Ch. 1-3 quiz

Question 1

Objective risk

Answer 1

(also called degree of risk) is defined as the relative variation of actual loss from expected loss
Ex: assume that a property insurer has 10,000 homes insured in Los Angeles and 10,000 homes insured in Philadelphia, and that the chance of a fire in each city is 1 percent. Thus, on average, 100 homes should burn annually in each city. However, if the annual variation in losses ranges from 75 to 125 in Philadelphia, but only from 90 to 110 in Los Angeles, objective risk is greater in Philadelphia even though the chance of loss in both cities is the same

Question 2

Subjective risk

Answer 2

is defined as uncertainty based on a person’s mental condition or state of mind

Question 3

Peril

Answer 3

Cause of loss

Question 4

Physical hazard

Answer 4

is a physical condition that increases the frequency or severity of loss. Ex: Examples of physical hazards include icy roads that increase the chance of an auto accident, defective wiring in a building that increases the chance of fire, and a defective lock on a door that increases the chance of theft.

Question 5

Moral hazard

Answer 5

is dishonesty or character defects in an individual that increase the frequency or severity of loss. Ex: Examples of moral hazard in insurance include faking an accident to collect benefits from an insurer, submitting a fraudulent claim, inflating the amount of a claim, and intentionally burning unsold merchandise that is insured. Murdering the insured to collect the life insurance proceeds is another important example of moral hazard.

Question 6

Attitudinal hazard

Answer 6

is carelessness or indifference to a loss, which increases the frequency or severity of a loss. Ex: Examples of attitudinal hazard include leaving car keys in an unlocked car, which increases the chance of theft; leaving a door unlocked, which allows a burglar to enter; and changing lanes suddenly on a congested expressway without signaling, which increases the chance of an accident. Careless acts like these increase the frequency and severity of loss.

Question 7

Legal hazard

Answer 7

refers to characteristics of the legal system or regulatory environment that increase the frequency or severity of losses. Ex: Examples include adverse jury verdicts or large damage awards in liability lawsuits; statutes that require insurers to include coverage for certain benefits in health insurance plans, such as coverage for alcoholism; and regulatory action by state insurance departments that prevents insurers from withdrawing from a state because of poor underwriting results.

Question 8

Pure risk

Answer 8

No gain, only loss possible

Question 9

Speculative risk

Answer 9

Potential for both gain and loss. ex:L stpck market

Question 10

Diversifiable risk

Answer 10

A risk that only affects individuals or a small group, not the entire economy. ex: a broad stock portfolio, CD’s there is less risk to a property and liability insurer if different lines of insurance are underwritten rather than only one line. Losses on one line can be offset by profits on other lines

Question 11

Non-diversifiable risk

Answer 11

Risk that affects the entire economy Ex: Cyclical unemployment, war, floods, rapid inflation

Question 12

Strategic risk

Answer 12

refers to uncertainty regarding the firm’s financial goals and objectives; for example, if a firm enters a new line of business, the line may be unprofitable.

Question 13

Operational risk

Answer 13

results from the firm’s business operations. For example, a bank that offers online banking services may incur losses if “hackers” break into the bank’s computer

Question 14

Systemic risk

Answer 14

is the risk of collapse of an entire system or entire market due to the failure of a single entity or group of entities that can result in the breakdown of the entire financial system.

Question 15

Human life value

Answer 15

present value of the family’s share of the deceased breadwinner’s future earnings.

Question 16

Property risk

Answer 16

the risk of having property damaged or destroyed from numerous causes.

Question 17

Direct loss

Answer 17

financial loss that results from the physical damage, destruction, or theft of the property. For example, if you own a home that is damaged or destroyed by a fire, the physical damage to the home is a direct loss.

Question 18

Indirect loss

Answer 18

financial loss that results indirectly from the occurrence of a direct physical damage or theft loss. For example, as a result of the fire to your home, you may incur additional living expenses to maintain your normal standard of living. You may have to get a motel room or rent an apartment while the home is being repaired. You may have to eat some or all of your meals at local restaurants. You may also lose rental income if a room is rented and the house is not habitable. These additional expenses that resulted from the fire would be a consequential loss.

Question 19

Risk control

Answer 19

refers to techniques that reduce the frequency or severity of losses.

Question 20

Risk financing

Answer 20

refers to techniques that provide for the funding of losses.

Question 21

Reinsurance

Answer 21

an arrangement by which the primary insurer that initially writes the insurance transfers to another insurer part or all of the potential losses associated with such insurance

Question 22

Adverse selection

Answer 22

tendency of persons with a higher-than-average chance of loss to seek insurance at standard (average) rates, which, if not controlled by underwriting and policy provisions, results in higher-than-expected loss levels and unprofitable business.

Question 23

Underwriting

Answer 23

refers to the process of selecting and classifying applicants for insurance.

Question 24

Expense loading

Answer 24

amount needed to pay all expenses, including underwriting and loss-adjustment expenses, commissions, general administrative expenses, state premium taxes, acquisition expenses, and an allowance for contingencies and profit.

Question 25

Risk management

Answer 25

a process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating the loss exposures.