102-1 Principles of Ins. & Ins. Needs Analysis Flashcards
Risk
A condition in which there is a possibility of an adverse result from the expected desired outcome
Peril
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
Hazard
A condition increasing the probability that a peril will, in fact, occur
3 categories for hazards
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
Deductible
The stated amount of money the insured is required to pay on a loss before the insurer will make any payments under the policy
Riders
And Endorsements
Written additions to an insurance contract that modify the original provisions
Allow policyholders to customize an insurance contract to their needs
Law of Large Numbers
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
Adverse Selection
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
Self-insurance
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
Static Risks
Result from factors other than changes in the economy
Tend to incur with regularity and can be insured
Examples: earthquakes, floods
Dynamic risks
Result of changes in the economy such as changes in the business cycle or inflation
Insurance does not typically cover dynamic risks
Fundamental risks
Affect a large group of people
Examples: recessions, earthquakes
Particular risks
Affect individuals or small groups of people
Pure risk
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
Speculative risk
Involves both the chance of loss and the chance of gain
Example: gambling
Not insurable
4 elements of an insurable risk
- Must be a large and similar sample of individuals or events
- Must be measurable, definite
- Must be accidental and not intentional
- Cannot be catastrophic to society
Insurable interest
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
5 methods of managing risk
- Risk avoidance
- Risk diversification
- Risk reduction
- Risk retention
- Risk transfer
Indemnity
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
Adhesion
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
Unilateral Contracts
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
Aleatory contracts
Means that the outcome is affected by chance and that the dollars collected by the parties are usually unequal
Contracts of utmost good faith
Full disclosure on the part of the proposed insured is required
Right of subrogation
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
Collateral Source Rule
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
5 required elements to make an insurance contract legally enforceable
- Offer and acceptance
- Consideration (exchange of value)
- Legal object
- Legal capacity
- Legal form
Voidable contract
Means that for reasons deemed satisfactory by a court, the contract can be set aside by one of the parties
Tort
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
Negligence
When someone fails to act in a reasonably prudent manner and causes harm to someone
(An unintentional tort)
Vicarious Liability
When a person is liable for the torts committed by someone else
Defenses to Negligence
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
Strict Liability
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”
Types of Damages
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
Agents vs Brokers
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
3 types of Agent Authority
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
National Association of Insurance Commissioners (NAIC)
Created by state commissioners
Exchange info and ideas and coordinate regulatory activities
Makes recommendations for legislation and policy
Warranty
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
Representations
Statements made by the proposed insured to the insurer in the application process
Concealment
Occurs when the insured is silent about a fact that is material to the risk
3 ways to value losses for property insurance
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
2 major types of insurance companies
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
Rating Services and their ranges for instance products
A.M. Best: A++ through D
Standard & Poor’s: AAA through D
Moody’s: Aaa through C
Fitch: AAA through D
Social Insurance
Mandatory insurance administered by the government with benefits mandated by law
Examples: social security, Medicare, Medicaid, worker’s compensation
Public Insurance
Designed to enhance public trust in financial institutions
Examples: FDIC, PBGC, SIPC
Private Insurance
Insurance marketed by private insurance companies
Includes: disability, health, long-term care insurance, property insurance, liability insurance, life insurance
3 methods for life insurance needs analysis
- 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 - Human life value method
- uses an individual’s income-earning ability as the basis for determining the required amount of life insurance - 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
Conditional
An insurance policy is conditional in that the insurer is obligated to compensate the insured only if certain conditions are met
McCarran-Ferguson Act of 1945
Gave states the authority to regulate the insurance industry
Required for a loss to be insurable
- 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
Classic risk management model
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
