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Friday, February 24, 2012

Chance of Loss

The concept of chance of loss is closely related to that of risk. 

Chance of loss
 can be defined as the likelihood or probability that an event will occur. Like risk, there are objective and subjective probability.
 



Objective Probability
 
Consider an experiment being repeated a very large number of times under identical conditions. The relative frequency of an event occurring in these repetitions is referred to as the objective probability of the event. The objective probability of an event can be determined by either deductive or inductive reasoning.
 

Objective probabilities determined by deduction are also called a priori probabilities. For example, if an unbiased coin is tossed, the probability of getting a head is 50%, since there are only two sides and one of them is a head. Similarly, if a card is picked at random from a pack of cards, the probability that the chosen card is a club is 25%, since there are four suits and one of them is club.
 

Sometimes probability cannot be deduced logically. For example, it would be wrong to deduce that the probability of a male driver having an accident within the next year is 50%, since he either will or will not meet with an accident. There are many factors that affect the probability of an accident such as the driver's age, the usage of the car, etc and such a simple logical deduction will be flawed. However, by careful analysis of past accident experience of motor vehicles, insurers can estimate the probability of an accident by inductive reasoning.

Subjective Probability
Subjective probability is the individual's personal estimate of the chance of loss, which may not be the same as the objective probability. For example, if one milion lottery tickets are sold and only one of them can win a prize, the objective probability of winning for a person who purchases one ticket is 1:1000000. Although the probability of winnin is slim, some people may nevertheless purchase the lottery tickets because their subjective probability of winning is much higher. A wide variety of factors have been found to influence subjective probability, including the individual's age, sex, educational level and superstition.

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