Risk management in insurance
As a result of mastering the material in Chapter 3, the student must:
• Basic concepts and methods of risk management;
be able to
• analyze and evaluate the main parameters of the risks offered for insurance;
• Risk analysis methods.
Key terms: risk; identification and risk assessment; probability and chance; the coefficient of variation; uncertainty; net and speculative risks; solvency.
Origin, definition and classification of risks
Risk is inherent in the private and public life of a person throughout its history and invariably accompanies any purposeful activity. Risk is a fundamental manifestation of stochasticity, uncertainty and randomness of the reality surrounding us and the incompleteness of our ideas about it. The well-known English economist JM Keynes supplemented the theory of risk "pleasure factor", reflecting the desire of entrepreneurs for the sake of increasing profits to take on a greater risk.
In its etymology, the concept of "risk" goes back to the Greek words ridsikon, ridsa, which means rock, rock.
In ancient times, seafarers rarely ventured to swim in the dark and preferred to stick to the shore for the night. Therefore, they often had to maneuver between the coastal rocks with the risk of bumping into them and sinking. Historians believe that property insurance originated in the societies of Phoenician and Greek merchant seafarers as a form of mutual protection against the loss of a ship and cargo as a result of shipwrecks and attacks by pirates and local residents.
From the Italian language, the word risiko is translated as "danger", "threat"; risicare - how to "maneuver between rocks". Translated from the French risqoe means "threat", "risk" (literally, "go around the cliff, the rock").
In Webster's Dictionary, the "risk is defined as "danger, possibility of loss or damage". In the dictionary Ozhegova risk is treated as a "danger possibility" or as an "action at random in the hope of a happy outcome."
In modern dictionaries, the "risk" determine how, for example, "the probability of incurring a loss or missing the benefit", i.e. as a quantifiable measured uncertainty in obtaining an appropriate income or loss in connection with natural disasters, accidental changes in the conditions of economic activity, adverse circumstances, etc.
Some authors define risk as an "event or group of related incidental events that are detrimental to an entity that has this risk." Economic risk is understood as a certain possibility of a loss, measured in monetary terms. A characteristic feature of these and similar definitions is the judgment of risk as a possibility of danger, failure, leading to economic and, in some cases, human losses.
In everyday life and business, risk is often associated with the choice of certain alternatives, calculating the probabilities of their outcome. This is his subjective side. In addition, it manifests itself in the fact that people do not perceive the consequences of risk differently because of differences in psychological, moral, ideological orientations, principles, attitudes, etc.
The objective existence of risk is determined by the probabilistic nature of many natural, social and technological processes, the multivariate nature of material and ideological relations, in which the subjects of social and economic life enter. And the risk exists regardless of whether it is aware of its presence or not, take it into account or ignore it.
The emergence of risk is directly related to the presence of uncertainty, which is heterogeneous in form of manifestation and in content. The main causes of uncertainty and sources of risk are:
1) spontaneity of natural processes and phenomena, natural disasters;
2) the probabilistic nature of many socio-economic and technological processes, the multivariance of material relations, in which the subjects of productive activity enter, which predetermines the impossibility of an unambiguous prediction of the expected result (as practice shows, despite the measures taken to reduce the probability of their occurrence and reducing the amount of damage caused by them, the above random events remain possible, they can not be excluded from the most expensive engineering measures);
3) the presence of opposing trends, the clash of different interests; this source of risk manifests itself in a variety of ways: from wars and interethnic conflicts to competition and simple mismatch of interests;
4) the probabilistic and increasingly risky nature of scientific and technological progress;
5) incompleteness and limited knowledge of the object, process, phenomenon, in relation to which the decision is made, the limitations of man and technical devices in the collection and processing of information with the constant variability of this information;
6) the limited material, financial, labor and other resources in making and implementing decisions;
7) differences in socio-psychological attitudes, ideals, intentions, assessments, behavior stereotypes.
An entrepreneur in his business, a person in his life perceives risk only as a possibility of the appearance of negative results, losses or damage. These are the risks of road accidents, industrial accidents, thefts, fires. Such risks in insurance are called pure , or statistical.
But in life and in business, risk can lead not only to losses, but also to a win, for example, in a lottery. This is the dualistic nature of risk. Such risks are called speculative (from Latin speculatio - "looking out"), and the opportunity to win is called a chance . Therefore, in general, the risk can be defined as a probabilistic, random distribution of the results of the economic actions of the subject. Ambiguity, randomness of these results is caused by the influence of previously unknown factors of the external environment, the incompleteness of our knowledge about future activities and their conditions during the planning period and mistakes made during the planning and implementation of plans.
Clean risks can be insured, and speculative - virtually none, because they depend not only on objective circumstances, but also on personal psychological characteristics of a person. Therefore, when insuring entrepreneurial risks, it is necessary to exclude the subjective risks of the entrepreneur from the insurance coverage.
Risk is a fundamental concept in insurance and determines the basic postulates of its theory.
The 1st postulate. The environment in some of its states poses a danger to living organisms, including humans. These states can be definite and time-consuming, but can occur periodically, accidentally. This may show the Heisenberg uncertainty principle, but most likely in this case there is an interaction of such a large number of nonrandom factors that the result of this interaction can not be calculated exactly with modern computing capabilities and is perceived as vague and random. Today it is trying to describe it with the help of the theory of chaos. Formally, chaos theory is defined as the theory of complex nonlinear dynamical systems based on mathematical concepts of recursion, in the form of a recursive process or a set of differential equations modeling a physical system.
2nd postulate . Living beings, by virtue of the manifestation of the instinct of self-preservation inherent in all living organisms, try to protect themselves from dangerous manifestations of the environment and, depending on their level of development, to foresee the onset of these manifestations. These are biological and psychological theories.
3rd postulate . As people evolve (and many animals), the method of creating stocks is suitable as a protection against adverse environmental manifestations that can be foreseen (calculation, conscious or intuitive). This biology, psychology, mathematics.
4th postulate . As human society evolves and develops, people realize that it is more effective to make reserves collectively, in the form of a maximally preserved and liquid form, and they should be distributed among the victims both from the actions of the elements and from social phenomena (disability, breadwinner, etc.). There are beginnings of insurance on reciprocity. This is social psychology and sociology.
5th postulate . With the further development and stratification of society and the emergence of money as a universal equivalent, including power and position in society, individual people saw the opportunity, based on calculations, to earn on the formation and distribution of a reserve fund (it can already be called an insurance fund). There is commercial insurance. It's still social psychology and mathematics, but with some elements of economics and finance.
6th postulate . As the interpersonal and group relations become more complex, the ways of forming and managing insurance funds and organizing insurance activities are changing and acquiring the force of business customs and laws. This is social psychology, logic, law, mathematics and finance.
Postulates 1-4 follow from the basic laws of physics, mathematics and biology (and psychology, as part of general biology), have repeatedly been observed and additional evidence does not require. Postulates 5 and 6 are confirmed by historical documents and direct observations.
These postulates express the general idea of insurance as an objective and conscious need of individuals and society as a whole in protecting against unfavorable random factors and the way this protection is provided in the form of sharing and transferring risks to professional organizations - insurers.
At the heart of insurance is the notion of risk as a possible, random and probabilistic event, leading to loss, damage. A phenomenon is called a random phenomenon, which, if repeated, manifests itself differently each time, or it may not occur at all in the observed period.
In Art. 9 of the US law "On the organization of insurance in the United States"; the following definitions of insurance risk and insured event are given.
US law "On the organization of insurance business in the United States"
1. The insurance risk is an alleged event, in case of occurrence of which insurance is carried out. An event considered as an insurance risk must have signs of the probability and randomness of its occurrence.
2. The insured event is a committed event provided by an insurance contract or a law, with the onset of which the insurer's duty arises to make an insurance payment to the insured, the insured person, the beneficiary or other third parties.
Randomness and measurability of insurance risk are the most important terms of insurance, because insurance is based on risk pooling (risk pooling) assuming that all those who are united in the insurance pool are at risk, but the risk will occur (an insurance event will occur) only for a part of the merged. The payment for acceptance for risk insurance should be adequate to this risk.
• Risk Entity is called an active participant in the activity that makes the decision. Such participants include the nation, the state, in the person of its management bodies, the entrepreneur, the owner, the family, individual citizens.
• The integrity of the state, the welfare of the nation, material interests, life, health, welfare of groups of people and individual citizens, entrepreneurial activity are objects of risk
Risks can be classified by the sphere of origin, duration in time, the degree of impact on the object and the nature of the consequences.
In terms of the scope of the risks are divided into external and internal. The source of external risks is external, in relation to the subject, the environment. The subject is practically unable to exert influence on such risks, he can only foresee and take them into account in his activities. External risks include those not directly related to the activities of the entity: natural phenomena, unforeseen changes in legislation regulating entrepreneurial activity and the private life of citizens, instability of the state regime and other similar situations. The source of internal risks is the activity of the entity itself. External risks are objective in relation to the subject, the internal ones contain a significant share of subjectivity, because they depend on the conditions of the subject's activity and decisions made by him. Among the external risks, there are fundamental (catastrophic) and specific risks. Fundamental risks affect large areas and many entities and are associated with such phenomena as climate change, natural disasters (for example, earthquakes and floods), as well as with military actions, major man-made disasters. Fundamental risks in insurance are often referred to as force majeure. Specific risks are associated with individuals, groups of people, enterprises, projects. The negative manifestation of specific risks is usually determined by insufficient consideration or neglect of any circumstances.
For the duration in time, the risks are divided into short-term and permanent. Short-term risks are those that threaten the subject during the final known period of time, for example, transport risk during transportation or the risk of non-payment for a particular transaction. Permanent risks include those that threaten a person permanently in a given place or in a particular area of activity, for example, the risk of illness in an unfavorable environment, the risk of default in a country with an imperfect legal system, or the risk of destroying buildings in an area of increased seismic hazard. >
The degree of risk is characterized by the probability of loss (loss), the amount of expected (possible) loss (damage) and the range of fluctuations in the magnitude of the loss relative to the average value. Even J. Keynes in his classic works noted that, other things being equal, a stable profit margin is preferable to a larger but accidentally changing profit.
To assess the "quality" or the degree of risk from an insurance perspective, use a coefficient of variation equal to the ratio of the standard deviation of the total loss on the insurance portfolio to the mathematical expectation of this loss. This approach, in particular, suggested K. Burrow. If the insurance portfolio is homogeneous, i.е. the random values of losses for individual risks are distributed approximately equally, then with an increase in the volume of contracts in n times the coefficient of variation decreases in times. Therefore, it is sufficient to consider the situation for one insurance contract.
p be the probability of occurrence of an insured event with a loss u, whose magnitude is distributed according to a known law. This allows us to calculate the conditional mathematical expectation M [u | A] and the variance D [u | A] of the loss, and then on their basis the total characteristics: the mathematical expectation M [u] of the loss of unit loss and and its variance D [u].
This allows us to assess the degree of risk (coefficient of loss variation).
We introduce the conditional mathematical expectation of a loss under the sign of the square root and after simple transformations we obtain the expression
Let's analyze it. If the amount of loss in the event of an insured event is known and fixed, then D = 0 and , from which it follows that in the event of accepting rare events with insignificant probability p, , a high degree of risk for the insurer to receive an insured event with a large payout, especially if the insured amount is high.
Thus, a well-known coefficient of Professor V. S. Konshin, who estimates the financial reliability of insurance:
where t is the insurance tariff; n - the number of concluded insurance contracts.
The nature of the consequences of the risk depends on the relative (to the total value of the risk object) of the loss. The loss can be replenished, for example, by repairing the affected property or treating a sick person, and irreversible, in case of death or destruction of property as a result of the risk. In business, the following levels of risk are distinguished:
• Permissible risk - if there is a threat of a complete loss of profit from the planned project;
• Critical risk - with the threat of loss not only of the expected profit, but also of income and loss;
• catastrophic risk - when there is a threat of loss of capital, property and bankruptcy of an entrepreneur.
The quantitative values of these risk levels are determined by the subjective perception of the subject of risk.
• Acceptable risk level (absorbable risk ) - justified in terms of economic, social and environmental factors, the risk with which society as a whole is prepared to put up for the sake of obtaining certain positive results of their activities.
An acceptable level of risk does not lead to irreversible consequences and is adopted by legislative, regulatory and other acts based on the achieved level of knowledge, socio-economic capabilities of the state, public opinion, taking into account regional peculiarities. The quantitative assessment of an acceptable risk may be an acceptable level of individual risk, i.e. risk to which the life of an individual undergoes accidents and natural disasters.
The question of acceptance or non-acceptance of risk depends on the definition of an acceptable risk for this situation. In many cases, these decisions are formed almost automatically from the perceptions and habits acquired with experience and training. However, if the situation has changed, the decision making becomes more complicated. To understand why people take a certain risk in some situations and refuse it to others, it is necessary, taking into account the opinion of experts such as Rüdiger Trimpop (Rudiger Trimpop ) and Bernhard Zimolong (Bernhard Zimolong ), consider an acceptable level of risk taking into account psychology. In general, when people take risks, they do it voluntarily, without thinking or following the habit, believing that as a result they will receive some benefit or even pleasure, or are compelled, due to the circumstances. For example, people using a car take risks of injury, death or pollution in exchange for possible benefits from increasing mobility. Investing funds, people expect to get income, realizing, but not always completely, the possibility of losing not only income, but also invested money. There are those who enjoy the risk, and they are engaged in extreme sports or gambling. A generalized idea of the limits of risk acceptability is given in Fig. 3.1
Fig. 3.1. Risk acceptance limits
However, in most life situations, people are forced to expose themselves to risk in order to earn money. The decision to perform any work, along with the receipt of a remuneration for work, entails a variety of likely adverse consequences (suffering, trauma or death), based on statistical retrospective data on accidents. Obviously, the probability and severity of these adverse consequences depend on the type of activity and working conditions.
The threshold criterion, in which most people feel themselves in complete safety (for example, near a hazardous production facility), is 10-6 (one millionth) accidents (accidents, disasters, etc.) per year. This threshold is used in a number of countries (the Netherlands, the United Kingdom, the United States) in the design of industrial enterprises. A significant part of people feel anxiety and anxiety at a threshold probability of 10-5. In a number of cases, for example, for nuclear power plants, the value of the threshold probability is reduced to 10-8.
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