FIN 3440 Chapter : Ch1
Document Summary
We can define risk in our course as the possibility of an unfavorable variation from a desired result. An individual, for example, hopes that his house will not burn down, or that he will not die prematurely. The insurer hires professionals (actuaries) to predict losses and to develop insurance pricing (premiums) so that the company is profitable; the insurer hopes that actual losses will not vary unfavorably from forecasted losses. The concept of expected value that you learned in statistics is also useful in assessing risk for our purposes because it captures the probability and severity of a loss in the calculation. For example, if the potential severity of a loss ,000,000 but its probability of occurrence is 1%, the expected value of the loss is only ,000. Conversely, if the potential severity were quite low, say , and the probability of loss were high at 95%, the expected value of the loss would be quite low at 95 cents.
