102-1 Principles of Ins. & Ins. Needs Analysis

Question 1

Risk

Answer 1

A condition in which there is a possibility of an adverse result from the expected desired outcome

Question 2

Peril

Answer 2

The cause of a financial loss, and in the insurance world, is the actual event for which an individual purchases insurance

E.g. a fire destroying an individual’s home

Question 3

Hazard

Answer 3

A condition increasing the probability that a peril will, in fact, occur

Question 4

3 categories for hazards

Answer 4

Physical hazard: e.g. leaving oily rags near a furnace

Moral hazard: dishonesty of an employee who embezzles funds from employer

Morale hazard: (I.e. indifference) leaving car running when you go into the store knowing that it’s insured if it’s stolen

Question 5

Deductible

Answer 5

The stated amount of money the insured is required to pay on a loss before the insurer will make any payments under the policy

Question 6

Riders

And Endorsements

Answer 6

Written additions to an insurance contract that modify the original provisions

Allow policyholders to customize an insurance contract to their needs

Question 7

Law of Large Numbers

Answer 7

This theory asserts that the larger the # of members in a group, the greater the probability that the actual loss experience will equal the expected loss experience

Question 8

Adverse Selection

Answer 8

Broadly illustrated by the fact that people with the highest risk of loss will also be the most likely to purchase insurance, thereby causing the insurer the greatest cost in terms of claims

Question 9

Self-insurance

Answer 9

Involves insuring individuals or entities by setting aside money to cover potential future losses rather than purchasing insurance, as may be the case with health insurance

Question 10

Static Risks

Answer 10

Result from factors other than changes in the economy

Tend to incur with regularity and can be insured

Examples: earthquakes, floods

Question 11

Dynamic risks

Answer 11

Result of changes in the economy such as changes in the business cycle or inflation

Insurance does not typically cover dynamic risks

Question 12

Fundamental risks

Answer 12

Affect a large group of people

Examples: recessions, earthquakes

Question 13

Particular risks

Answer 13

Affect individuals or small groups of people

Question 14

Pure risk

Answer 14

Involves only the chance of loss or no loss
No chance of gain

Example: the possibility that a person’s home will burn

Pure risks are insurable

Question 15

Speculative risk

Answer 15

Involves both the chance of loss and the chance of gain

Example: gambling

Not insurable

Question 16

4 elements of an insurable risk

Answer 16

1. Must be a large and similar sample of individuals or events
2. Must be measurable, definite
3. Must be accidental and not intentional
4. Cannot be catastrophic to society

Question 17

Insurable interest

Answer 17

Means there must be a relationship in which the person applying for the insurance will incur a loss (financial and/or emotional) from the destruction, damage, or death of the insured subject

For property and casualty insurance, an insurable interest must exist both when the policy is written and when loss occurs

For life insurance, insurable interest only needs to exist when the policy is written

Question 18

5 methods of managing risk

Answer 18

1. Risk avoidance
2. Risk diversification
3. Risk reduction
4. Risk retention
5. Risk transfer

Question 19

Indemnity

Answer 19

The policy owner will be reimbursed by the insurer only up to the actual loss and cannot profit

2 purposes:

• prevent the insured from profiting from insurance claims
• reduce moral hazards

Question 20

Adhesion

Answer 20

The policy owner can only accept or reject the contract and cannot modify its terms

Because of this characteristic of insurance contracts, if a provision in a policy is disputed in court, the policyowner will get the benefit of the doubt regarding any ambiguity in its terms

Question 21

Unilateral Contracts

Answer 21

Means that only the insurance company legally promised to perform and that there is no legally enforceable promise to pay the premiums to the policyowner

Question 22

Aleatory contracts

Answer 22

Means that the outcome is affected by chance and that the dollars collected by the parties are usually unequal

Question 23

Contracts of utmost good faith

Answer 23

Full disclosure on the part of the proposed insured is required

Question 24

Right of subrogation

Answer 24

Means that the policyowner is required to assign the right of recovery against a third party to the insurance company if the company pays for a loss caused by the third party

Question 25

Collateral Source Rule

Answer 25

This rule holds that damages against a negligent patty should not be reduced simply because the injured party has insurance protecting against the specific peril

Question 26

5 required elements to make an insurance contract legally enforceable

Answer 26

1. Offer and acceptance
2. Consideration (exchange of value)
3. Legal object
4. Legal capacity
5. Legal form

Question 27

Voidable contract

Answer 27

Means that for reasons deemed satisfactory by a court, the contract can be set aside by one of the parties

Question 28

Tort

Answer 28

A private wrong.

A tort occurs when a person infringes on the rights of another person in a way that gives the injured person the right to sue for damages

Classified as intentional or unintentional

Question 29

Negligence

Answer 29

When someone fails to act in a reasonably prudent manner and causes harm to someone

(An unintentional tort)

Question 30

Vicarious Liability

Answer 30

When a person is liable for the torts committed by someone else

Question 31

Defenses to Negligence

Answer 31

Assumption of risk
-example: fan hit by baseball at game, fan understood risk

Contributory negligence
-example: person cannot recover damages if he was in any way responsible for the accident

Comparative negligence
-example: if person was responsible for 50% of the accident, he could recover up to 50% of damages

Question 32

Strict Liability

Answer 32

Holds tortfeasors- a party who commits a tort- liable for damages sustained by their actions or from their products, whether or not they were deemed “at fault”

Question 33

Types of Damages

Answer 33

Special damages: designed to compensate the injured person for measurable losses, such as doctor bills and automobile repairs

General damages: compensate the injured person for intangible losses, such as pain and suffering, that cannot be measured in dollars and cents

Punitive damages: typically imposed when the wrongdoer acted intentionally or in a way that recklessly disregarded the rights of others

Question 34

Agents vs Brokers

Answer 34

Agents: Represent a specific company and act on behalf of the insurance company (I.e., the principal)

Brokers: must submit the application to the insurance company for approval before the insurance is bound

Question 35

3 types of Agent Authority

Answer 35

1) Express Authority: typically spelled out in writing and is contained in the agency agreement or contract
2) Implied Authority: Authority the insurance company does not expressly give to agents but that agents in similar circumstances normally possess
3) Apparent Authority: e.g. an agent who has the insurer’s logo on one’s stationery and on the office’s signage has the apparent authority to represent that insurer to the public

Question 36

National Association of Insurance Commissioners (NAIC)

Answer 36

Created by state commissioners

Exchange info and ideas and coordinate regulatory activities

Makes recommendations for legislation and policy

Question 37

Warranty

Answer 37

Merely a promise made by the insured to the insurer that is part of the insurance contract and, as such, must be adhered to be the insured

Question 38

Representations

Answer 38

Statements made by the proposed insured to the insurer in the application process

Question 39

Concealment

Answer 39

Occurs when the insured is silent about a fact that is material to the risk

Question 40

3 ways to value losses for property insurance

Answer 40

1) Replacement Cost: the current cost of replacing property with new materials of kind and quality
2) Actual cash value (ACV): equal to replacement cost minus functional depreciation
3) Agreed-upon value: used at times because valuing certain losses is so difficult, amounts paid for a loss are agreed upon by the insurer and the insured at the time a policy is issued

Question 41

2 major types of insurance companies

Answer 41

1) mutual companies: owned by their policyholders and offer participating policies that share in the profits of the company through the payment of policy dividends
2) stock companies: owned by the stockholders and usually offer nonparticipating policies

Question 42

Rating Services and their ranges for instance products

Answer 42

A.M. Best: A++ through D

Standard & Poor’s: AAA through D

Moody’s: Aaa through C

Fitch: AAA through D

Question 43

Social Insurance

Answer 43

Mandatory insurance administered by the government with benefits mandated by law

Examples: social security, Medicare, Medicaid, worker’s compensation

Question 44

Public Insurance

Answer 44

Designed to enhance public trust in financial institutions

Examples: FDIC, PBGC, SIPC

Question 45

Private Insurance

Answer 45

Insurance marketed by private insurance companies

Includes: disability, health, long-term care insurance, property insurance, liability insurance, life insurance

Question 46

3 methods for life insurance needs analysis

Answer 46

1. Capital retention method
   - method of determining the amount of life insurance needed which uses the interest of earnings only to furnish the continued support of the family
2. Human life value method
   - uses an individual’s income-earning ability as the basis for determining the required amount of life insurance
3. Financial needs or insurance needs analysis method
   - aka insurance needs method
   - analyzes all recurring expenses of the dependent survivors and any unusual expenses that may result from the death of the insured
   - then compares these needs with the existing assets that would be available at the death of the insured and then funds the difference

Question 47

Conditional

Answer 47

An insurance policy is conditional in that the insurer is obligated to compensate the insured only if certain conditions are met

Question 48

McCarran-Ferguson Act of 1945

Answer 48

Gave states the authority to regulate the insurance industry

Question 49

Required for a loss to be insurable

Answer 49

• accidental, not intentional
• measurable
• noncatastrophic to society
• must be a sufficiently large and similar sample of individuals or events to make the loss reasonably certain

Question 50

Classic risk management model

Answer 50

High probability, high severity: avoid the risk

High probability, low severity: reduce the risk

Low probability, high severity: transfer the risk

Low probability, low severity: retain the risk