Principles of Risk Management and Insurance
What the exam tests
Principles of Risk Management and Insurance tests whether you can identify a pure exposure, measure it, and justify a treatment. Expect insurable-interest timing, indemnity, subrogation, and the characteristics that make a risk insurable.
Core rules
- Pure risk involves loss or no loss; speculative risk includes gain and is generally uninsurable.
- The risk-management process is identify, measure frequency and severity, select treatment, implement, monitor.
- Treatments are avoidance, loss reduction, retention, transfer, and sharing. Insurance transfers financial consequences; it does not eliminate the hazard.
- Insurable exposures usually need many homogeneous units, accidental loss, measurable loss, affordable premium, and no catastrophic concentration.
- Indemnity restores approximate financial position. Policy limits, deductibles, and actual cash value enforce it.
- Life insurance requires insurable interest at inception; property insurance requires it at the time of loss.
Worked example
A landlord owns a $900,000 building. Raising the deductible from $1,000 to $5,000 saves $1,800 a year. The landlord holds a $25,000 reserve, so the extra $4,000 retention is funded. The higher deductible is rational if the premium savings exceed the expected extra retained losses and the reserve can absorb a severe loss. If the building is mortgaged, the lender may limit the deductible.
Traps that cost marks
Do not treat predictable wear and tear as insurable. Do not confuse retention with failure to manage risk. Watch insurable-interest timing: life at inception, property at loss. A coinsurance clause can reduce recovery even when the loss is below the limit.