1.8 Risk Management

Question 1

Risk

Answer 1

A condition where the chance, likelihood, probability or potential for a loss exists.

Question 2

Management

Answer 2

The determination of what types of protection are required to meet an insured’s needs. Risk may be manageable, but it cannot be eliminated. A survey of the insured’s operations, health, and risk exposures that could give rise to losses, including the identification of hazardous conditions or situations that could be reduced or eliminated to prevent losses. In the producer needs to gather the necessary information for the applicant’s loss frequency and severity to be assessed. Physical inspections, applications, or medical exams used in underwriting may help to manage or raise awareness of risks. Health insurance providers may offer insureds “wellness” programs at low or not cost for weight loss, smoking reduction, stress, or medical conditions such as diabetes in order to reduce the company’s future claims exposure.

Question 3

Speculative Risk - (Types of Risk)

Answer 3

Situations where there is a chance for loss, gain, or neither loss or gain to occur. Examples of speculative risk include gambling, investing, or starting a new business. Speculative risk cannot be insured.

Question 4

Pure Risk - (Types of Risk)

Answer 4

Situations where there is no chance for gain; the only outcome is for nothing to occur or for a loss to occur. Pure risk is the only risk that can be insured.

Examples include the possibility of:

Damage to property caused by a fire or other natural disaster

Financial loss as a result of injury, illness, or death

Question 5

Loss

Answer 5

Reduction, decrease, or disappearance of value. A loss is the basis of a claim under the terms of an insurance policy.

Question 6

Peril

Answer 6

The cause or source of a loss, such as fire, windstorm, embezzlement, disease, death.

Question 7

Hazard

Answer 7

A specific condition that increases the probability, likelihood, or severity of a loss from a peril.

Question 8

Physical Hazard - (3 Types of Hazard)

Answer 8

A physical condition that increases the likelihood or probability of loss; may include the use, condition, or occupancy of property. Physical hazards may be seen, heard, felt, tasted, or smelled.

Example: Flammable material stored near a furnace.

Question 9

Moral Hazard - (3 Types of Hazard)

Answer 9

Dishonest tendencies that increase the probability of a loss; may include certain characteristics and behaviors of people. Moral hazards most closely related to some form of lying, cheating, or stealing.

Example: An insured burns down their own house to collect the insurance payout.

Question 10

Morale Hazard - (3 Types of Hazard)

Answer 10

An attitude of indifference toward the risk of loss that increases the probability of a loss occurring.

Example: Driving too fast for conditions, not wearing a seat belt, and ignoring stop signs at familiar intersections, smoking, failure to take medications that could control a medical condition are all morale hazards.

Question 11

Loss Exposure

Answer 11

The condition of being at risk of loss. Simply by existing, property and people are subject to many different risks. To an insurance company, each insured person or their covered property represents the risk of loss and the value of each potential claim is a known loss exposure.

Question 12

Adverse Selection

Answer 12

An imbalance created when risks that are hard to insure (more prone to losses than the average (standard) risk) are the only risks seeking insurance within a specific marketplace. For example, only those living in earthquake-prone areas seek to buy earthquake insurance or those in the poorest of health seeking to acquire life or health insurance. High risks exposures tend to seek or continue insurance at a higher participation rate than the average risk exposures do.

Question 13

Managing Risk

Answer 13

Analyzing exposures that create risk and designing programs to minimize the possibility of a loss.

Question 14

Ways of managing risk:

Answer 14

STARR

S - Sharing
T - Transfer
A - Avoidance
R - Reduction
R - Retention

Question 15

Sharing - (STARR)

Answer 15

Investments of a large number of people may be pooled by use of a corporation or partnership

Pooling or spreading the risk among a large number of persons or entities

Question 16

Transfer - (STARR)

Answer 16

Transferring the risk from one party to another, such as from a consumer to an insurance company

Transfer the uncertainty of loss via a contract

Question 17

Avoidance - (STARR)

Answer 17

Elimination of the risk

Avoid the activity that gives rise to the chance of loss

After potential areas of hazards have been identified, it may be found that some exposure to risk can be eliminated, but it is impossible to avoid all risk

A risk may be avoided by not accepting or entering into the event which has hazards. This method has severe limitations because such a choice is not always possible, or if possible, it may require giving up some important advantages.

Question 18

Reduction - (STARR)

Answer 18

Minimizing the chance of loss, but not preventing the risk. For example, sprinkler systems, burglar alarms, pollution controls and safety guards on machinery, or taking medications and having preventive medical care

Question 19

Retention - (STARR)

Answer 19

Assume the responsibility for loss

Self-insure the entire loss or a portion of the loss. Choosing deductibles is a method of risk retention.

It may be economically practical for an insured to not insure each exposure to loss and, instead insure only those risks that threaten financial stability or security

Question 20

Insurable Risks Must Include:

Answer 20

Large number of homogeneous units or groups with the same perils

Law of Large Numbers – As the number of units in a group increases, the more likely it is to predict a particular outcome

Auto insurance losses are the easiest type of insurance loss to predict precisely because the number of units insured is so great

The chance of loss must be calculable. A statistical expectation of loss is used by insurers to calculate premiums

The loss must be measurable (definite and verifiable in terms of amount, cause, place and time)

The premiums must be affordable

From the perspective of the insured, the loss must be accidental in nature

Catastrophic perils are not covered; examples include war, nuclear hazard and illegal operations