Chapter 1 - Core Principles of Insurance Flashcards
What is risk? (5 factors)
1.Possibility of unfortunate occurrence
2. Doubt concerning the outcome of a situation
3. Unpredictable
4. Possibility of Loss
5. Possibility of gain
What do all risks have in common?
Risks have an element of UNCERTAINTY
What is risk perception?
How people think about risks and assess them
What is the purpose of insurance?
Risk transfer - helps insured replace uncertainty of loss with an agreed premium
2 ways the term risk is used in the Insurance market
- The peril that is insured
- The liability that is insured
When an underwriter mentions risk, what do they mean?
Both the thing Insured& the contingencies/scope of cover required
Difference in Individual/Business attitude to risk
Individuals cannot evaluate with accuracy risks they are exposed to, whereas companies attempt to
Define Risk Management
Identification and treatment of a defined risk and is a continuous and developing process embedded in firms strategies. Addressing methodically risks surrounding firms past, present and future.
Why commercial risk is important? (3 ways)
Reduces losses by identifying and managing hazards
Increases shareholder confidence
Provides a disciplined approach to quantifying risk
What 3 things do you need to manage risk?
- Identify the risk
- Analyse the risk
- Control or transfer the risk
What is risk identification?
To discover the threat that may already exist, or potential threats which may exist in the future
What is risk analysis?
The examination of data to evaluate and analyse the risk through patterns.
What is the purpose of risk analysis?
Reduce risks and predict those in the future
Define risk control and a key question when controlling risk
Course of action to reduce or eliminate the risk.
Is the cost of elimination greater than the cost of the feared event occurring?
What are the 3 ways of controlling risk?
- Physical control (locks on doors)
- Financial control (transferring risk)
- Developing good risk culture (education on avoidance and reduction)
What are the 3 internal risk controls?
- Detective controls (detecting errors or irregularities)
- Corrective controls (correcting errors or irregularities which have been detected)
- Preventative controls (keeping errors from happening in the first place)
Why do surveys take place?
For Insurers to identify potential risks and make recommendations to policyholders in the attempt to reduce risk to acceptable standard
What is the fire protection association (FPA) an example of?
Insurers being involved in a researching area of loss and prevention looking through new methods of construction & new rules for constructing
What is an example of risks being mitigated and managed by Insurers? & what is its purpose?
MIATFR (Motor Insurance Anti-Fraud and Theft Register) formed by the ABI to combat fraudulent claims. Records all total losses arising from any cause and provides reference for new claims to see if any matches are made e.g. addresses/names
What is the ABI?
Association of British Insurers
What are the two main components of risk?
- Uncertainty
- Level of the risk
What is the relationship between frequency and severity?
Inverse relationship. High frequency, low severity and reverse
What is a peril?
Anything that exposes an individual to the possibility of risk or a potential loss e.g. fire
What is a hazard?
Conditions or situations which increase the chances of a loss arising from a peril
What are 4 examples of perils?
Explosion, lightening, collision, dishonesty
What is a physical hazard? Provide examples
Physical characteristic of a risk and includes a measurable dimension (increase the likelihood of a risk occurring) e.g.
Explain moral hazard?
Attitude & behaviour of people (often conduct of those Insured) e.g. employees or society as a while - carelessness, dishonesty
What are the 3 categories of risk?
- Financial or non-financial
- Pure or speculative
- Particular or fundamental
Needs to be financial, pure & particular to be Insured
What is a financial risk? Provide an example
Financial risk is measurable in financial terms. e.g. damage to a car & the cost of repair/replacement
What is a key exception for a risk to be insurable?
Benefit policies - Personal accident and sickness policies. Cannot value the precise loss of life so are taken out with pre-agreed amounts.
Explain a non-financial risk.
Risks which are not capable of financial measurement. Real risk arises from decision and actions motivated by other considerations. e.g the value of a family heirloom is beyond its intrinsic or market value
What is a pure risk? Provide two examples
Where there is a possibility of loss but not of gain, so the best outcome achieved is break-even.
1. Risk of natural event/accident
2. Risk of injury
Explain a speculative risk. Give an example
May involve 3 outcomes: loss, break-even or gain. There risks are NOT insured as they are undertaken voluntarily with hope of gain.
e.g. winning the lottery or investing in the stock market
What is a particular risk?
Is a localised risk which affects only individuals and are personal in their cause and effect.
What is an example of a particular risk?
A factory fire - cause localised damaged to the factory and possibly its surroundings but not affect the whole community
Define a fundamental risk.
Effects are widespread & the cause is outside of the control of one individual or group. Loss associated is often catastrophic
What is are 3 examples of a fundamental risk?
Economic recession, war, earthquake
Are earthquakes a particular risk or a fundamental risk?
Classified as a fundamental risk but can also be insured in areas that pose no great likelihood of loss. Yes in UK but no in Japan. Same with storm damage
What 3 features must be present for a risk to be insurable? Order is important
- Event must be fortuitous
- Must be Insurable interest
- Must not be against public policy
What is a fortuitous event?
An unexpected/unforeseen event
Explain insurable interest
A legally recognised financial relationship between the insured and the object or liability that is being insured.
Explain what ‘Not against public policy’ relates to
This is a feature of an insurable risk and shows that the risk must not go against what society considers to be right
Define a homogenous exposure.
Exposure to a large number of similar risks
What is homogenous risk used for?
For Insurers to determine the expected frequency and likely extent of losses.
Explain the Law of Large Numbers
Theory that determines that predictions become more accurate as the base of data used increases in size.
Why is homogenous exposure helpful when using the Law of Large Numbers
Without homogenous exposures, predicting a loss or level of loss is more difficult as patterns and trends are more difficult to determine. However, Insurers often are forced to do this to calculate premiums.
Provide a rough basic principle of insurance
The losses of the few are met by the contributions of the many.
Define a common pool
A pot of money, gathered together from people who want to be protected from similar types of perils, operated by an Insurer. Premiums go into the pool, payments to compensate the losses go out.
What 3 factors are imperative for a common pool?
- Premiums must be large enough to meet the losses is any year.
- Premiums must cover cost of operating the pool.
- Premiums must provide an element of profit
Explain the application of the Law of Large Numbers in Insurance
Law of Large Numbers enables the insurer to predict the final cost of claims in any one year confidently. Insurers predict the losses, so can charge a fixed premium to the Insurer. However, competition and business always want to grow
How do Insurers decide on equitable premiums?
Take into account the element of risk brough in to the pool by each policyholder. Referred to as discriminatory factors
Why is the correct assessment of risk important when determining premiums?
Ensure that a fair premium is charged by the Insurer, and a fair profit can be made.
Explain the EU Gender Directive
A law passed in 2011 by the CJEU (Court of Justice EU) ruling that Insurers can no longer use gender as a premium calculation tool.
What is the link between the EU gender directive in the UK?
Was transposed into UK law through the Equality Act 2010 (Amendment) Regulations 2012 - so applies in a post Brexit landscape.
What 5 areas of insurance were affected by the EU gender directive?
Motor, Life, Private Medical, Income Protection and Annuities.
What happens when a risk is offered to an Insurer but the amount of risk is greater than the Insurer’s retention limits for that category?
- Decline the offer for the risk
- Find a way of sharing the risk (co-insurance)
What is co-insurance & what are two ways it is used in the insurance market?
- Risk sharing between Insurers
- Risk sharing with the Insured.
Explain risk-sharing between Insurers
(Mainly London Market) = Insurers agree rating and terms & issue a collective policy together. Each Insurer receives a proportion of the premium and pays that same proportion if the loss occurs. While there is a ‘lead office’, each Insurer is separately liable to pay their proportion of the claim.
What is the positive/negative of risk sharing between Insurers in the London Market?
The system is entirely transparent for the policyholder, but is very time consuming
Explain when co-insurance in the context of risk sharing with the Insured occurs?
This risk sharing occurs when the Insured is responsible for a substantial proportion of each loss (excess), either through choice (to reduce prem) or necessity (insurer demands it to accept the risk)
What is a deductible?
A large fixed sum retained by the Insured in the event of a claim (= high excess)
How do Insurers benefit from risk-sharing with the Insured?
Large excesses or deductibles deter the policyholder from making small claims and are more likely to prevent damage or loss if they are financially impacted.
What is dual insurance? When does it often occur?
When two or more policies in force cover the same risk. Occurs inadvertently where an aspect of cover provided as a package overlaps with a primary cover intentionally purchased.
What is self-insurance?
An individual or company that has decided to not use insurance as a risk transfer mechanism but to carry the risk themselves.
Explain a retention. (Often called self-insured retention)
When a substantial sum which is retained by the Insured as an act of voluntary or involuntary self-insurance.
Give 4 reasons why individuals (or businesses) decide whether or not to buy insurance
- Their attitude to the potential risk
- Whether it is a legal requirement
- The price they are prepared to pay for ‘peace of mind’
- Whether they feel they have a choice
How does insurance enable the risk of financial loss to be transferred?
Replaces an unknown risk with a certain premium, so it provides CERTAINTY
What are the 5 benefits of insurance?
- Improved cash flow - money does not have to be kept in reserve
- Companies have greater confidence - encourages investing, innovation & expansion
- Loss control - is improved as Insurers want to reduce frequency & severity of losses
- Premiums invested - premiums can be invested to earn interest creating a larger claim reserve
- Job protection/social benefits - encourages business activity and helps to keep people in employment (e.g. business interruption)
