Chapter 1 - Fundamental principles of insurance

Question 1

What is the definition(s) of risk?

Answer 1

• Possibility of something unfortunate happening
• doubt regarding how something will turn out
• unpredictability
• possibility of a loss
• chance there might be a gain (e.g. betting)

Question 2

How is risk managed (risk management)?

Answer 2

insuring the risk by the owner paying a premium in return for the insurer accepting the future cost of that risk occurring. Insurer promises to pay for what is agreed in the contract

Question 3

What are the 3 other terms of risk in insurance?

Answer 3

• peril being insured (e.g. fire or collision)
• subject matter of insurance (what is being insured)
• the thing insured and the range of contingencies or scope of cover required.

Question 4

What is risk seeking?

Answer 4

people or companies who are willing to carry certain risks themselves

Question 5

what is risk averse?

Answer 5

feeling happier minimising exposure to risk, perhaps through insurance or reinsurance

Question 6

Why is risk management important?

Answer 6

reduces the potential for loss.
gives shareholders confidence.
provides a disciplined approach to quantifying risk.

Question 7

how is risk management different for individuals and businesses?

Answer 7

Businesses usually adopt a formal approach, often with a financial advisor.

individuals usually less structured, mainly insure due to compulsory (motor insurance) and third-party financial incentives

Question 8

What are the stages of risk management? (definition)

Answer 8

the Identification, analysis and economic control of those risks which can threaten the assets or earning capacity of an enterprise

Question 9

What does identification entail?

Answer 9

discovering possible existing and potential future threats, through things such as surveys etc

Question 10

What does analysis entail?

Answer 10

examining past data to evaluate or analyse risk, e.g. looking at past loss patterns from natural disasters.

Question 11

What does control entail?

Answer 11

minimising the potential risk with 2 distinct aspects:
- Physical controls such as sprinklers and alarms
- financial controls e.g. making sure contracts are well worded
Insurers help to impose requirements and make recommendations to control risk.

Question 12

What do bodies such as the building research establishment (BRE) and Fire protection association (FPA) undertake?

Answer 12

provide construction guidelines, research new methods, provide reports on new industrial processes

Question 13

What are the components of risk?

Answer 13

Uncertainty, level of risk, peril and hazard

Question 14

What does uncertainty mean?

Answer 14

the incomplete ability to predict what is going to happen and when it is going to happen

Question 15

How is risk usually assessed?

Answer 15

Frequency
Severity

Question 16

What is high frequency, low severity?

Answer 16

Many losses that are low in value (such as comprehensive private motor insurance)

Question 17

What is low frequency, high severity?

Answer 17

small number of events that incur very high costs, such as aircraft accidents

Question 18

Why is predicting severity and frequency important for insurers?

Answer 18

to plan and prepare for their financial exposure

Question 19

What is the difference between peril and hazard

Answer 19

Peril: That which gives rise to a loss i.e. fire or flood

Hazard: that which influences the operation or effect of the peril e.g thatched roof making a fire worse

Question 20

What is physical hazard plus some examples?

Answer 20

physical characteristics of the risk and any measurable dimension.
I.E. Security protection at a shop
the construction of a property
Age of a proposer and type of car for motor insurance

Question 21

What is moral hazard plus some examples?

Answer 21

Hazards arising from the attitude and behaviour of people
I.E. Carelessness (drink driving)
Dishonesty (fraud)
Social attitudes
Also includes the way in which the business is run

Question 22

Categories of risk

Answer 22

Financial and non-financial risk

Pure and speculative risks

particular and fundamental risks

Question 23

What are some good examples of moral and physical hazard?

Answer 23

fireworks factory having world class safety protocols

A driver sticking to speed limits and rules of the road

Question 24

What cannot be insured?

Answer 24

Non-financial risks (i.e. sentiment)

Speculative risks (i.e. gambling or misreading the market)

Fundamental risks - risks occurring on such a large scale they are uninsurable such as famine and economic recession

Question 25

What can be insured?

Answer 25

Financial risks (I.E. theft of property)

Pure risks - possibility of loss but best situation is to break even i.e. safe aircraft landing

Particular risks - localised or personal in their cause and effect i.e. a factory fire

Question 26

what must an event be to be deemed insurable?

Answer 26

Fortuitous - accidental or unexpected and not inevitable

must be of a financial nature

must be insurable interest - the recognised financial relationship between the insured and the thing that is being insured, could be your own property or that of clients which is on your premises

Risk must not go against public policy i.e. committing a crime is uninsurable

Question 27

What is the pooling of risk?

Answer 27

Premiums paid by the insured go into the pool, which combined of all customers must be large enough to meet the losses (claims paid) in any one year.

The premiums paid are fair for the risk that each insured brings and the claims they can make from the pool if they incur any losses

Insurers use the law of large numbers in working out the levels of fair contribution as well as historic figures

Question 28

What are the reasons for buying insurance and what is it based upon?

Answer 28

based on their attitude to personal risk

what price they are prepared to pay for the peace of mind and risk transferring insurance brings

the extent to which they have/feel a choice about insuring the risk

Question 29

What are the primary functions of insurance?

Answer 29

Spreading the risk

Providing a degree of certainty

Transferring risk

Question 30

What are the secondary functions of insurance?

Answer 30

Companies do not have to set aside large sums of money

Companies can be confident to look to expand their business

Jobs are protected

Losses are reduced in size and number

Insurers are largely investors of funds - benefitting the economy

‘Invisisble’ exports

Question 31

how can compulsory insurance by law be summarised?

Answer 31

Private individuals - motor insurance (Road traffic act 1988) and public liability insurance for things such as ownership of dangerous animals (Dangerous wild animals act 1976 or Dangerous dogs act 1991)

professions and business - Motor insurance and employers’ liability (Employers’ liability (compulsory insurance) act 1969), Solicitors must hold PI insurance (Solicitors act 1974)

Question 32

Why are some forms of insurance compulsory?

Answer 32

To provide funds for compensation

In response to national concerns

Reputation of the profession

Question 33

why is the claims process important?

Answer 33

Claims process is vital as insurance is a service industry and the claims process is likely what customers will remember the most, so a good process is important

Question 34

What is the role of claims personnel

Answer 34

deal efficiently and fairly with all claims

identify invalid claims

assess and calculate funds to be set aside to pay the claim (reserves)

instruct any necessary experts

settle claims cost-effectively

liaise with colleagues to provide data relating to claims