Chapter 2 Flashcards

1
Q

Define Insurance

A

Insurance is the pooling of fortuitous losses by transfer of such risks to insurers, who agree to indemnify insureds for such losses.

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2
Q

What are the basic characteristics of insurance?

A
  1. Pooling of losses
  2. Payment of fortuitous losses
  3. Risk transfer
  4. Indemnification
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3
Q

What does the law of large numbers state?

A

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.

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4
Q

What is a fortuitous loss?

A

One that is unforeseen, unexpected, and occur as a result of chance

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5
Q

What occurs during risk transfer?

A

A pure risk is transferred from the insured to the insurer, who typically is in a stronger financial position

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6
Q

What does indemnification mean?

A

The insured is restored to his or her approximate financial position prior to the occurrence of the loss

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7
Q

What are the characteristics of an ideally insurable risk?

A
  1. Large number of exposure units
  2. Accidental and unintentional loss
  3. Determinable and measurable loss
  4. No catastrophic loss
  5. Calculable chance of loss
  6. Economically feasible premium
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8
Q

Why would an insurance company want to have a large number of exposure units?

A

To predict average loss based on the law of large numbers

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9
Q

Why would an insurance company want to insure accidental and unintentional loss?

A

To assure random occurrence of events

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10
Q

Why would an insurance company want determinable and measurable loss?

A

To determine how much should be paid

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11
Q

Why would an insurance company want to avoid catastrophic loss?

A

T allow the pooling technique to work

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12
Q

How can exposure to catastrophic loss be managed?

A

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

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13
Q

Why would an insurance company want calculable chance of loss?

A

To establish a premium that is sufficient to pay all claims and expenses and yields a profit during the policy period

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14
Q

Why would an insurance company want economically feasible premiums?

A
  • 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
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15
Q

Based on the characteristics of ideally insurable risk:

A
  • Most personal, property and liability risks can be insured
  • Market risks, financial risks, production risks and political risks are difficult to insure
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16
Q

What is adverse selection?

A

The tendency of persons with a higher-than-average chance of loss to seek insurance at standard rates (ex. a high risk driver)

17
Q

If not controlled by underwriting adverse selection:

A

Results in higher-than-expected loss levels

18
Q

Adverse selection can be controlled by:

A

-Careful underwriting (selection & classification of applicants for insurance) if standards are not met, insurance is denied
- Policy provisions (e.g., suicide clause in life insurance)

19
Q

Compare Gambling and Insurance

A

Insurance
- Handles an already existing pure risk
- Is always socially productive: both parties have a common interest in the prevention of a loss
Gambling
- Creates a new speculative risk
- Is not socially productive: The winner’s gain comes at the expense of the loser

20
Q

Compare Insurance and Hedging

A

Insurance
- Risk is transferred by a contract
- Involves the transfer of pure (insurable) risks
- Moral hazard and adverse selection are more severe problems for insurers
Hedging
- Risk is transferred by a contract
- Involves risks that are typically uninsurable
- Fewer problems of moral hazard and adverse selection for entities who buy or sell futures contracts

21
Q

Insurance can be classified as either:

A

Private or government insurance

22
Q

Private insurance includes:

A

Life and health insurance as well as property and liability insurance

23
Q

Government Insurance includes:

A

Social insurance programs and other government insurance plans

24
Q

Life Insurance:

A

Pays death benefits to beneficiaries when the insured dies

25
Q

Health insurance:

A

covers medical expenses because of sickness or injury

26
Q

Property insurance:

A

indemnifies property owners against the loss or damage of real or personal property

27
Q

Liability insurance:

A

Covers the insured’s legal liability arising out of property damage or bodily injury to others

28
Q

Casualty Insurance:

A

Refers to insurance that covers whatever is not covered by fire, marine, and life insurance

29
Q

Private insurance coverages can be grouped into two major categories:

A
  • Personal lines
  • Private lines
30
Q

Private lines of insurance:

A

Coverages that insure the real estate and personal property of individuals and families or provide protection against legal liability

31
Q

Commercial lines of insurance:

A

Coverages for business firms, nonprofit organizations, and government agencies

32
Q

Characteristics of social insurance programs include:

A
  • Financed entirely or in large part by contributions from employers and/or employees
  • Benefits are heavily weighted in favor of low-income groups
  • Eligibility and benefits are prescribed by statute
    Examples: Social Security, Unemployment, Workers Comp
33
Q

What benefits does insurance provide for society?

A
  1. Indemnification for Loss
  2. Reduction of Worry and Fear
  3. Source of Investment Funds
  4. Loss Prevention
  5. Enhancement of Credit
34
Q

The major social costs of insurance are:

A
  • Cost of during business
  • Fraudulent claims
  • Inflated claims
35
Q

What is expense loading in reference to the cost of doing business and insurance’s burden on society?

A

An expense loading is the amount needed to pay all expenses, including commissions, general administrative expenses, state premium taxes, acquisition expenses, and an allowance for contingencies and profit