Risk management is the systematic process of identifying, analyzing, and dealing with pure risks. In life insurance, the primary concern is managing mortality risk - the financial consequences of premature death.

Understanding Pure vs Speculative Risk

Pure Risk
- Only two outcomes: loss or no loss (never gain)
- Examples: death, disability, property damage, liability claims
- Insurable because losses are predictable across large groups
- Focus of insurance industry

Speculative Risk
- Three outcomes: loss, no change, or gain
- Examples: investing in stocks, starting a business, gambling
- Not insurable because includes profit opportunity
- Managed through investment strategies

The Four Risk Management Techniques

1. Risk Avoidance

Definition: Eliminating exposure to a particular risk entirely

Examples:
- Not flying to avoid aviation accidents
- Not driving to avoid car accidents
- Not working in hazardous occupations

Limitations:
- Often impractical or impossible
- May eliminate beneficial activities
- Cannot avoid death (universal risk)

2. Risk Reduction (Risk Control/Mitigation)

Definition: Taking measures to decrease frequency or severity of losses

Examples:
- Installing smoke detectors (reduces fire damage severity)
- Regular health checkups (early disease detection)
- Safety training programs (reduces accident frequency)
- Wearing seatbelts (reduces injury severity)

Benefits:
- May lower insurance premiums
- Proactive loss prevention
- Reduces overall exposure

3. Risk Retention (Self-Insurance)

Definition: Accepting responsibility for losses as they occur

Appropriate when:
- Losses are small and affordable
- Frequency is low
- Insurance is too expensive
- Required by deductibles and coinsurance

Types:
- Planned retention: Conscious decision with emergency fund
- Unplanned retention: Being uninsured by default

Examples:
- Using high deductibles
- Self-funding small repairs
- Emergency savings fund

4. Risk Transfer

Definition: Shifting financial burden of loss to another party

Methods:
- Insurance: Most common method (transfer to insurance company)
- Contracts: Hold-harmless agreements, indemnification clauses
- Hedging: Financial instruments for business risks

Life Insurance as Risk Transfer:
- Transfers mortality risk to insurer
- Insurer assumes financial burden of death
- Policyholder pays premiums
- Beneficiaries receive death benefit

Perils vs Hazards

Peril
- The actual cause of loss
- The event that triggers a claim
- Examples: death, fire, theft, accident
- Named in insurance policies

Hazard
- Conditions that increase likelihood or severity of loss
- Makes perils more likely to occur or worse

Three Types of Hazards:

1. Physical Hazard
2. Tangible characteristics that increase risk
3. Examples: poor health, dangerous occupation, hazardous hobby

4. Observable and measurable

5. Moral Hazard

6. Dishonest tendencies that increase risk
7. Intentional actions to cause or inflate losses
8. Examples: arson, fraud, staged accidents

9. Reason for underwriting investigation

10. Morale Hazard

11. Carelessness or indifference due to insurance
12. Not intentional fraud, but reduced caution
13. Examples: less maintenance because "insurance will pay"
14. Addressed through deductibles and coinsurance

Risk Management Process

1. Identify Risks - Recognize potential exposures
2. Analyze Risks - Assess frequency and severity
3. Evaluate Alternatives - Consider all four techniques
4. Select Best Technique - Choose most cost-effective approach
5. Implement Plan - Put strategy into action
6. Monitor & Review - Adjust as circumstances change

Why Life Insurance?

Life insurance is the primary method of transferring mortality risk because:
- Death is inevitable but timing uncertain
- Financial impact can be catastrophic
- Cannot be avoided or adequately reduced
- Self-retention rarely feasible for full needs
- Transfer through insurance is cost-effective