Chapter 1 - Fundamental principles of insurance Flashcards
What is the definition(s) of risk?
- 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)
How is risk managed (risk management)?
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
What are the 3 other terms of risk in insurance?
- 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.
What is risk seeking?
people or companies who are willing to carry certain risks themselves
what is risk averse?
feeling happier minimising exposure to risk, perhaps through insurance or reinsurance
Why is risk management important?
reduces the potential for loss.
gives shareholders confidence.
provides a disciplined approach to quantifying risk.
how is risk management different for individuals and businesses?
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
What are the stages of risk management? (definition)
the Identification, analysis and economic control of those risks which can threaten the assets or earning capacity of an enterprise
What does identification entail?
discovering possible existing and potential future threats, through things such as surveys etc
What does analysis entail?
examining past data to evaluate or analyse risk, e.g. looking at past loss patterns from natural disasters.
What does control entail?
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.
What do bodies such as the building research establishment (BRE) and Fire protection association (FPA) undertake?
provide construction guidelines, research new methods, provide reports on new industrial processes
What are the components of risk?
Uncertainty, level of risk, peril and hazard
What does uncertainty mean?
the incomplete ability to predict what is going to happen and when it is going to happen
How is risk usually assessed?
Frequency
Severity
What is high frequency, low severity?
Many losses that are low in value (such as comprehensive private motor insurance)
What is low frequency, high severity?
small number of events that incur very high costs, such as aircraft accidents
Why is predicting severity and frequency important for insurers?
to plan and prepare for their financial exposure
What is the difference between peril and hazard
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
What is physical hazard plus some examples?
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
What is moral hazard plus some examples?
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
Categories of risk
Financial and non-financial risk
Pure and speculative risks
particular and fundamental risks
What are some good examples of moral and physical hazard?
fireworks factory having world class safety protocols
A driver sticking to speed limits and rules of the road
What cannot be insured?
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
What can be insured?
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
what must an event be to be deemed insurable?
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
What is the pooling of risk?
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
What are the reasons for buying insurance and what is it based upon?
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
What are the primary functions of insurance?
Spreading the risk
Providing a degree of certainty
Transferring risk
What are the secondary functions of insurance?
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
how can compulsory insurance by law be summarised?
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)
Why are some forms of insurance compulsory?
To provide funds for compensation
In response to national concerns
Reputation of the profession
why is the claims process important?
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
What is the role of claims personnel
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
