Assignment 2

Question 1

Means uncertainty with respect to possible losses. It refers to the inability to determine with definiteness (certainty) the actual number and value of the claims that a benefit plan will have to meet

Answer 1

Risk

Question 2

basically is the cause of a loss. Such things as fires, floods, theft, illness and death

Answer 2

Peril

Question 3

a condition that increases the probability that a peril will occur or tends to increase the severity of the loss when a peril occurs

Answer 3

Hazard

Question 4

a physical condition, such as defective wiring in a building or the absence of fire-extinguishing equipment, that increases the chances of loss.

Answer 4

physical hazard

Question 5

exists when dishonesty or other character defects in an individual increase the chances of loss. A classic example is arson

Answer 5

moral hazard

Question 6

consists of carelessness or indifference that individuals have because they are covered by insurance and thereby protected against loss ie. employees or medical providers scheduling unneeded medical tests or medications

Answer 6

Morale hazard

Question 7

involve situations where only two alternatives are possible —either the risk will not happen (no financial loss), or it will happen and a financial loss takes place. Also, many employee benefit coverages fall into this classification.

Answer 7

Pure risks

Question 8

involve situations where a possibility that does not exist in a pure risk is present, namely, the possibility of a gain. Thus, they have have three potential outcomes:

(1) a loss,
(2) no loss
(3) a gain.

Some examples are the purchase of a share of common stock, acquiring a new business venture or gambling.

Answer 8

Speculative risks

Question 9

From an employee benefit perspective, what is the most important type of pure risk to cover?

Answer 9

The most important classification of pure risk from an employee benefit standpoint is personal risk. Personal risks are losses that directly impact an individual’s life or health.

Question 10

involve losses resulting from the negligent or wrongful actions of individuals that result in injuries or losses to others. They stem from lawsuits by the injured people seeking damages from negligent parties

Answer 10

legal liability risks

Question 11

Briefly summarize the methods that can be used for handling risk.

Answer 11

(a) Avoidance.
(b) Control.
(c) Retention.
(d) Transfer.
(e) Insurance.

Question 12

a mechanism in which the insured (employer/employee) pays money (premiums) into a fund (insurance company). Upon the occurrence of a loss, reimbursement is provided to the person suffering the loss. Thus, the risk has been reduced or eliminated; and all the individuals who paid into the fund share the resulting loss.

Answer 12

Insurance

Question 13

The fact that insurance is used to make the victims of losses whole reflects the principle of ________ on which insurance is structured. An insured is _______ if a covered loss occurs. That is, he or she is placed in somewhat the same situation that existed prior to the loss, for example, reimbursement for damaged property, medical bills, disability income and the like.

Answer 13

Indemnification

Question 14

Which risk-handling alternative is the only one that is mutually exclusive of the others? Why?

Answer 14

Avoidance. When you avoid a risk, you have no losses, so there is no need for other risk handling techniques.

Question 15

Advantages of using insurance to fund an employee benefit plan are:

Answer 15

(a) Known premium
(b) Outside administration
(c) Financial backing.
(d) Cost management
(e) Economy.

Question 16

Insurance is not always the preferred method of funding employee benefit plans. Some disadvantages in using insurance to fund a plan are:

Answer 16

(a) Possible additional costs

(b) Employee satisfaction

Question 17

the greater the number of exposures, the more closely the actual results will approach the probable results that are expected from an infinite number of exposures.

Answer 17

The law of large numbers

Question 18

exists when individuals who have higher-than-average risks join a group or comprise a larger percentage of a group than anticipated, because of the availability of insurance or other benefits. In that case, they are said to “select against” the insurer

Answer 18

concept of adverse selection.

Question 19

How does the group insurance underwriting technique used in employee benefit plans allow the problem of adverse selection to be dealt with differently from the way it is handled under individual insurance?

Answer 19

Group insurance is based on the group as a unit and, typically, individual insurance eligibility requirements are not used for the group insurance underwriting used in employee benefit plans. As an alternative, the group technique itself is used to control the problem of adverse selection

Question 20

Characteristics of the group technique

Answer 20

(a) Only certain groups are eligible. A group should not be formed solely for the purpose of obtaining insurance. The purpose of obtaining insurance should be incidental to the formation of the group.
(b) There should be a steady flow of lives through the group. Younger individuals should come into the group as older individuals leave it to maintain a fairly constant mortality or morbidity ratio in the group.
(c) There should be a minimum number of persons in the group. This is meant to prevent unhealthy individuals from being a major part of the group and to spread the expenses of the benefit plan over a larger number of individuals.
(d) A minimum portion of the group must participate. The rationale for this provision, too, is to reduce the possibility of adverse selection and to spread the expense of administration of the plan.
(e) Frequently, eligibility requirements are imposed under group plans for the purpose, once again, of preventing adverse selection.
(f) Maximum limits on the amount of benefits may be imposed to prevent the possibility of an excessive amount of coverage on any particular unhealthy individual.
(g) To prevent unhealthy lives in a group from obtaining an extremely large amount of a particular benefit, there is automatic determination of benefits whereby coverage is determined for all individuals in the group on an automatic basis.

Question 21

Means that an organization retains the risks as opposed to an insurance company taking on the risks in return for a premium. The key characteristic of an ideally insurable risk that must be present is that the organization be big enough to permit the combination of a sufficiently large number of exposure units to make losses predictable. That is, the program must be based on the operation of the law of large numbers.

Answer 21

Self-funding or self-insurance