainty concerning the occurrence of a loss. Because the term “risk” is
ambiguous, many risk managers use the term “loss exposure.”
Take some time to discuss the major types of pure risks that can result in great financial insecurity. Pure
risks can result in loss or no loss. Speculative risks may produce a loss or a gain. This chapter summarizes
the important points concerning the different types of risk and methods of handling risk.
In discussing the major methods of handling risk, several points should also be stressed. First, explain that
these concepts are discussed in greater detail in Chapter 3. Second, stress the idea that insurance is only
one of several methods for handling risk. Finally, explain that in many cases other methods for handling
risk may be more effective and that several risk treatment measures may be used together.
Outline
I. Definitions of Risk
A. Traditional Definition of Risk; risk historically has been defined as uncertainty.
B. Risk Distinguished from Uncertainty
1. Risk is used in situations where the probabilities of possible outcomes are known or can be
estimated with some degree of accuracy.
2. Uncertainty is used in situations where such probabilities cannot be estimated.
C. Loss Exposure
1. Any situation or circumstance in which a loss is possible, regardless of whether a loss actually
occurs.
2. Examples of loss exposures include manufacturing plants that may be damaged by an
earthquake or flood and defective products that may result in lawsuits against the manufacturer.
, 2 Rejda/McNamara • Principles of Risk Management and Insurance, Fifteenth Edition
D. Objective Risk
1. Defined as the relative variation of actual loss from expected loss.
2. Declines as the number of exposure units increases.
3. Can be measured by using the standard deviation or coefficient of variation.
E. Subjective (Perceived) Risk
1. Defined as uncertainty based on one’s mental condition or state of mind.
2. Difficult to measure.
II. Chance of Loss
A. 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
conditions1. A priori—by logical deduction such as in games of chance.
2. Empirically—by induction, through analysis of data.
B. Subjective Probability—a personal estimate of the chance of loss. It need not coincide with
objective probability and is influenced by a variety of factors including age, sex, intelligence,
education, and personality.
C. Chance of Loss Versus Objective Risk—although chance of loss may be the same for two
groups, the relative variation of actual loss from expected loss may be quite different. The
expected prices of two stocks might each be $60 one year from today, and the distribution of
expected prices might symmetric, meaning a fifty percent chance the price will be greater than
$60 and a fifty percent change the price will be less than $60.
III. Peril and Hazard
A. Peril—defined as the cause of loss
B. Hazard—a condition that creates or increases the frequency or severity of loss.
1. Physical hazard—physical condition that increases the chance of loss. Examples are icy
streets, poorly designed intersections, and dimly lit stairways.
2. Moral hazard—dishonesty or characteristics of an individual that increase the chance of loss
3. Attitudinal (Morale) hazard—carelessness or indifference to a loss, which increases the
frequency or severity of loss.
4. Legal hazard—characteristics of the legal system or regulatory environment that increase the
frequency or severity of losses.
IV. Classifications of Risk
A. Pure and Speculative Risk
1. Pure risk—a situation where there are only the possibilities of loss or no loss.
2. Speculative risk—a situation where either profit or loss is possible.
B. Diversifiable Risk and Nondiversifiable Risk. Diversifiable risk affects only individuals or small
groups and not the entire economy; it can be reduced or eliminated by diversification.
Nondiversifiable risk affects large numbers of persons or groups in the economy and cannot be
eliminated or reduced by diversification.
C. Enterprise Risk. This is a term that encompasses all major risks faced by a business firm,
including pure risk, speculative risk, strategic risk, operational risk, and financial risk.
D. Systemic Risk. This is the risk of collapse of an entire system or entire market due to the failure
of a single entity or group of entities that can result in the breakdown of the entire financial
system.
** All Chapters included
** Answers to Review Questions
** Answers to Case Application
** Answers to Application Questions
,Table of Contents are given below
1. Risk and Its Treatment
2. Insurance and Risk
3. Introduction to Risk Management
4. Enterprise Risk Management
5. Types of Insurers and Marketing Systems
6. Insurance Company Operations
7. Financial Operations of Insurers
8. Government Regulation of Insurance
9. Fundamental Legal Principles
10. Analysis of Insurance Contracts
11. Life Insurance
12. Life Insurance Contractual Provisions
13. Annuities and Individual Retirement Accounts
14. Individual Health Insurance Coverages
15. Employee Benefits: Group Life and Health Insurance
16. Employee Benefits: Retirement Plans
17. Social Insurance
18. The Liability Risk
19. Auto Insurance
20. Auto Insurance (Continued)
21. Homeowners Insurance, Section I
22. Homeowners Insurance, Section II
23. Other Property and Liability Insurance Coverages
24. Commercial Property Insurance
25. Commercial Liability Insurance
26. Crime Insurance and Surety Bonds
,Chapter 1
Risk and Its Treatment
Teaching Note
Welcome to Principles of Risk Management and Insurance! As you start the course, you may want to
emphasize to your students the practical nature of the material that will be covered. Individuals and
families face real-world risks—premature death, poor health, property damage, liability claims, and other
loss exposures.
In presenting the material in this chapter, keep in mind that students must master a certain amount of new
insurance terminology. Studying insurance is similar to becoming fluent in a foreign language. The student
starts by building upon a basic vocabulary when learning a new language. The same is true for insurance.
Insurance is a technical subject that requires a basic vocabulary.
It is also worthwhile to point out that there is no single definition of risk. However, risk has been
traditionally defined as uncertainty concerning the occurrence of a loss. Because the term “risk” is
ambiguous, many risk managers use the term “loss exposure.”
Take some time to discuss the major types of pure risks that can result in great financial insecurity. Pure
risks can result in loss or no loss. Speculative risks may produce a loss or a gain. This chapter summarizes
the important points concerning the different types of risk and methods of handling risk.
In discussing the major methods of handling risk, several points should also be stressed. First, explain that
these concepts are discussed in greater detail in Chapter 3. Second, stress the idea that insurance is only
one of several methods for handling risk. Finally, explain that in many cases other methods for handling
risk may be more effective and that several risk treatment measures may be used together.
Outline
I. Definitions of Risk
A. Traditional Definition of Risk; risk historically has been defined as uncertainty.
B. Risk Distinguished from Uncertainty
1. Risk is used in situations where the probabilities of possible outcomes are known or can be
estimated with some degree of accuracy.
2. Uncertainty is used in situations where such probabilities cannot be estimated.
C. Loss Exposure
1. Any situation or circumstance in which a loss is possible, regardless of whether a loss actually
occurs.
2. Examples of loss exposures include manufacturing plants that may be damaged by an
earthquake or flood and defective products that may result in lawsuits against the manufacturer.
, 2 Rejda/McNamara • Principles of Risk Management and Insurance, Fifteenth Edition
D. Objective Risk
1. Defined as the relative variation of actual loss from expected loss.
2. Declines as the number of exposure units increases.
3. Can be measured by using the standard deviation or coefficient of variation.
E. Subjective (Perceived) Risk
1. Defined as uncertainty based on one’s mental condition or state of mind.
2. Difficult to measure.
II. Chance of Loss
A. 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
conditions1. A priori—by logical deduction such as in games of chance.
2. Empirically—by induction, through analysis of data.
B. Subjective Probability—a personal estimate of the chance of loss. It need not coincide with
objective probability and is influenced by a variety of factors including age, sex, intelligence,
education, and personality.
C. Chance of Loss Versus Objective Risk—although chance of loss may be the same for two
groups, the relative variation of actual loss from expected loss may be quite different. The
expected prices of two stocks might each be $60 one year from today, and the distribution of
expected prices might symmetric, meaning a fifty percent chance the price will be greater than
$60 and a fifty percent change the price will be less than $60.
III. Peril and Hazard
A. Peril—defined as the cause of loss
B. Hazard—a condition that creates or increases the frequency or severity of loss.
1. Physical hazard—physical condition that increases the chance of loss. Examples are icy
streets, poorly designed intersections, and dimly lit stairways.
2. Moral hazard—dishonesty or characteristics of an individual that increase the chance of loss
3. Attitudinal (Morale) hazard—carelessness or indifference to a loss, which increases the
frequency or severity of loss.
4. Legal hazard—characteristics of the legal system or regulatory environment that increase the
frequency or severity of losses.
IV. Classifications of Risk
A. Pure and Speculative Risk
1. Pure risk—a situation where there are only the possibilities of loss or no loss.
2. Speculative risk—a situation where either profit or loss is possible.
B. Diversifiable Risk and Nondiversifiable Risk. Diversifiable risk affects only individuals or small
groups and not the entire economy; it can be reduced or eliminated by diversification.
Nondiversifiable risk affects large numbers of persons or groups in the economy and cannot be
eliminated or reduced by diversification.
C. Enterprise Risk. This is a term that encompasses all major risks faced by a business firm,
including pure risk, speculative risk, strategic risk, operational risk, and financial risk.
D. Systemic Risk. This is the risk of collapse of an entire system or entire market due to the failure
of a single entity or group of entities that can result in the breakdown of the entire financial
system.
