Chapter 1: Basic Insurance Concepts and Principles Flashcards
Basic Insurance Concepts and Principles
What is ISO?
Insurance Services Office: One of its many functions is to create standardized property and casualty insurance policies that are then approved by the individual states and used as a standard policy form for insurers. The basic ISO policy forms are modified to comply with each state’s regulations, and may be modified to a degree by each insurance company to create its own policy form.
What kind of producers/agents are you testing to be?
A personal Line producer
What insurance products can be transacted by being a Personal Lines agent/producer?
- automobile insurance
- residential property insurance
- earthquake
- flood insurance
- personal watercraft insurance
- umbrella or excess liability insurance providing coverage when written over one or more underlying automobile or residential property insurance policies
What is Insurance?
Insurance is a transfer of risk of loss an individual or a business entity to an insurance company, which in turn, spreads the costs of unexpected losses to many individuals. If there were no insurance mechanism, the cost of a loss would have to be borne solely by the individual who suffered the loss.
What is Insurance as defined in Cal. Ins. Code Section 22?
Insurance is a contract whereby one undertakes to indemnify another against loss, damage, or liability arising from a contingent or unknown event.
Agent/ Producer
A legal representative of an insurance company; classification of producer usually includes agents and brokers; agents are the agents of the insurer.
Applicant or proposed insured
A person applying for insurance.
Beneficiary
A person who receives the benefits of an insurance policy.
Broker
An insurance producer not appointed by an insurer and is deemed to represent the client.
Indemnity
Main principle of insurance, meaning that the insured cannot recover more than their loss; the purpose of insurance is to restore the insured to the same position as before the loss.
Insurance Policy
A contract between a policy owner and/or insured and an insurance company which agrees to pay the insured or the beneficiary for loss caused by specific events.
Insured
The person covered by the insurance policy. The person may or may not be the policy owner.
Insurer (principal)
The company who issues an insurance policy.
Law of Large numbers
The larger the number of people with a similar exposure to loss, the more predictable actual losses will be.
Policyowner
The person entitles to exercise the rights and privileges in the policy.
Premium
The money paid to the insurance company for the insurance policy.
Reciprocity/Reciprocal
A mutual interchange of rights and privileges.
Risk
The uncertainty or chance of a loss occurring. There are 2 type of risk: Pure and Speculative - only one is insurable.
Pure Risk
Refers to situations that can only result in a loss or no change. There is no opportunity for financial gain. Pure Risk is the only type of Risk that Insurance Companies are willing to accept
Speculative Risk
Involves the opportunity for either loss or gain. Ex: Gambling
Peril
Perils are the causes of loss insured against in an insurance policy. Example: Fire, Hail, Windstorm, earthquake… whatever the cause may be of the loss…
Hazards
Conditions or situation that increase the probability of an insured loss from occurring. Conditions such as slippery floors, or congested traffic are hazards and may increase the chance of a loss occurring.
Physical Hazard
Those arising from the material, structural or operational features of the risk, apart from the persons owning or managing it.
Moral Hazard
Refers to those applicants that may lie on an application for insurance, or in the past, have submitted to fraudulent claims against an insurer.
Morale Hazard
Refers to an increase in the hazard presented by a risk, arising from the insured’s indifference to loss because of the existence of insurance. (Eg. I’m not going to bother fixing this. If it breaks my insurance will pay to replace it.)
Legal Hazard
Describes a set of legal or regulatory conditions that affect an insurer’s ability to collect premiums that are commensurate with (equal in value) the exposure to loss that the insurer must bear. Example: a court notice about a property, dispute of an insured person or some other similar legal matter which could result in loss for the insured and for which insurance company may have to pay
Law of Large Numbers
The law of large numbers states that the larger the number of people with a similar exposure to loss, the more predictable actual losses will be. This law forms the basis for statistical prediction of loss upon which insurance rates are calculated.
Exposure
A unit of measurement used to determine the rates charged for insurance coverage.
Loss Exposure in Property Insurance
Loss exposure is based on the location of the property, type of construction (frame, masonry, or noncombustible, etc.), occupancy, adjacent structures, and fire protection class, etc.
Loss Exposure in General Casualty
Loss exposure is based upon area, payroll, gross receipts, and the insured’s risk and location.
Loss Exposure in Automobile Liability
Loss exposure factors include driver’s age, territory of garage, etc.
Loss Exposure
Loss potential which are the basis for setting rates. Again, the
Loss in Property Insurance
The amount of reduction in value of an insured property, caused by a peril insured against.
Loss in Casualty Insurance
The amount paid to a third party on behalf of an insured who was legally obligated to pay.
Loss in insurer operations
The basis of a claim for indemnification or damages against an insurance policy.
Name the Risk Management Techniques
Sharing (reciprocal insurance) , Transfer (Insurance policy), Avoidance (never doing anything ever to avoid risk), Retention (Deductibles, co-payments, self insurance) and Reduction (preventing… installing smoke detectors, puts an alarm system in your house)
Definition of Self Insurance
When the insured accepts the responsibility for the loss before the insurance company pays.
Insurable risk- Requisites/ characteristics or elements must be present before a pure risk can be insured:
Chance, definite (time, place, amount and cause) and measurable, predictable, not catastrophic (war), must be large (law of large #s), must not be mandatory (liberty of insurer to say no to an applicant)
What is an Insurable Event according to the CIC (California insurance code) section 250
Any contingent or unknown event, whether past or future, which may damnify a person having an insurable interest, or create a liability against him, may be insured against.
Insurable Interest
The financial interest in property to be insured. In property and casualty insurance, insurable interest must exist at the time of loss.
3 requirements to prove insurable interest
Legitimate financial interest in preserving the property to be insured, there must be no potential for gain, there must be a potential for loss.
What is Underwriting
The process of reviewing applications for insurance and the information on the application. In other words, it’s a risk selection process.
What is Loss Ratio
A formula used by insurance companies to compare premium income to losses, including claims paid and claim-related expenses. (Incurred losses + Loss adjusting expense) / Earned premium = Loss Ratio
What is Adverse Selection
the insuring of risks that are more prone to losses than the average risk. Poorer risks tend to seek insurance or file claims to a greater extent than better risks.
When does Spread of Risk/ Profitable Distribution of Exposure happen?
When poor risks are balanced with preferred risks, with “average” or “standard” risk in the middle.
Benefits and Costs of Insurance to Society
Reduction of uncertainty, Loss Control, Securing Credit, Reduction of Social Burden and Social Costs of Insurance.
What is the role of deductibles in insurance?
The dollar amount the insured will pay on a claim before the insurer (insurance policy) provides coverage. A higher deductible amount usually lowers the premium.
Definition of Reinsurance
A contract of reinsurance is one by which an insurer procures a third person to insure it against loss or liability by reason of such original insurance. A reinsurance contract is presumed to be for indemnity against liability, and not merely against damages.
Purposes of Insurers Obtaining Reinsurance
The purpose of reinsurance is to allow the insurer to avoid having to pay for large or catastrophic losses. In other words, reinsurance is the sharing or spreading of a risk between insurance companies, which is too large for one insurance company to accept. The risk or part of the risk is transferred to another insurance company called a reinsurer.
Fire Insurance California Ins. Code sections 101
Fire insurance covers losses in the following categories:
By fire, lightning, windstorm, tornado or earthquake;
Loss or destruction of, or damage to different types of property;
All-risk policies known as Personal Property Floater against any kind of loss of, or damage to any personal property other than merchandise.
Liability Insurance California Ins. Code sections 102
Liability insurance includes insurance against loss resulting from liability for injury, fatal or nonfatal, suffered by any natural person, or resulting from liability for damage to property, or property interests of others but does not include workers compensation, common carrier liability, boiler and machinery, or team and vehicle insurance.
Ocean Marine California Ins. Code sections 103
Ocean marine insurance is written on ships and conveyances and on goods, merchandise, and other personal property being imported into or exported out of a country by ocean. This insurance also covers the shipment’s transportation by land or water from point of origin to it final destination if any portion of the trip was on any ocean. Property is also covered while being prepared for and awaiting shipment, and during any delays, storage or reshipment.
Inland Marine California Ins. Code sections 104
Inland marine insurance covers loss to movable property or unusual risks transported on land or air. In personal lines, inland marine includes coverage for personal effects like jewelry, fine art, sports or musical equipment. Inland marine insurance includes hull insurance on pleasure watercraft not used for commercial purposes.
Automobile Insurance California Ins. Code sections 105
Automobile insurance includes insurance of automobile owners, users, dealers, or others having insurable interests against hazards incidental to ownership, maintenance, operation, and use of automobiles. Automobile insurance also includes any contract of warranty or guarantee that promises service, maintenance, parts replacement, repair, money, or any other indemnity in event of loss of or damage to a motor vehicle or any part from any cause.
Title Insurance California Ins. Code sections 106
Title insurance insures, guarantees and indemnifies (insures free and clear ownership of the property) owners of real and personal property or the holders of liens against loss or damage suffered by reason of any of the following:
Liens or encumbrances on, or defects in the title to said property;
Invalidity or unenforceability of any liens or encumbrances thereon; or
Incorrectness of searches relating to the title to real or personal property.
Surety Insurance California Ins. Code sections 107
Surety insurance includes the following types of coverage:
Guaranty of performance of contracts other than insurance policies;
Loss resulting from the forgery or alteration of any instrument or signature;
Protection against loss or destruction from any cause of evidence of debt, evidence of ownership of deeds, mortgages, bills of lading, etc.
Plate Glass Insurance California Ins. Code sections 108
Plate glass insurance protects against breakage of glass.
Worker Compensation Insurance California Ins. Code sections 109
Workers Compensation insurance includes insurance against loss from liability imposed by law upon employers to compensate employees and their dependents for injury sustained by the employees arising out of and in the course of the employment, irrespective of negligence or of the fault of either party.
Common carrier liability Insurance California Ins. Code sections 110
Common carrier liability insurance includes insurance against loss resulting from liability of a common carrier for accident or injury, fatal or nonfatal, to any person but does not include liability or Workers Compensation insurance.
Boiler and machinery Insurance California Ins. Code sections 111
Boiler and machinery insurance includes insurance against loss of property and liability for damage to persons or property from explosion of, or accident to, boilers, tanks, pipes, pressure vessels, engines, wheels, electrical machinery, or apparatus connected to or operating nearby.
Burglary Insurance California Ins. Code sections 112
Burglary insurance includes insurance against loss by burglary or theft or both, as well as against loss or destruction of, or damage to, any of the following property, resulting from any cause:
Moneys, stamps, coins, and bullion;
Securities, notes, drafts, and accounts;
Books, maps, manuscripts, indexes and other valuable papers; or
Documents and records incidental to the business or profession or activity in which the insured is engaged.
Excludes coverage of property listed above while in the custody of, or possession of, or being transported by, any carrier for hire or in the mail.
Credit insurance California Ins. Code sections 113
Credit insurance includes insurance of persons engaged in business against loss by reason of extending credit to those dealing with them, and insurance against loss from the failure of persons to meet existing or contemplated obligations to the insured.
Sprinkler insurance California Ins. Code sections 114
Sprinkler insurance includes insurance against loss through damage by water to goods or premises arising from the breakage or leakage of sprinklers, pumps, or other apparatus placed for extinguishing fires, or loss arising from the breakage or leakage of water pipes, or through accidental injury to such sprinklers, pumps, or other apparatus.
Team and vehicle insurance California Ins. Code sections 115
Team and vehicle insurance includes insurance against loss through damage or legal liability for damage, to property caused by the use of teams or vehicles other than ships, boats, or railroad rolling stock, whether by accident or collision or by explosion of engine, tank, boiler, pipe, or tire of the vehicle, and insurance against theft of the whole or part of such vehicle.
Mortgage insurance California Ins. Code sections 116
Mortgage insurance includes the guaranteeing of the payment of the principal, interest and other sums agreed to be paid under the terms of any note or bond secured by mortgage.
Mortgage guaranty insurance California Ins. Code sections 117
Mortgage guaranty insurance includes insurance against financial loss by reason of the nonpayment of principal, interest and other sums agreed to be paid under the terms of any note or bond or other evidence of indebtedness secured by a mortgage, deed of trust, or other instrument constituting a lien or charge on real estate.
Aircraft insurance California Ins. Code sections 118
Aircraft insurance includes insurance of aircraft owners, users, and dealers, against loss through hazards incidental to ownership, maintenance, operation and use of aircraft, other than against loss resulting from accident or physical injury, fatal or nonfatal, to any natural person.
Insolvency insurance California Ins. Code sections 119
Insolvency insurance includes insurance against loss arising from the failure of an insolvent insurer to discharge its obligations under its insurance policies.
Legal insurance California Ins. Code sections 120
Legal insurance includes the assumption of a contractual obligation to reimburse the insured against all or a portion of his fees, costs, and expenses related to or arising out of services performed by or under the supervision of an attorney who is an active member of the bar of any jurisdiction or jurisdictions of the United States, in which these legal services are performed.
Miscellaneous insurance California Ins. Code sections 121
Miscellaneous insurance includes the following:
Against loss from direct or indirect damage by lightning, windstorm, tornado, earthquake; or
An open policy indemnifying the producer of any motion picture, television, theatrical, sport, or similar production, event, or exhibition against loss by reason of the interruption, postponement, or cancellation of such production, event, or exhibition due to death, accidental injury, or sickness preventing performers, directors, or other principals from beginning or continuing their performances or duties; and
Any insurance not included in any of the classes which is a proper subject of insurance.
Profitable Distribution of Exposure
Balancing Poor Risks and preferred risks with average risks in the middle creates a profitable distribution of exposures.
