1. Fundamental Principles of Insurance

Question 1

Define ‘risk management’

Answer 1

The identification, analysis and economic control
of those risks which can threaten the assets or earning capacity of an enterprise.

Question 2

What are 5 definitions of risk

Answer 2

1. Possibility of something unfortunate happening
2. Doubt concerning outcome
3. Unpredictability
4. Possibility of a loss
5. Chance of gain

Question 3

Define insurance in terms of a risk transfer mechanism

Answer 3

The acceptance of an unknown future potential risk by an insurer for an agreed premium

Question 4

What might risk refer to in an insurance marketplace? (3 things)

Answer 4

1. Peril being insured (fire or collision)
2. Subject matter (factory, ship etc)
3. The thing insured (property itself and the range of contingencies)

Question 5

What does risk-averse mean?

Answer 5

Feeling happier to minimise the risk to which they are exposed

Question 6

What does risk-seeking mean?

Answer 6

A willingness to carry certain risks.

Question 7

Why is risk management important?

Answer 7

1. It reduces the potential for loss.
2. It gives confidence to shareholders of proper business management.
3. It is a disciplined approach to quantifying risk.

Question 8

What are the 3 steps in the risk management process?

Answer 8

1. Identification
2. Analysis
3. Control

Question 9

What are two aspects of risk control?

Answer 9

1. Physical controls - risk mitigation
2. Financial controls - contract wording

Question 10

What are the 3 components of risk?

Answer 10

1. Uncertainty - implied doubt about the future
2. Level of risk - frequency and severity
3. Peril or hazard -

Question 11

Define ‘peril’

Answer 11

That which gives rise to a loss e.g. fire or flood

Question 12

Define ‘hazard’

Answer 12

That which influences the operation or effect of the peril

Question 13

What is the difference between a physical and moral hazard?

Answer 13

A physical hazard related to the physical characteristics of the risk.

A moral hazard arises from the attitude and behaviour of people e.g. carelessness, dishonesty.

Question 14

What is the difference between a financial and non-financial risk?

Answer 14

A non-financial risk cannot be accurately measured in financial terms.

For a risk to be insurable, the outcome of adverse events must be capable of measurement in financial terms.

Question 15

What is the difference between a compensatory and benefits policy?

Answer 15

A compensatory policy means the value placed on the loss is not determined in advance. A benefits policy is determined in advance (e.g. fixed payout for loss of sight)

Question 16

What are speculative risks?

Answer 16

Risks where we speculate to make some kind of gain e.g. lottery / stock market investment. These risks cannot be insured.

Question 17

What are pure risks?

Answer 17

Those with possibility of a loss but not of a gain. The best we can achieve is break even.

e.g. travelling in an aircraft. These risks are insurable.

Question 18

What are fundamental risks?

Answer 18

Risks that occur on such a vast scale as to be uninsurable e.g. famine or recession.

Fundamental risks can be defined as those that arise from social, economic, political or
natural causes and are widespread in their effect.

Question 19

What are particular risks?

Answer 19

Localised or even personal in their cause and effect. Cause may be widespread (e.g. storm) but effect can be local (e.g. property damage).

Question 20

What are the features of insurable risks?

Answer 20

1. Financial
2. Pure
3. (Generally) particular
4. A fortuitous event
5. Insurable interest
6. Risk itself must not be against public policy
7. Risk must generally not be a one-off

Question 21

What is a fortuitous event?

Answer 21

It must be
accidental or unexpected and not inevitable, for the insured.

Question 22

What is an insurable interest?

Answer 22

Insurable interest is the legally recognised financial relationship between the insured and the
object or liability that is being insured.

Question 23

What does the term homogeneous exposures mean?

Answer 23

The risks are similar to those seen before.

Question 24

What does the term risk pooling mean?

Answer 24

The losses of the few who suffer misfortune are met by the contributions of the many, who are exposed to similar potential loss.

Question 25

What is meant by the term equitable premiums?

Answer 25

A pool is set up for each main group of risks being underwritten. Each insured wishing to join a pool must be prepared to make an equitable contribution to that pool proportionate to the risk which they introduce to the pool.

Question 26

What are the primary functions of insurance?

Answer 26

1. Spreading the risk.
2. Providing a degree of certainty.
3. Transferring risk.

Question 27

What are the secondary functions of insurance?

Answer 27

1. Capital liquidity (not having to reserve cash stocks)
2. Business confidence.
3. Protected jobs.
4. Risk management.
5. Fund investment.
6. Invisible exports

Question 28

Why is insurance sometimes compulsory?

Answer 28

1. To provide funds for compensation
2. in response to national concern
3. Professional reputation