Risk management is the systematic process of identifying, analyzing, and dealing with pure risks. In life insurance, the primary concern is managing mortality risk - the financial consequences of premature death.
Pure Risk - Only two outcomes: loss or no loss (never gain) - Examples: death, disability, property damage, liability claims - Insurable because losses are predictable across large groups - Focus of insurance industry
Speculative Risk - Three outcomes: loss, no change, or gain - Examples: investing in stocks, starting a business, gambling - Not insurable because includes profit opportunity - Managed through investment strategies
Definition: Eliminating exposure to a particular risk entirely
Examples: - Not flying to avoid aviation accidents - Not driving to avoid car accidents - Not working in hazardous occupations
Limitations: - Often impractical or impossible - May eliminate beneficial activities - Cannot avoid death (universal risk)
Definition: Taking measures to decrease frequency or severity of losses
Examples: - Installing smoke detectors (reduces fire damage severity) - Regular health checkups (early disease detection) - Safety training programs (reduces accident frequency) - Wearing seatbelts (reduces injury severity)
Benefits: - May lower insurance premiums - Proactive loss prevention - Reduces overall exposure
Definition: Accepting responsibility for losses as they occur
Appropriate when: - Losses are small and affordable - Frequency is low - Insurance is too expensive - Required by deductibles and coinsurance
Types: - Planned retention: Conscious decision with emergency fund - Unplanned retention: Being uninsured by default
Examples: - Using high deductibles - Self-funding small repairs - Emergency savings fund
Definition: Shifting financial burden of loss to another party
Methods: - Insurance: Most common method (transfer to insurance company) - Contracts: Hold-harmless agreements, indemnification clauses - Hedging: Financial instruments for business risks
Life Insurance as Risk Transfer: - Transfers mortality risk to insurer - Insurer assumes financial burden of death - Policyholder pays premiums - Beneficiaries receive death benefit
Peril - The actual cause of loss - The event that triggers a claim - Examples: death, fire, theft, accident - Named in insurance policies
Hazard - Conditions that increase likelihood or severity of loss - Makes perils more likely to occur or worse
Three Types of Hazards:
Observable and measurable
Moral Hazard
Reason for underwriting investigation
Morale Hazard
Life insurance is the primary method of transferring mortality risk because: - Death is inevitable but timing uncertain - Financial impact can be catastrophic - Cannot be avoided or adequately reduced - Self-retention rarely feasible for full needs - Transfer through insurance is cost-effective
Risk management is the systematic process of identifying, analyzing, and dealing with pure risks. In life insurance, the primary concern is managing mortality risk - the financial consequences of premature death.
Pure Risk - Only two outcomes: loss or no loss (never gain) - Examples: death, disability, property damage, liability claims - Insurable because losses are predictable across large groups - Focus of insurance industry
Speculative Risk - Three outcomes: loss, no change, or gain - Examples: investing in stocks, starting a business, gambling - Not insurable because includes profit opportunity - Managed through investment strategies
Definition: Eliminating exposure to a particular risk entirely
Examples: - Not flying to avoid aviation accidents - Not driving to avoid car accidents - Not working in hazardous occupations
Limitations: - Often impractical or impossible - May eliminate beneficial activities - Cannot avoid death (universal risk)
Definition: Taking measures to decrease frequency or severity of losses
Examples: - Installing smoke detectors (reduces fire damage severity) - Regular health checkups (early disease detection) - Safety training programs (reduces accident frequency) - Wearing seatbelts (reduces injury severity)
Benefits: - May lower insurance premiums - Proactive loss prevention - Reduces overall exposure
Definition: Accepting responsibility for losses as they occur
Appropriate when: - Losses are small and affordable - Frequency is low - Insurance is too expensive - Required by deductibles and coinsurance
Types: - Planned retention: Conscious decision with emergency fund - Unplanned retention: Being uninsured by default
Examples: - Using high deductibles - Self-funding small repairs - Emergency savings fund
Definition: Shifting financial burden of loss to another party
Methods: - Insurance: Most common method (transfer to insurance company) - Contracts: Hold-harmless agreements, indemnification clauses - Hedging: Financial instruments for business risks
Life Insurance as Risk Transfer: - Transfers mortality risk to insurer - Insurer assumes financial burden of death - Policyholder pays premiums - Beneficiaries receive death benefit
Peril - The actual cause of loss - The event that triggers a claim - Examples: death, fire, theft, accident - Named in insurance policies
Hazard - Conditions that increase likelihood or severity of loss - Makes perils more likely to occur or worse
Three Types of Hazards:
Observable and measurable
Moral Hazard
Reason for underwriting investigation
Morale Hazard
Life insurance is the primary method of transferring mortality risk because: - Death is inevitable but timing uncertain - Financial impact can be catastrophic - Cannot be avoided or adequately reduced - Self-retention rarely feasible for full needs - Transfer through insurance is cost-effective