Chapter 3

Risk Management Fundamentals

Risk management had primarily been viewed as an insurance-related concept for many years. Based on this broad concept, an individual or an enterprise will envision some type of threat, such as the danger of a residential fire or casualty loss, and will decide to purchase insurance using a risk-based approach to decide what type and how much insurance coverage to purchase. Key decision factors here are the perceived risks of these threats and the insurance costs to cover that risk; these have always entered into the decision to purchase insurance, and both risks and insurance costs also change over time. Fire insurance to cover an individual's home is an example. Back in the days of oil lanterns used for light and straw stored in a nearby stable, there was always a high risk of fires. We only need to think of the great Chicago fire of 1871 when, as legend suggests, a cow kicked over a lantern and caused a fire that devastated the city. The risk of that type of fire is not as great today, and fire insurance is no longer that expensive, in a relative sense. However, there is always the possibility of a lightning strike or electrical malfunction to cause a fire in the home today, and mortgage finance companies generally require fire insurance coverage. Even if there is no mortgage, all prudent persons today will purchase such fire insurance even if not required. A destructive fire to one's home presents a low level but consistent risk. While ...

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