Introduction to Risk Management
What the exam tests
The Introduction domain tests whether you can define risk precisely and place insurance inside a broader management process. Questions target pure versus speculative risk, insurable versus uninsurable exposures, the five-step risk management process, hazards and perils, and the risk manager's role in setting retention and transfer policy.
Core rules
- Risk is uncertainty about outcomes. Pure risk has only loss or no-loss outcomes; speculative risk includes gain. Insurance is designed for pure risk.
- A peril is the cause of loss - fire, windstorm, theft. A hazard is a condition that increases the chance or size of loss: physical (oily rags), moral (staged fire), morale (carelessness because insurance exists), legal (regulatory change).
- Process: identify, analyze, control, finance, administer. Administration monitors results and loops back to identification.
- Cost of risk = insurance premiums + retained losses + risk control expense + administrative cost + taxes and fees. Premium alone is not the cost of risk.
- Risk management is not insurance buying. Avoidance, prevention, contractual transfer, and planned retention can outrank insurance.
- Enterprise risk management extends the process to strategic and speculative risks; traditional risk management focuses on pure risk.
Worked example
A 40-person machine shop has a $2.5 million building, $800,000 of equipment, and a history of small cut injuries. The owner wants to cancel property insurance to save an $18,000 premium. Analysis shows a fire could cost $3.2 million including business income; retained injury losses average $9,000 annually. The building exposure is low-frequency/high-severity and should be insured with a $10,000 deductible. The injury exposure is higher-frequency and can be reduced with guarding and training, then retained through a $25,000 self-insured retention if cash flow allows. The recommendation separates control from financing rather than treating the premium as the only cost.
Traps that cost marks
- Calling insurance a risk control technique; it is financing.
- Treating speculative risk as insurable.
- Confusing hazard with peril in scenario questions.
- Assuming the lowest premium is the lowest cost of risk.