Chapter 1 - Core Principles of Insurance Flashcards
A - Concept of Risk and Risk Transfer
A1 - Risk Perception
- Why is it difficult to define risk?
One person’s perception of a particular risk can be significantly different from another’s.
A - Concept of Risk and Risk Transfer
A1 - Risk Perception
- What is meant by Risk Management?
Measuring risk and the means of attempting to deal with it by applying scientific process.
A - Concept of Risk and Risk Transfer
A1 - Risk Perception
- What kind of questions does Risk Management ask in a commercial context?
“How much will it cost if things go wrong?”
“What are the chances of the risk becoming a reality?”
A - Concept of Risk and Risk Transfer
A2 - Definition of Risk
- What are the key elements contained in definitions of risk?
Uncertainty
Unpredictability
Danger (in some cases)
A - Concept of Risk and Risk Transfer
A2 - Definition of Risk
- What is meant by Risk Transfer?
The accepting of an unknown future potential risk by an insurer for an agreed premium.
A - Concept of Risk and Risk Transfer
A2 - Definition of Risk
- Why does Risk Transfer bring peace of mind to the insured?
Because they have replaced the uncertainty of possible future loss with the certainty of the agreed premium.
A - Concept of Risk and Risk Transfer
A4 - Attitude to Risk
- What is somebody who is willing to carry certain risks for themselves called?
Risk Seeking
A - Concept of Risk and Risk Transfer
A4 - Attitude to Risk
- How would you describe a Risk Averse person?
Somebody who is happier minimising the risk they are exposed to, perhaps by transferring the risk with insurance.
A - Concept of Risk and Risk Transfer
A4 - Attitude to Risk
- Why do many companies carry out Risk Management?
To attempt to accurately evaluate the risk they are exposed to.
B - Risk Management
- What are the key steps of Risk Management?
Identification
Analysis
Control (including risk transfer)
B - Risk Management
- What does Risk Management achieve?
It reduces the potential for loss by identifying and managing hazards.
It gives shareholders a greater degree of confidence in a company’s ability to manage risks.
It provides a disciplined approach to quantifying risks.
B - Risk Management
- What is a defining characteristic of Commercial Risk Management?
It should be a continuous and developing process.
B - Risk Management
- Which body has published a risk management standard?
The Association of Insurance and Risk Managment in Industry and Commerce (AIRMIC)
B - Risk Management
- What are the main reasons for buying insurance? Provide examples.
Compulsory e.g. third party motor insurance.
Financial interest e.g. mortgage lenders may insist on property insurance.
B - Risk Management
B1 - Risk Identification
- What is involved in Risk Identification?
Discovering threats that already exist and potential threats that may exist in the future.
B - Risk Management
B2 - Risk Analysis
- What do Risk Managers use to analyse risks?
Past data
B - Risk Management
B3 - Risk Control
- What are the two levels of Risk Control, and which is preferable?
Reduction
Elimination (preferable, and most effective, but may be costly or impractical)
B - Risk Management
B3 - Risk Control
- What will be considered when controlling risk?
The test of whether the cost of controlling the risk is reasonable compared to the cost of the feared event happening.
B - Risk Management
B3 - Risk Control
- What types of measures can be taken to control risk? Provide examples.
Physical control measures e.g. locks on doors to reduce theft
Financial control measures e.g. transferring risk with insurance
Developing good risk culture e.g. educating employees to reduce risk
B - Risk Management
B3 - Risk Control
- How are Internal Controls categorised?
Detective controls - detect errors that may have occurred
Corrective controls - correct errors that may have occurred
Preventative controls - keep errors from occurring in the first place
B - Risk Management
B3 - Risk Control
- Why do insurers often make clients complete surveys?
To improve the risk to an acceptable standard.
B - Risk Management
B3 - Risk Control
- How can insurers incentivise clients to make worthwhile risk improvements?
By offering premium reductions.
B - Risk Management
B3 - Risk Control
- For what purpose do bodies like the Fire Protection Association and Thatcham Research Centre serve insurers?
They research areas of loss prevention and control.
B - Risk Management
B3A - Fraud and Cyber Crime
- How are insurers managing and mitigating the risk of fraud?
They have created databases for use in the recording and detection of fraudulent activity.
C - Components of Risk
- What are the components of risk?
Uncertainty
Level of Risk
Peril and Hazard
C - Components of Risk
C2 - Level of Risk
- On what basis is the level of risk assessed by insurers?
Frequency
Severity
C - Components of Risk
C2 - Level of Risk
- What are the typical relationships between frequency and severity?
High frequency and low severity e.g. motor insurance, dented bumpers and cracked windscreens.
Low frequency and high severity e.g. aircraft accidents and oil spillages.
C - Components of Risk
C3 - Peril and Hazard
- What is a peril?
Perils give rise to a loss e.g. fire, explosions, lightning, collision, dishonesty
C - Components of Risk
C3 - Peril and Hazard
- What is a hazard?
Hazards influence the effect of the peril e.g. fuel.
C - Components of Risk
C3A - Physical and Moral Hazard
- What is meant by a physical hazard?
Relates to the physical characteristics of the risk and includes any measurable dimension of the risk.
C - Components of Risk
C3A - Physical and Moral Hazard
- Give examples of physical hazards.
Security protection at a shop
Construction of the property
The age of the proposer and the make of the vehicle
C - Components of Risk
C3A - Physical and Moral Hazard
- What is a Moral Hazard based on?
The attitude and behaviour of people.
C - Components of Risk
C3A - Physical and Moral Hazard
- Give examples of Moral Hazards.
Carelessness e.g. driving without care
Dishonesty
Social Attitudes e.g. a person who regards insurance fraud as acceptable and not immoral.
D - Categories of Risk
D1 - Financial and Non-Financial Risks
- What is required for a risk to be insurable?
The outcome of the adverse event must be measurable in financial terms.
D - Categories of Risk
D1 - Financial and Non-Financial Risks
- What is the nature of General Insurances?
Compensatory in nature. The value placed on the loss is not determined in advance.
D - Categories of Risk
D1 - Financial and Non-Financial Risks
- Give examples of Benefits Policies and explain how they differ from General Insurance policies.
Personal Accident and Sickness policies
Life policies
There is no way of valuing precisely the loss of a life or sight, so these policies are taken out to provide pre-agreed amounts.
D - Categories of Risk
D1 - Financial and Non-Financial Risks
- What are Non-Financial Risks? Provide examples.
Risks we are not capable of financially measuring e.g. sentimental value of an heirloom.
D - Categories of Risk
D2 - Pure and Spectulative Risks
- What is a Pure Risk? Provide examples.
A risk where there is the possibility of a loss, but not a gain. The best we can hope to achieve is a break-even situation e.g. fire, machinery breakdown, injury to employees at work.
D - Categories of Risk
D2 - Pure and Speculative Risks
- What is a Speculative Risk? Provide examples.
A speculative risk may involve three possible outcomes: loss, break-even, gain e.g. gambling, investing in the stock market, starting up a new business.
D - Categories of Risk
D2 - Pure and Speculative Risks
- Why don’t insurers cover Speculative Risks?
They are risks that are taken up voluntarily in the hope that there will be a gain. The risk element would be completely removed if the insured knew that the insurer would cover any losses.
D - Categories of Risk
D3 - Particular and Fundamental Risks
- What are Particular Risks? Give examples.
Localised or even personal in their cause and effect e.g.
Factory fire
Car collision
Theft of personal possessions from a home
Storm over a whole region (the effect is personal because not all properties will have been damaged)
D - Categories of Risk
D3 - Particular and Fundamental Risks
- What are Fundamental Risks? Give examples.
Risks that rise from a cause outside the control of any one individual or group and their effects are usually widespread e.g.
Economic recession
War
Earthquake
Famine
D - Categories of Risk
D3 - Particular and Fundamental Risks
- Can insurers provide cover for Fundamental Risks?
Fundamental risks may have particular consequences for individuals which can be insured. So, although it is not possible to insure against the general effects of economic recession, insurance is available which would cover mortgage repayments in the event of the insured becoming unemployed.
E - Features of Insurable Risks
- What features must be present for a risk to be insurable?
A fortuitous event
An insurable interest
Insuring the risk must not be against public policy
E - Features of Insurable Risks
E1 - A Fortuitous Event
- What makes an event fortuitous?
Accidental or unexpected, happening by chance rather than intentional.
E - Features of Insurable Risks
E1 - A Fortuitous Event
- Give an example of a Non-Fortuitous Loss.
A policyholder who deliberately damages their car.
E - Features of Insurable Risks
E2 - Insurable Interest present
- What is an Insurable Interest? Provide an example.
The legally recognised financial relationship between the insured and the object or liability e.g. proof of ownership.
E - Features of Insurable Risks
E3 - Not against Public Policy
- Using an example, explain why insurers cannot insure risks that go against public policy.
Insuring the incurring a fine for criminal activity can’t be covered because, while the risk may be fortuitous (accidental) and the insured has an Insurable interest i.e. financial loss, insuring against paying the fine clearly goes against the purpose of the fine, punishment, and may actually encourage criminal behaviour.
E - Features of Insurable Risks
E4 - Homogeneous Exposures
- Why do insurers use the law of large numbers?
When given a sufficient number of exposures to similar risks, known as homogeneous exposures, the insurer can forecast the expected frequency and likely extent of losses.
F - Pooling of Risk
- Explain the concept behind pooling.
The losses of the few are met by the contributions of the many.
F - Pooling of Risk
- How does an insurance company create a pool?
They gather relatively small sums of money from insurers and set themselves up to operate a common pool.
F - Pooling of Risk
- What comes out of the common pool?
Payments to compensate the losses of the few.
F - Pooling of Risk
- How do insurers set the premiums they charge?
Insurers endeavour to charge fair and reasonable premiums in relation to the risk they introduce to the pool and the costs of operating the pool.
F - Pooling of Risk
F1 - Law of Large Numbers
- Why do insurers use the law of large numbers?
It enables them to predict the final cost of claims in any one year fairly confidently, allowing them to charge a fixed premium.
F - Pooling of Risk
F1 - Law of Large Numbers
- What financial factors can affect the level of premium put forward to the client?
Competitive pressures
Business imperative to grow or defend market share
F - Pooling of Risk
F2 - Equitable Premiums
- What do insurers take into account when deciding on equitable premiums (fair contributions)?
Discrimination Factors - the different elements of risk brought to the pool by each policyholder.
F - Pooling of Risk
F2 - Equitable Premiums
- Why is a correct assessment of risk important?
It ensures a fair premium is charged, and a profit can be made.
F - Pooling of Risk
F2 - Equitable Premiums
- Who carries out the task of assessing a risk?
An underwriter.
F - Pooling of Risk
F2A - EU Gender Directive
- When did the European Court of Justice rule that insurers could no longer use gender as a premium calculation tool?
2011
F - Pooling of Risk
F2A - EU Gender Directive
- When did the UK adopt the EU Gender Directive?
2012 - as part of the Equality Act 2010 (Amendment) Regulations 2012
G - Co-Insurance
- What are two ways Co-Insurance is used in the insurance market?
Risk sharing between insurers
Risk sharing with the insured
G - Co-Insurance
- What is Reinsurance?
When insurers come together to form a common pool and agree to jointly underwrite particular risks.
G - Co-Insurance
- When is Reinsurance used?
To cover catastrophic risks.
G - Co-Insurance
G1 - Risk sharing between Insurers
- What is Co-Insurance?
A risk sharing mechanism.
G - Co-Insurance
G1 - Risk sharing between Insurers
- How does Co-Insurance work?
Each insurer receives a stated proportion of the premium and pays the proportion of any losses that occur.
G - Co-Insurance
G1 - Risk sharing between Insurers
- What are the responsibilities of the “lead party”?
They are the first named insurer on the policy
They invariably carry the largest share of the risk
They are responsible for issuing the documentation
G - Co-Insurance
G1 - Risk sharing between Insurers
- What happens when a change is needed to Co-Insured policy?
The lead office issues closing instructions to each of the co-insurers, requesting their acceptance of the change.
G - Co-Insurance
G1 - Risk sharing between Insurers
- What happens in the event of a claim on a Co-Insured policy?
The lead office will settle losses on behalf of the co-insurers and recoup the sums from them afterwards.
G - Co-Insurance
G1 - Risk sharing between Insurers
- What happens when a substantial claim occurs on a Co-Insured policy? £50,000+
A payment is made by each co-insurer to the leading office for onward transmission to the policyholder.
G - Co-Insurance
G2 - Risk sharing with the Insured
- What does Co-Insurance refer to when the risk is shared with the Insured?
The amount of the risk that the insured retains.
G - Co-Insurance
G2 - Risk sharing with the Insured
- What is an excess?
A small fixed sum retained by the insured.
G - Co-Insurance
G2 - Risk sharing with the Insured
- What is a deductible?
A large fixed sum retained by the insured.
G - Co-Insurance
G2 - Risk sharing with the Insured
- What are the benefits of risk sharing with the insured for insurers?
The policyholder is deterred from making small claims.
They are more likely to take steps to prevent damage or loss occurring if they are likely to be financially impacted.
G - Co-Insurance
G2 - Risk sharing with the Insured
- What is Dual Insurance? Provide an example.
When two or more policies cover the same risk e.g. travel insurance and property insurance both cover contents.
H - Self-Insurance
- What is Self Insurance?
When an individual or company has decided not to use insurance as the risk transfer mechanism, but to carry the risk themselves.
H - Self-Insurance
- What can Self-Insurance also refer to?
The part of a loss that the insured retains, although in this context it usually applies to substantial sums. This amount is called the Retention.
I - Reasons for Buying Insurance
I1 - Benefits of Insurance
- List the benefits of insurance.
Risk Transfer
Peace of Mind
Cash Flow - money doesn’t have to be kept in reserve for potential losses, which frees up capital.
Expansion of Business
Loss Control - is improved. Insurers have an interest in reducing the frequency and severity of losses, not only to enhance their profitability but also to contribute to a general reduction in economic waste which follows a loss. The policyholder suffers less business interruption and inconvenience as the effects of loss are minimised.
Premiums Invested - premiums can be invested in earn interest.
Social Benefits
