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CPCU 500 all
| Question | Answer |
|---|---|
| What are the steps in the risk management process? | 1. risk identification 2. risk measurement 3. determining feasible techniques 4. choose optimal technique 5. implement selected technique 6. monitor outcomes and revise |
| chance of loss | The probability that a (loss) event will occur |
| Diversifiable risk | Also known as particular or specific risk. A risk that affects only individuals and not an entire community. This is no correlation among losses. |
| Nondiversifiable risk | Also know as fundamental or market risk. A risk that affects an entire community or large numbers of persons or groups within the economy. There is significant correlation among those experiencing losses. |
| Enterprise risk | A term that encompasses all major risks faced by a business, including pure (hazard) risks, speculative risks, business and financial risks, even strategic risks. |
| What are the four quadrants of risk often considered in enterprise risk management? | 1. hazard risk 2. financial risk 3. operational risk 4. strategic risk |
| hazard | conditions that increase the frequency or severity of losses. |
| Name four types of hazards. | 1. Physical hazard 2. Moral hazard 3. Morale hazard 4. Legal hazard |
| Financial risk | A risk that is faced by businesses due to adverse changes in commodity prices, interest rates, or foreign exchange rates |
| Moral hazard | The existence of insurance often provides some incentive to cause a loss or to inflate losses through dishonest acts such as fraud. |
| Morale hazard | Also called attitudinal hazard. Carelessness or indifference to a loss because of the existence of insurance. |
| Physical hazard | A physical condition that increases the frequency and/or severity of loss (example: icy roads) |
| Legal hazard | The possibility that a change in laws will ultimately increase losses (especially for insurers). |
| What are three financial consequences of risk? | 1. Expected cost of paying losses (offset by potential gains) 2. Expenditures on risk management (in an attempt to reduce losses) 3. Cost of residual uncertainty |
| Loss exposure | Any situation or circumstance in which a loss is possible, regardless of whether a loss occurs |
| Objective risk | Uncertainty that can be quantified. It is the relative variation of actual loss from what was expected. Often objective risk can be quantified using statistics and can agreed upon by all who understand the structure of the risk. |
| Subjective risk | uncertainty based on state of mind or opinions. Unlike objective risk, subjective risk is in the eye of the beholder. |
| Peril | a specific cause of loss (example: fire) |
| Risk | uncertainty regarding outcomes. Risk includes the uncertainty in the amount of the outcome and its timing. Also, one of the outcomes is negative |
| Pure risk | A situation in which there are only the possibilities of loss or no loss. That is, only bad outcomes are possible (downsided risk only) |
| Speculative risk | A situation in which either profit or loss are possible (two sided risk - win or lose) |
| What are the three elements of loss exposures? | 1. an asset is exposed to loss in value 2. a peril can impair the asset, as well as the hazards which increase the chance of loss 3. financial consequences of the loss |
| What are four types of loss exposure? | 1. property 2. liability 3. personnel (personal) 4. net income |
| Tangible vs. intangible property | Tangible property has a physical form and can be touched. Intangible property cannot be physically touched (e.g., goodwill or patents) |
| Property loss exposure | a property owner can sustain loss from damage, destruction, or theft in which the owner has financial interest |
| Liability loss exposure | the possibility that another party will make a claim that a person or business is responsible for their injuries or damages |
| Personnel loss exposures | possibility that the skills of a key employee will be lost due to injury, sickness, disability, or death |
| Net income exposure | Possibility that net income will decline. Often result |
| What are pre-loss goals of risk management? | 1. preparation for loss in the most cost effective manner 2. Keeps uncertainty at a tolerable level 3. Ensure legal obligations are satisfied 4. social responsibility |
| What are different levels of goals for risk management after a loss has occurred? | 1. ultimate survival 2. continuity of operations 3. any level of profitability 4. stable earnings (no loss in profit 5. social responsibility (to employees, suppliers, customers, and community) 6. continued growth |
| direct loss | Financial loss that results from (is speciafally caused by) an insured peril |
| indirect loss | Financial loss occurring as the result of some other loss (also called consequential loss). An example is business interruption where a business is closed following a direct loss. |
| objective probability | frequency of an event that can be estimated precisely, either by induction (such as mortality) or by the structure of the event (such as drawing an ace out of a standard deck of cards) |
| subjective probability | frequency that cannot be verified because it is based on the state of mind of the observer (such as the likelihood of a stock increasing in value) |
| law of large numbers | as the number of observations or trials increases, the amount of objective risk falls. important for insurers, it says that the experience of a group of policyholders becomes more predictable as the number of policies increases. |
| Risk map or risk matrix | A two-dimensional assessment of the risks faced by an organization which begins the process of selecting risk management tools. A risk map illustrates the frequency and the severity/impact of each risk. |
| Frequency | the probability of a loss occurring, or the number of losses occurring during a particular time period |
| Severity | the dollar impact of a loss if a business or individual becomes affected |
| What are the two major categories of risk management techniques that are available? | risk control and risk financing |
| Risk control | any technique that attempts to reduce the amount of losses experienced |
| risk financing | any technique that is used to pay for losses when they occur |
| What are the costs of risk to society? | reduction in productive capacity of economy (damaged factories don't produce), individuals would have larger emergency funds, discontinued goods/services, worry and fear |
| What are the benefits of risk management? | Fewer/smaller losses saving resources, reduced financing costs for businesses, no societal burden for unfortunate, reduced residual uncertainty |
| What are four requirements when compiling data when analyzing loss exposures? | relevancy, complete, consistent, and organized |
| What are four measures of central tendency? | expected value, mean, median, and mode |
| What are common measures of dispersion? | variance, standard deviation, coefficient of variation, and tail percentiles (such as the 5th or 95th percentiles, called value at risk) |
| When forecasting outcomes using the normal distribution, what percentage of outcomes is predicted to be within one, two, and three standard deviations of the mean? | 68%, 95%, and over 99% |
| What methods are used to identify loss exposures? | Document analysis, compliance review, inspections |
| List some examples of documents that are reviewed when identifying loss exposures | financial statements (balance sheet, income statement, cash flow statement), checklists/questionnaires, organizational policies/documents, organizational chart/flowchart, loss history, contracts, insurance policies |
| theoretical probability | likelihood of an event is based on the known structure of possible outcomes, such as the roll of a die or spin of a roulette wheel. In risk management, we rarely know the structure of the event so we don't know theoretical probabilities. |
| empirical probability | estimate of the likelihood based on a sample of data |
| law of large numbers | when increasing the amount of historical data for loss exposures (assuming the risk environment is similar) improves the accuracy of forecasting. (e.g., remember the accuracy of rolling the dice in class) |
| probability distribution | presents estimates of the probability of all possible outcomes. these can be presented as a graph/chart or as a table |
| discrete probability distribution | outcomes have only a countable number of potential outcomes, often used for the frequency of events (e.g., the number of hurricanes in a year) |
| continuous probability distribution | outcomes have an infinite number of possible outcomes, often used for severity (e.g., the total amount of damages caused by a hurricane) |
| expected value | using the theoretical probability distribution, the expected value is the weighted average of the outcomes, where the weights are theoretical probabilities |
| central tendency | a single number that attempts to represent a distribution of outcomes. (e.g., the "middle" of the distribution) |
| mean | it's the average that you and I tend to think of. To determine the mean, add up all outcomes and divide by the number of observations. without additional information, it is likely the best "guess" at what an outcome would be (i.e., the predicted outcome) |
| median | 50th percentile of a distribution, or the midpoint of sequenced data. 50% of outcomes are larger than the median and 50% are less. |
| mode | the outcome occurring most frequently in a dataset |
| dispersion | a measure of how spread out a probability distribution is. If the dispersion is high, measures of central tendency are less reliable since some outcomes are far away from the middle of the distribution |
| variance | the "average" squared deviation from the mean. first, you must calculate the mean. next, subtract the mean from each data point and square this result. finally, add up these squared deviations and divide by the number of observations minus one (n-1) |
| standard deviation | the most common measure of the dispersion of a probability distribution. to determine the standard deviation, take the square root of the variance. |
| coefficient of variation | a measure of dispersion that relates the standard deviation of a distribution to its mean. useful for comparing the dispersion of two distributions. |
| loss frequency | the number of losses that occur in a given period of time. or the probability that a loss will occur |
| loss severity | the size of a given loss |
| total dollar losses | the cumulative value of all losses that occur during a period of time |
| maximum possible loss (MPL) | the total value of loss exposures that can be caused by any one particular event |
| risk map / matrix | a two dimensional graph that depicts both the frequency of losses (horizontal access) and the severity (vertical access) |
| Prouty approach | a type of risk map assisting risk managers in identifying risk management techniques. includes four categories of frequency (zero, slight, occasional, and definite) as well as three categories of severity (slight, significant, and severe) |
| data credibility | the weight (or confidence) attached to historical data when forecasting future events |
| collectively exhaustive | in a probability distribution, all possible outcomes should be illustrated - an outcome not listed is not possible |
| Mutually exclusive | when only one outcome is possible at a time (like heads vs. tails on a flip of a coin) |
| percentile | indicates the likelihood of falling below a specific value |
| tail percentile (value at risk) | percentiles that are close to the minimum and maximum of a dataset. tail percentiles give a measure of the worst case scenario with a particular probability (like the 5th or 95th percentile) |
| cumulative probability distribution | based on a ranked sample of data, illustrates the probability of being less than or equal to observed values (see percentiles) |
| What are four dimensions of loss exposures? | frequency, severity, total dollar losses, and timing |
| Risk control | a technique that is aimed at reducing losses of an organization by targeting the frequency or severity of losses or speeding recovery of operations |
| Avoidance | a risk control technique where an organization decides to not engage is an activity which has some type of loss exposure. It eliminates any losses from that activity |
| Loss prevention | A risk control technique aimed at reducing the frequency of loss. An example would be a training program for employees to help reduce the incidence of workplace injury |
| Loss reduction | A risk control technique aimed at reducing the severity of losses that occur. These techniques can be initiated both before the loss (sprinkler system) or post-loss (execute business continuity plan) |
| List six risk control techniques | avoidance, loss prevention, loss reduction, duplication, separation, diversification |
| Separation | A risk control technique that physically divides assets to minimize the impact of a single loss event and to help continue operations. |
| Duplication | a risk control technique that uses backup copies or spares of important property of information. The backup replaces the original in case of loss |
| Diversification | A risk control technique to spread loss exposures across several different products, markets, or locations. |
| What are the four major goals of risk control? | 1. Implement effective and efficient measures (choose techniques that reduce losses and are cheaper) 2. Comply with legal requirements 3. Promote life safety 4. Ensure business continuity |
| Life safety | Based on the occupancy of a building, these are required construction, operation, and maintenance requirements to assure that people have a safe exit in the event of a fire |
| What does the acronym "COPE" stand for? | Used for assessing (and perhaps reducing) property risk, COPE is: Construction, Occupancy, Protection (internal and external), Environment (neighboring property) |
| What are the six steps to the business continuity process? | 1. identify critical functions 2. identify risks/threats to critical functions 3. evaluate impact to critical functions 4. develop a continuity strategy 5. develop a business continuity plan 6. monitor and revise |
| Which three risk control techniques are most useful for liability exposures? | avoidance, loss prevention, and loss reduction |
| proactive avoidance | before the fact, choosing not to engage in a venture that has risk |
| reactive avoidance | abandonment of risky activities, often after experiencing significant losses |
| engineering approach to risk control | uses elements of design and technology in an effort to minimize losses and hazards (e.g., air bags in cars) |
| human behavior approach to risk control | seeks to understand and modify existing behaviors of people in an effort to reduce losses (e.g., training program) |
| premises liability | liability that occurs at a business's location, such as customers slipping on a floor in a retail store |
| operations liability | liability that arises from the normal activities of a business such as property damage and/or bodily injury (e.g., auto liability by delivery personnel is an example) |
| completed operations liability | liability that arises after work has been completed for customers, such as an improperly installed plumbing fixture that causes property damage |
| products liability | liability that arises due to the defect of distributed goods |
| workers compensation liability | liability that arises from employee injuries while performing their job |
| professional liability | liability incurred by professionals, such as lawyers or accountants, who don't exercise the higher standard of care toward others as required by their occupation |
| management liability | liability incurred by managers and their employers as a result of engaging in wrongful acts that injure shareholders, employees, or others |
| What are the goals of risk financing? | Availability/Pay for losses, Manage the cost of risk (admin, risk mgmt), Manage cash flow variability, Maintain appropriate liquidity, Comply with legal/contractual requirements |
| Retention | One extreme of risk financing where the organization that suffers losses are financially responsible and use internal funds to pay for them |
| Risk transfer | One extreme of risk financing where the financial responsibility for paying losses of an organization are shifted to another party |
| When compared with risk transfer (insurance), what are the advantages of retention? | cost savings (insurer overhead/admin/commissions), control of the claims process, timing of the cash flows, strong incentive for risk control |
| When compared with retention, what are the advantages of risk transfer (insurance)? | Reduced exposure to large losses, reduced cash flow / earnings volatility, professional loss control and claims administration services |
| What are some organization specific characteristics that affect the selection of risk financing measures? | Risk tolerance of stakeholders (managers, investors), financial strength, core operations (knowledge of risk), ability to diversity, ability to control losses, ability to administer retention |
| Primary insurance layer | First level of insurance that begins payment after satisfaction of a deductible |
| Excess insurance layer(s) | Begins payment for loss after the limit on the primary layer of insurance has been exhausted. |
| Umbrella policy | A type of liability insurance that often sits between primary coverages (such as auto and general liability) and excess coverage. |
| Self insurance | A risk financing technique that is a carefully designed form of retention where the organization evaluates loss exposures and develops internal systems to track losses and fund them with payments that look like premiums. |
| Large deductible plan | A risk financing technique where an insurer provides administrative/claims services and the organization reimburses insurer for losses under a large deductible |
| Captive insurer | A risk financing technique where a parent company forms a subsidiary to insure its loss exposures |
| risk retention group (RRG) | Similar to a group captive, where an insurer is formed to provide liability insurance for several parent companies' loss exposures. |
| finite risk insurance plan | A risk financing technique that involves very large premiums and only transfers a small portion of the risk of an organization to an insurer. |
| pools | A risk financing technique where a group of organizations come together to provide protection in the event of a loss. |
| Retrospective rating plan | A risk financing technique where the premium for an insured is based on the actual loss experience during the policy period subject to a minimum and maximum |
| hold harmless agreement | A type of risk transfer that does not involve insurance. It is a contractual arrangement to assign financial responsibility when there is a relationship between organizations |
| What capital market solutions exist as risk financing techniques? | securitization, hedging with derivatives, and contingent capital |
| (insurance) securitization | instead of absorbing the losses directly, securitization involves the creation of a financial security soldl directly to investors whose underlying cash flows are tied to losses. |
| hedging | using a financial asset, such as options and futures contracts, in a way to offset the underlying loss exposure of an organization |
| contingent capital arrangement | A risk financing technique that allows an organization to raise capital by entering into an agreement with another party who agrees to buy securities at prearranged terms if losses exceed some amount. |
| What are methods of retention? | ad hoc, reserves (unfunded or funded), self-insurance, borrowing (line of credit), captive insurer |
| active retention | a conscious decision of an organization that recognizes a loss exposure and decides to pay subsequent losses directly |
| passive retention | unplanned retention, where a business does not recognize its exposure to a loss and by default must pay for losses if they occur |
| guaranteed cost insurance | a type of risk financing where an organization pays a fixed price ahead of time and an insurer pays for specified losses. some retention remains due to deductibles and a policy limit (plus uninsured losses) |
| self insurance | a type of retention where an organization prefunds losses based on formal analysis and establishes claims services. |
| large deductible plan | a type of risk transfer that uses an insurance company, but losses are reimbursed only after an organization has absorbed a certain level of losses. |
| pure captive | an insurance subsidiary that is owned by only the parent company |
| group captive | an insurance company formed and owned by several companies, often from the same industry, who are looking to insure their own losses |
| catastrophe (cat) bonds | a type of debt instrument sold to investors where interest and principal repayments are tied to losses or other type of trigger (such as an external index) |
| What are the quadrants of enterprise risk? | hazard, operational, financial, strategic |
| What are the two major categories of benefits that stem from implementation of ERM? | Enhanced decision making and improved risk communication |
| What are four types of financial risk? | foreign exchange, interest rate, commodity price, and equity price (also credit risk) |
| What are some differences between traditional risk management and ERM? | expand categories of risk, integration with organizational strategy, performance metrics, top level risk manager (organizational structure) |
| What is strategic planning? | board of directors and top managers of company discuss, develop, and refine overall business strategies for the company |
| What are the dimensions of SWOT analysis? | strengths, weaknesses, opportunities, and threats |
| How is decision making enhanced by companies adopting ERM? | increased profitability from exploiting opportunities, reduced volatility in overall financial performance, improved ability in meeting strategic goals, increased managerial accountability |
| How is risk communication improved by businesses that adopt ERM? | more consensus by managers, more acceptance and cooperation by all stakeholders |
| What are the three specific risks identified in banking standard called Basel II? | market risk (which includes changes in interest rates, FX, and equity prices), credit risk (defaults on loans), and operational risks (IT or personnel failure) |
| Describe the law of large numbers | As the number of exposure units increases, the actual losses will more closely approach the expected losses |
| What is adverse selection? | "Only sick people buy insurance". Adverse selection is the tendency of persons with higher-than-average chance of loss to seek insurance at average rates which, if not controlled by an insurer's underwriters, results in higher-than-expected loss levels. |
| What is "commercial" insurance? | Property and liability coverage for businesses, non-profit organizations, and government agencies. Not personal lines coverage |
| What is commercial general liability (CGL) insurance? | One of the most common types of commercial insurance. Covers premises and business operations liability faced by almost all companies. |
| What is a fortuitous loss? | An unforeseen and unexpected loss that occurs as a result of chance |
| What is indemnification? | Compensation to the victim of a loss in an attempt to make them financially whole by payment, repair, or replacement |
| How does pooling work? | Spreading of losses incurred by the few over an entire group of insureds, so that in the process, average loss is substituted for actual loss. |
| What the requirements of ideally insurable risk? | (1) Pure risk (2) A large number of exposure units (3) Accidental and unintentional loss (4) Definite and measurable loss (5) No catastrophic loss (6) The chance of a loss must be calculable (7) The premium must be economically feasible |
| What is risk transfer? | Occurs when a pure risk is transferred from the insured another party (such as an insurer) who is typically in a stronger financial position to pay the loss than the insured |
| What are some of the benefits of insurance? | indemnification for losses, improved financial security/peace of mind, enhances credit (by protecting collateral), may help comply with legal requirements, promotes risk control activity, insurers are a source of investment capital, reduces social burden |
| What are the costs of insurance? | using insurance may be more expensive because of insurer expenses and profit, moral hazard (such as fraud) |
| What are reasons for governments to get involved in insurance markets? | a risk may not meet requirements of ideal insurable risk by private insurers, government may be more efficient provider, insurer of last resort, other social purposes |
| What is a contract of adhesion? | when a party of a contract (such as the insured) has no input into contract language and must accept the entire contract with all of its terms and conditions. if ambiguous, courts often rule against the writer of contracts of adhesion (the insurer) |
| What is the difference between a commutative and an aleatory contract? | Unlike a commutative contracts in which dollar values exchanged by both parties are equal, an aleatory contract is one in which specific dollar values exchanged may not be equal |
| What is the broad evidence rule? | one method for determining the actual cash value which should include all relevant factors an expert would use in determining the value of the property |
| What is a conditional contract? | A contract with provisions that qualify or place limits on the insurer’s promise to perform |
| In the context of contracting, what is an assignment? | transfer of legal rights of a contract to another party |
| What is the principle of indemnity? | loss payment should bring the policyholder's financial position back to where it was before a loss occurred. the insurer should not pay MORE than the amount of loss so the policyholder does not profit from insurance |
| In the context of insurance, what is the end result of the principle of utmost good faith? | A higher degree of honesty is imposed on both parties to an insurance contract than what is imposed on parties to other contracts |
| What is subrogation? | upon paying for a loss, the insurer receives the legal rights of the policyholder to recover from a negligent third party |
| What is a unilateral contract? | one where only one party makes a legally enforceable promise |
| What is a bilateral contract? | one where both parties make a legally enforceable promise |
| What is a valued policy? | Policy that pays the face amount of insurance regardless of actual cash value if a total loss occurs (e.g., life insurance) |
| In an insurance policy, what is the declarations page (decs page)? | contains unique information about the insurance contract including the insured’s name, address, property to be insured, policy limits, policy period, and premium |
| What is the insuring agreement? | that part of an insurance contract that states the promises of the insurer. specifically it describe the circumstances under which the insurer makes a loss payment |
| What is an endorsement (or rider)? | written provisions that add to, delete or modify the provisions in the original contract |
| In the context of an insurance policy, what are exclusions? | provisions in an insurance contract that list perils, losses, and property that are explicitly not covered |
| In the context of an insurance policy, what are conditions? | provisions inserted in an insurance contract that qualify or place limits on the insurer’s promise to perform |
| In the context of an insurance policy, what does the acronym "DICE" stand for? | these are the major sections of an insurance contract: Declarations, insuring agreement, conditions, and exclusions |
| What is the difference between monoline and multiline policies? | a monoline insurance policy includes only a single type of insurance while a multiline (or package) policy contains more than one type of insurance in the same policy. e.g., HO and personal auto includes both property insurance and liability coverage |
| What is the difference between a self-contained policy and a modular policy? | a self-contained policy has all necessary contract provisions in a singular document. A modular policy must combine several separate documents to complete the policy (such as combining coverage forms/insuring agreements with a conditions form) |
| What are the requirements of any contract? | offer/acceptance, consideration, legally competent parties, legal purpose |
| What are some reasons for exclusions in insurance contracts? | some perils are not insurable, assist in moral/morale hazard, other policies are better designed for coverage, coverage not needed by typical insureds, specialized underwriting is required, keep premiums reasonable |
| actual cash value (ACV) | often used as a method to determine loss payments under property insurance. Most often determined by subtracting depreciation of the item from its replacement cost |
| Deductible | The amount of loss that must be absorbed by the policyholder before insurance provides any payment. the deductible amount is subtracted from the total loss payment that would otherwise be paid |
| elimination period | common in disability insurance, it is a deductible in days - the period during which benefits are not paid or the period of time that must elapse before benefits are payable |
| coinsurance requirement (property) | an insurance to value requirement, meaning that the policyholder must maintain a policy limit at a stated percentage of its insurable value (80% is typical) |
| principle of insurable interest | in order to receive any loss payment from an insurance contract, the insured must stand to lose financially if the covered loss occurs |
| negligence | the failure to exercise the standard of care required by law to protect others. if you are found negligent, you may become financially responsible for another's injuries |
| compensatory damages | types of damages that are related to the actual losses incurred |
| What are the methods for determining actual cash value? | replacement cost less depreciation, fair market value, broad evidence rule |
| What are some legal bases for demonstrating insurable interest in property insurance? | ownership, secured creditors, contractual rights, factual expectancy, representation of another party |
| What are some legal bases for demonstrating insurance interest in life insurance? | Self (unlimited), close family ties (e.g., spouse, children, parents), other pecuniary interests |
| bailee | a party who has temporary possession of another's property |
| joint tenancy | several parties have entire ownership, including survivorship interest |
| tenancy by the entirety | same as joint tenancy, but between a husband and wife |
| tenancy in common | joint partial ownership, but survivorship interest remains with heirs of owners, not surrendered to surviving owners |
| Agreed value policy | also called a valued policy, it eliminates the risk of a coinsurance penalty by negotiating a policy limit that acceptable to both the policyholder and the insurer |
| functional valuation | the insurer may replace damaged property with functionally equivalent materials (like drywall instead of plaster walls), often used with older properties that have unique craftsmanship |
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