Chapter 1: Risk and Insurance

Question 1

What term describes an individual who is keen to remove/transfer risk wherever possible?

Answer 1

Risk adverse

Question 2

A factory installing sprinklers is an example of what activity?

Answer 2

Risk control

Question 3

What 2 characteristics are used to assess the level of risk?

Answer 3

Frequency and severity

Question 4

What are the 4 key components of risk?

Answer 4

Uncertainty, level of risk, peril, and hazard

Question 5

Give an example of a high frequency, low severity, event

Answer 5

Broken windscreen/window, minor car accident, etc (anything that could happen often but doesn’t cause a high cost)

Question 6

Give an example of a low frequency, high severity, event

Answer 6

Plane crash, earthquake, subsidence, any other natural catastrophe etc

Question 7

What is the difference between a physical and moral hazard?

Answer 7

A physical hazard relates to the physical characteristics of the risk itself. A moral hazard relates to the characteristics and behaviour of people (usually the insured)

Question 8

Give an example of a physical hazard

Answer 8

Security systems, fire alarm/sprinklers, construction of the building, location, vehicle modifications

Question 9

Give an example of a moral hazard

Answer 9

Occupation, convictions, claim history, experience, company policies and attitude towards health and safety, carelessness, dishonesty

Question 10

What is the definition of a peril?

Answer 10

An event that causes a loss

Question 11

What is the definition of a hazard?

Answer 11

Something which influences a peril. Can have a good or poor impact

Question 12

A fire is caused by a smoker in bed. What is the peril and what is the hazard?

Answer 12

Peril = Fire
Hazard = Smoker

Question 13

What two words best describe risk?

Answer 13

Uncertainty and unpredictability

Question 14

What is risk management?

Answer 14

A way of taking control and developing a formal strategy to deal with various risks that may affect businesses

Question 15

What is AIRMIC?

Answer 15

Association of Insurance and Risk Managers in Industry and Commerce

Question 16

What are the three steps in risk management?

Answer 16

1. Risk identification
2. Risk analysis
3. Risk control (this includes risk transfer ie insurance)

Question 17

What are the three categories of internal risk control?

Answer 17

Detective controls - detect errors or irregularities

Corrective controls - correct errors or irregularities

Preventative controls - prevent errors or irregularities from occurring in the first place

Question 18

A fireworks factory is inspected by insurers and found to have excellent safety protocols and good staff training. What are these examples of?

Answer 18

Good moral hazard

Question 19

In general, what 3 classifications of risk are insurable?

Some exceptions, eg personal accident/sickness

Answer 19

Pure
Financial
Particular

Question 20

What is a “pure” risk?

Answer 20

A risk where there is the possibility of loss but not of financial gain. For example you couldn’t insure your gambling activities because there is the possibility you could win money

Question 21

What is a “financial” risk?

Answer 21

The outcome of an adverse event can be measured in financial terms. For example property damage or loss of profits/income

Question 22

What is a “particular” risk?

Answer 22

Localised, or even personal, in their cause and effect. Associated with one person or event

Question 23

For a risk to be insurable, what 3 features must it have?

Answer 23

1. The event insured against must be fortuitous (sudden, accidental, and unexpected)
2. There must be insurable interest
3. The risk must not be against public policy

Question 24

What are “homogenous exposures”?

Answer 24

A sufficient number of exposures to similar risks and their claims history that enables an insurer to forecast expected frequency and likely extent of losses

Question 25

What 3 kinds of risk are not insurable?

Answer 25

1. Non-financial: Outcome is not measurable in monetary terms 2. Speculative: Possibility of financial gain 3. Fundamental: Widespread effects caused by something outside the control of any one individual or group. For example economic recession, war, famine

Question 26

Name some benefits of insurance

Answer 26

1. Risk transfer mechanism 2. Peace of mind 3. Encourages enterprise/expansion of business 4. Reduction of losses + keeps people in employment 5. Invisible export (government income via IPT) 6. Investment by insurers (premium pool invested to earn income for the insurer, benefits both parties)

Question 27

What is insurance?

Answer 27

A legal agreement (contract) between the insured (first party) and insurer (second party) to provide financial compensation in the event of a financial loss

Question 28

What is meant by "the common pool"?

Answer 28

The contributions of the many pay for the losses of the few

Question 29

What is the law of large numbers?

Answer 29

The larger the number of similar risks and claims the insurer deals with, the more accurately they can forecast and set premiums

Question 30

What is meant by "equitable premium"?

Answer 30

A fair contribution - the size of the premium reflects the size of the risk brought into the pool

Question 31

When pooling risk, what does the law of large numbers allow insurers to reliably predict?

Answer 31

Future claim payments

Question 32

What is "co-insurance"?

Answer 32

An insurer agrees to share a risk with one or more co-insurers. They issue a collective policy and each sign for an agreed percentage. Each insurer receives that agreed percentage of the premium, and pays the same percentage of any losses that occur

Question 33

What is self insurance?

Answer 33

The insured decides not to transfer some of the risk, but to cover it themselves. For example the insured may pay the first £50,000 of any loss and take out insurance on losses above that amount. The amount is called the retention

Question 34

Which of the following can insurance cover be purchased for? A: An investment loss on the stock market B: Dishonesty of an employee C: Failure of a business venture D: War damage to a domestic property

Answer 34

B: Dishonesty of an employee | Fidelity guarantee

Question 35

What must the common pool be large enough to cover?

Answer 35

The losses in any one year + costs of operating the pool + an element of profit

Question 36

A business that regularly puts aside money to cover the costs of accidental damage is an example of what?

Answer 36

Self insurance

Question 37

What is dual insurance?

Answer 37

Where an event is covered by two separate policies. For example a homeowners policy that covers personal possessions outside the home and a travel insurance policy

Question 38

What is a benefits policy?

Answer 38

Where there is no way of precisely valuing a loss (eg death or loss of sight) policies can provide pre-agreed amounts as payments or lump sums.

Question 39

What was the Test-Achats judgement? What act transposed this into UK law?

Answer 39

Insurers cannot use gender as a factor in pricing or benefits. Equality Act 2010

Question 40

What kinds of insurance were most impacted by the changes in law due to the Test-Achats judgement?

Answer 40

Income protection, motor insurance + health/critical illness insurance (Test-Achats means insurers cannot use gender as a factor in pricing - Equality Act 2010)

Question 41

Money from premiums is held until a claim is made. What does this create?

Answer 41

A premium reserve

Question 42

In co-insurance who is liable to the insured?

Answer 42

Each insurer is separately liable to the insured for their proportion of any claim

Question 43

In co-insurance how will a claim be settled?

Answer 43

Usually the lead office will settle the claim and recoup the losses from each co-insurer (For large claims each insurer may send their share of the settlement to the lead office first which is when passed to the insured)

Question 44

What are the different ways of controlling a risk?

Answer 44

1. Physical control measure - eg locks 2. Financial control measure - eg insurance 3. Developing a good risk culture