Chapter 2 Flashcards
Define Insurance
Insurance is the pooling of fortuitous losses by transfer of such risks to insurers, who agree to indemnify insureds for such losses.
What are the basic characteristics of insurance?
- Pooling of losses
- Payment of fortuitous losses
- Risk transfer
- Indemnification
What does the law of large numbers state?
According to the Law of Large Numbers, the greater the number of exposures, the more closely will the actual results approach the probable results that are expected from an infinite number of exposures.
What is a fortuitous loss?
One that is unforeseen, unexpected, and occur as a result of chance
What occurs during risk transfer?
A pure risk is transferred from the insured to the insurer, who typically is in a stronger financial position
What does indemnification mean?
The insured is restored to his or her approximate financial position prior to the occurrence of the loss
What are the characteristics of an ideally insurable risk?
- Large number of exposure units
- Accidental and unintentional loss
- Determinable and measurable loss
- No catastrophic loss
- Calculable chance of loss
- Economically feasible premium
Why would an insurance company want to have a large number of exposure units?
To predict average loss based on the law of large numbers
Why would an insurance company want to insure accidental and unintentional loss?
To assure random occurrence of events
Why would an insurance company want determinable and measurable loss?
To determine how much should be paid
Why would an insurance company want to avoid catastrophic loss?
T allow the pooling technique to work
How can exposure to catastrophic loss be managed?
Exposures to catastrophic loss can be managed by using reinsurance, dispersing coverage over a large geographic area, or using financial instruments, such as catastrophe bonds
Why would an insurance company want calculable chance of loss?
To establish a premium that is sufficient to pay all claims and expenses and yields a profit during the policy period
Why would an insurance company want economically feasible premiums?
- So people can afford to purchase the policy
- For insurance to be an attractive purchase, the premiums paid must be substantially less than the face value, or amount, of the policy
Based on the characteristics of ideally insurable risk:
- Most personal, property and liability risks can be insured
- Market risks, financial risks, production risks and political risks are difficult to insure