Changing Scope of Risk Management

Question 1

Insurance offers several advantages in handling risk:

Answer 1

 Greater Predictability of Actual Losses (LOLN)
 Transfer of Risk
 Specialized Approach to Analyzing, Assessing and Handling Risk - insurance companies are specialists.

Question 2

Basic Characteristics of Insurance - 4 Basic Characteristics

Answer 2

1. Pooling of losses - spreading of losses over many exposures.
2. Payment of fortuitous losses - losses that are unforeseen and unexpected
3. Risk transfer - to have insurance you need to have a transfer of risks
4. Indemnification – financial reinstitution.

Question 3

Underwriter

Answer 3

any entity that is responsible for evaluating and assuming another entity’s risk, for a fee such as a commission, premium, spread or interest.

Question 4

General Requirements of an Insurable Risk

Answer 4

1. Large number of exposure units
2. Accidental and unintentional loss
3. Determinable and measurable loss
4. No catastrophe loss
5. Calculable chance of loss (frequency & loss severity)
6. Economically feasible premium

Question 5

Adverse Selection and Insurance

Answer 5

Adverse selection refers to a situation where sellers have information that buyers do not, or vice versa, about some aspect of product quality. In the case of insurance, adverse selection is the tendency of those in dangerous jobs or high-risk lifestyles to get life insurance.

Question 6

Law of large numbers use

Answer 6

A risk manager (or insurance executive) uses the law of large numbers to estimate future outcomes for planning purposes. The larger the sample size, the lower the relative risk, everything else being equal. The pooling of many exposures gives the insurer a better prediction of future losses. The insurer still has some risk or variability around the average. Nevertheless, the risk of an insurer with more exposures is relatively lower than that of an insurer with fewer exposures under the same expected distribution of losses

Question 7

Catastrophic loss

Answer 7

A catastrophic loss to an insurer is one that could imperil the insurer’s solvency. When an insurer assumes a group of risks, it expects the group as a whole to experience some losses—but only a small percentage of the group members to suffer loss at any one time. Given this assumption, a relatively small contribution by each member of the group will be sufficient to pay for all losses.