Chapter 2

Question 1

What is Adverse Selection?

Answer 1

Adverse Selection is the tendency of people with higher risks to seek or continue insurance more than those with lower risks. It occurs when the percentage of poor risks among those covered exceeds the ratio predicted by actuaries.

This includes the tendency of policy owners to take advantage of favorable options in insurance contracts.

Question 2

What is a Hazard?

Answer 2

A Hazard is any factor, condition, or situation that increases the possibility that a peril will occur.

Question 3

What are Homogeneous Exposure Units?

Answer 3

Homogeneous Exposure Units are similar ‘objects of insurance’ exposed to the same group of perils. These can be persons, businesses, or pieces of property.

Question 4

What does it mean to Indemnify?

Answer 4

To Indemnify is to restore insureds to the financial condition that existed prior to a loss.

Question 5

What is Indemnity?

Answer 5

Indemnity is the amount needed to restore an individual to the financial condition they were in before suffering a loss. It can be a reimbursement or a fixed dollar amount.

Question 6

What is an Indemnity Contract?

Answer 6

An Indemnity Contract attempts to return the insured to their original financial position.

Question 7

What is the Law of Large Numbers?

Answer 7

The Law of Large Numbers is a principle stating that the larger the number of individual risks combined into a group, the more certainty there is in predicting the degree or amount of loss in a given period.

Question 8

How is Loss defined in the insurance industry?

Answer 8

Loss is defined as the unintentional decrease in the monetary value of an asset due to a peril.

Question 9

What is Loss Exposure?

Answer 9

Loss Exposure is the risk of a possible loss.

Question 10

What is a Loss Exposure Unit?

Answer 10

A Loss Exposure Unit refers to each individual organization or asset exposed to potential financial loss due to a defined peril.

Question 11

What is Moral Hazard?

Answer 11

Moral Hazard exists due to the effect of an insured’s personal reputation, character, associates, personal living habits, or degree of financial responsibility, including criminal activity.

Question 12

What is Morale Hazard?

Answer 12

A hazard that arises from an insured’s indifference to loss because of the existence of insurance. Morale hazards are often associated with having a careless attitude.

Question 13

What is a Peril?

Answer 13

A peril is the immediate, specific event that causes loss and gives rise to risk.

Question 14

What is a Physical Hazard?

Answer 14

A physical or tangible condition that exists in a manner which makes a loss more likely to occur.

Question 15

What does Primary Insurance Company refer to?

Answer 15

It refers to the first policy to pay when more than one policy covers the same claim.

It also refers to the insurer that writes a policy to cover a risk in the marketplace and surrenders a portion of the risk to a reinsurer.

Question 16

What is Pure Risk?

Answer 16

A type of risk that involves the chance of loss only; there’s no opportunity for gain. Pure risks are the only form of insurable risks.

Question 17

What is Reinsurance?

Answer 17

The acceptance by one or more insurers, referred to as reinsurers, of a portion of the risk underwritten by another insurer that has contracted with an insured to provide coverage for the total value of a loss exposure.

Question 18

What is a Reinsurer?

Answer 18

An insurance company that assumes a portion of the risk underwritten by a primary insurance company.

Question 19

What is Risk?

Answer 19

The uncertainty regarding loss. Risk is the probability of a loss occurring for an insured or prospect.

Question 20

What is Risk Avoidance?

Answer 20

The act of evading risk entirely by not participating in an activity that could possibly cause a loss.

Question 21

What is Risk Management?

Answer 21

The process of analyzing exposures that create risk and then designing programs to address them.

Question 22

What is Risk Reduction?

Answer 22

A risk management strategy that focuses on taking actions which decrease the chances of a loss occurring and lessen the severity of a loss if one occurs.

Question 23

What is Risk Retention?

Answer 23

The act of analyzing the loss exposure presented by a risk and determining that the potential loss is acceptable. Risk retention is often associated with self-insurance.

Question 24

What is Risk Selection?

Answer 24

Risk Selection describes the insurance company’s process for determining whether to cover a new loss exposure. If done correctly, the ratio of losses to a premium should reflect what actuaries predicted when they created the product, established the price, and set the underwriting criteria.

Question 25

What is Risk Sharing (Risk Pooling or Loss Sharing)?

Answer 25

Risk Sharing is a risk management technique that manages an individual’s risk by sharing the possibility of loss with others and spreading the cost over a large number of individuals. This technique transfers risk from an individual to a group.

Question 26

What is Risk Transfer?

Answer 26

Risk Transfer is the act of exchanging the responsibility for a significant potential loss or risk to another party in exchange for a smaller, preset cost or premium.

Question 27

What is Self-Insurance?

Answer 27

Self-Insurance is a risk retention process where an individual or organization maintains monetary reserves to cover potential costs in the event of a financial loss occurring.

Question 28

What is Speculative Risk?

Answer 28

Speculative Risk is a type of risk that involves the chance of both loss and gain; it’s not insurable.