RISK MANAGEMENT AND
INSURANCE

RISK, PERIL AND HARZARDS
 Risk, peril and hazard are important terms in
insurance
 Risk is a condition in which there is a possibility of
an adverse deviation from a desired outcome that is
expected … .” (Vaughn)
 It is as the chance of having a loss due to
occurrence of an event
 Peril: is anything that may possibly cause a loss e.g.
fire, explosions, storms, accidents etc
 Hazard: is anything that increases the likelihood of
loss through some peril e.g. defective house wiring
is a hazard that increases the chance that fire will
start
ELEMENTS OF RISK

All forms of risk, whether they are classified as

speculative or Pure risks, comprise common
elements. This notion highlights the following
four basic components of risk: (1) context, (2)
action, (3) conditions, and (4) consequences.
1.Context: Context is the background, situation,
or environment in which risk is being viewed and
defines which actions and conditions are
relevant to that situation.
 In other words, the context provides the lens
through which all consequences are evaluated.
Without setting an appropriate context, you
cannot definitively determine which actions,
conditions, and consequences to include in
risk analysis and management activities.
 Context thus forms the foundation for all
subsequent risk management activities.
2. Action:
 The action is the act or occurrence that
triggers risk. It is the active component of risk
and must be combined with one or more
specific conditions for risk to be present.
 All forms of risk are triggered by an action;
without the action, there is no possibility of risk.
3. Conditions:
 Whereas the action is the active component of
risk, conditions constitute risk’s passive element.
They define the current state or the set of
circumstances that can lead to risk.
 Conditions, when combined with a specific
triggering action, can produce a set of
consequences, or outcomes.
4 Consequences:
 Consequences, the final element of risk, are
the potential results or effects of an action in
combination with a specific condition(s).
 When risk is present there is, by definition, a
potential for loss. Depending on the
circumstances, there might also be a potential
for gain (i.e., speculative risk).
Types of Risks

Pure risk/static risk

 Pure risk is one in which there are only
the possibilities of loss or no loss (e.g.
earthquake).
 The only outcome of pure risks are
adverse (in a loss) or neutral (with no
loss), never beneficial.
 A category of risk in which loss is the
only possible outcome; there is no
beneficial result.
 Pure risk is related to events that are
beyond the risk-taker’s control and,
therefore, a person cannot consciously take
on pure risk.
 For example, the possibility that a person’s
house will be destroyed due to a natural
disaster is pure risk. In this example, it is
unlikely that there would be any potential
benefit to this risk.
Speculative or Dynamic Risk
 Speculative (dynamic) risk is a situation in which
either profit OR loss is possible. Examples of
speculative risks are betting on a horse race and
sports, investing in stocks/bonds and real estate.
 Starting a small business that may or may not
succeed is also an example of a speculative risk
 Speculative risks are not insured
Risk Management
Methods/Techniques
 Risk management is the process of identifying
and evaluating situations involving pure risk to
determine and implement the appropriate
means for its management. In other words, it is
an organized plan for protecting yourself, your
family, and your property.
 Insurance is not the only way of dealing with risk,
four other risk management techniques are
commonly used, namely Risk avoidance, risk
reduction, risk assumption and risk shifting
Risk Avoidance

 A conscious decision not to expose

oneself to a particular risk
 Can be said to decrease one’s chance of
loss to zero
 A doctor may decide to leave the practice
of medicine rather than contend with the
risk of malpractice liability losses
 When risk is avoided, the potential
benefits, as well as costs, are given up
 Example:- Avoiding a low lying location which is
susceptible for flooding
RISK ASSUMPTION/RETENTION
 Risk assumption means taking on responsibility
for the negative effects/results of a risk.
 If a loss occurs, an individual will pay for it out
of whatever funds are available at the time
 Risk assumption may either be planned or
unplanned
Planned retention/assumption
 Involves a conscious and deliberate assumption
of recognized risk
 Sometimes occurs because it is the most
convenient risk treatment technique Or because
there are simply no alternatives available short
of ceasing operations
Unplanned retention
 When individual does not recognize that a risk
exists and unwittingly believes that no loss
could occur
 Sometimes occurs even when the existence of a
risk is acknowledged
Risk Reduction

 An individual can’t avoid risk completely,

however he/she can decrease the likelihood of
losses
 For example wearing a seat belt(reduces
likelihood injury when accident occurs),
installing fire extinguisher(reduce potential
damage out of fire outbreak)
Risk Shifting/Transfer

 Is the common method of dealing with risks.

 Involves payment by one party (the transferor)
to another (the transferee, or risk bearer)
 Transferee agrees to assume a risk that the
transferor desires to escape
 Most of the transferees are insurance
companies
 In exchange for the fee you pay, the insurance
company agrees to pay for your loss
Risk Management Process

 It is an important part of overall personal

financial planning management
 Risk management process involves five steps:
Step 1. Gather information to identify exposures:
 Sources of risk, called exposures are the
items you own e.g. vehicle, house, jewelry etc
and activities in which you engage e.g. driving,
smoking, travelling etc that expose you to
potential loss.
 In risk management, you should take an
inventory of what you own and what you do
to identify your exposures to loss
Step 2. Evaluate risk and Potential loss
 after identifying your exposure to risk,
estimate both loss frequency and loss severity
 loss frequency is the likely number of times
that a loss might occur over a period of time
WHILE loss severity is the potential magnitude
of loss that may occur
 An important consideration here is the range of
potential loss
Step 3: Choose among the methods/techniques of
handling risk (risk avoidance, transfer, retention
or reduction)
 Each technique may be appropriate for some
circumstances
 However you may choose the mix of it, the mix
that you choose depends on the source of the
risk, the size of the potential loss, personal
reaction to risk and financial resources available
for losses.
Step 4: Implement and Administer your risk
management plan/ Implement the chosen
technique/s
 this entails implementing and administering the
techniques you have chosen e.g. if risk transfer is
the chosen technique then buying an insurance
policy means implementation of the plan
Step 5: Evaluate and Adjust the Plan (Reviewing)
 the risk people face in their lives change
continually, therefore, no risk management plan
should be put in place and left alone for long
periods of time
 The necessary adjustments should be
implemented promptly to reflect the changing
scenario
INSURANCE
 Insurance is a mechanism for transferring and
reducing pure risk through which a large number of
individuals share in the financial losses suffered by
members of the group.
 It is a protection against any possible financial loss.
Common Terms
 An insurance company/insurer: a risk-sharing
business that agrees to pay for losses that may
happen to some it insures
 Policy: is a contract that a person purchase when
joining an insurance company
 Policy holder: a purchaser of the policy
 Premium: regular payments that a policy
holder pays to the insurer for agreeing to take
risk.
 Coverage: the protection provided by the terms
of an insurance policy
 Insured: people protected by the policy
Types Of Insurance An Individual
Can Take
1. Home and Property Insurance
 Home and personal belongings count a major
portion of peoples assets.
Homeowner’s insurance: is a coverage for your
place of residence and its associated financial
risks such as damage to personal property and
injuries to others.
 Homeowner’s insurance policy provides
coverage for the following
• The building in which you live and any other
structures on the property
• Additional living expenses caused by damage
of a house e.g. hotel expenses being paid by
insurer while repairing your home
• Personal property e.g. furniture, appliances,
clothes etc
• Personal liability and related coverage:
personal liability portion of a homeowner’s
policy protects you if others sue you for
injuries they suffer or damage to their property
Factors that affect home insurance
costs
 Location of home
 Type of structure e.g. bricks vs wood made
home
 Coverage amount and policy type. The policy
and amount of coverage you select affect the
premium you pay e.g. It costs more to insure a
ths 100m home than a tsh 70m one
 Home insurance discounts. Companies offer
discounts if an individual take action e.g.
installing smoke detectors and fire
extinguishers to reduce risks to his/her home
2. Automobile Insurance
 Traffic accidents can destroy people’s lives
physically, financially and emotionally.
 Insurance can not eliminate pain and suffering, it
can however only reduce a financial impact
 Two Major categories of automobile insurance exist
i. Bodily injury coverages: include bodily injury
liability, medical payments and uninsured
motorist’s protection
ii. Property damage coverages: including property
damage liability, collission and comprehensive
physical damage
Motor Vehicle Bodily Injury
Coverage
Bodily injury liability
 Bodily injury liability provides coverage in case you
cause an auto accident in which another person (or
people) is hurt. It covers the damages that you're legally
responsible.
Medical payment coverage
 Insurance that applies to medical expenses to everyone
injured in your vehicle including yourself
Uninsured motorist’s protection
 An insurance that covers you if you are involved in an
accident with other uninsured or negligent driver (some
one who has no insurance). The owner of the policy pays
a premium to the insurance company to include this
clause.
Motor Vehicle Property coverage

 Property damage coverage protect you from

financial loss if you damage someone else’s
property or if your vehicle is damaged
Property damage liability
 Automobile insurance coverage that protects a
person against financial loss when that person
damages the property of others
Collision
 Automobile insurance that pays for damage to
the insured’s car when it is involved in an
accident
 It allows you to collect money no matter who
was at fault
 However the amount you collect is limited to
the cash value of your vehicle at the time of the
accident
Comprehensive physical damage
 Protects insured if his/her vehicle is damaged
in a non accident situation. It covers your
vehicle against risks such as fire, theft, falling
objects, floods, earthquakes etc
Factors affecting Motor vehicle
insurance premium.
 Includes mainly three(3)
i. Vehicle type e.g. the year, make, model etc
affects premium
ii. Location in which a vehicle is used e.g. rural
areas has fewer accidents and theft than in
urban areas
iii. Driver classification e.g. age, gender, marital
status, driving record etc