Chapter 2

Question 1

Law of large numbers

Answer 1

a basic principal of insurance 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 that will be incurred in any given period.

larger groups provide an increased degree of accuracy in loss predictions, based on past experience. The higher the exposure, the more likely the event can be predicted.

Question 2

Risk

Answer 2

The uncertainty regarding loss; the probability of loss occurring for an insured or prospect.

the potential for loss

Question 3

Peril

Answer 3

the immediate specific event causing loss and giving rise to risk. (ex. natural disasters)

Question 4

Speculative risk

Answer 4

a type of risk that involves the chance of both loss and gain; it is not insurable

Ex. investing in the stock market or gambling

Question 5

Pure risk

Answer 5

the type of risk that involves the chance of loss only; there is no opportunity for gain; insurable

Ex. injuries, illness, and death

Question 6

Risk avoidance

Answer 6

occurs when individuals evade risk entirely. it is the act of not doing something that could possibly cause a loss or the inactivity of participation in an event that may potentially cause a loss situation. (ex. driving an automobile. if you never leave the house, you completely avoid the possibility of getting into an accident)

Question 7

Risk reduction

Answer 7

takes place when the chances of loss are lessened. ex. changing one’s lifestyle to minimize risk. (ex. only using public transportation)

minimizing the severity of a potential loss

Question 8

Risk retention aka self-insurance

Answer 8

being aware of the risks involved and taking precautions for financial protection. (public transport can’t get you everywhere. now you must decide what limits you put on your financial responsibility by choosing your deductible. The auto policy’s deductible is an illustration of risk retention. Through the deductible, the insured retains part of the risk, the part that you are responsible for.)

an individuals ability to financially fund losses by themselves when they occur. used when losses are highly predictable and the worst possible loss is not that serious.

Question 9

Risk transfer

Answer 9

the act of shifting the responsibility of risk to another in the form of an insurance contract. through the insurance contract, the burden of carrying the risk and indemnifying the financial loss is transferred from individual to the insurance company.

Question 10

adverse selection

Answer 10

selection “against the company”. Tendency of less favorable insurance risks to seek or continue insurance to a greater extent that others

Question 11

reinsurance

Answer 11

the acceptance by one or more insurers (called reinsurers) of a portion of the risk underwritten by another insurer who has contracted the entire coverage

Question 12

hazard

Answer 12

any factor that gives rise to peril (ex. icy roads, driving while intoxicated, improperly stored toxic waste, etc.)

Question 13

moral hazard

Answer 13

the effect of personal reputation, character, associates, personal living habits, financial responsibility, and environment, as distinguished from physical health, upon an individual’s general insurability.

Question 14

Morale hazard

Answer 14

hazard arising from indifference to loss because of the existence of insurance

Question 15

risk pooling

Answer 15

aka loss sharing, spreads risk by sharing the possibility of loss over a large number of people. it transfers frisk from an individual to a group.

Question 16

Principle of Indemnity

Answer 16

involves making an insured whole by restoring them to the same condition as before a loss.

Question 17

Loss

Answer 17

the unintentional decrease in the value of an asset due to a peril.

Question 18

Loss exposure

Answer 18

any situation that presents the possibility of a loss.

Question 19

Types of Hazards

Answer 19

Physical (poor health, overweight, blind, etc.)

Moral (dishonesty, drugs, alcohol abuse, etc.)

Morale (careless attitude, reckless driving, jumping off cliff, stealing, racing cars, etc.)

Question 20

Elements of insurable risk

Answer 20

Loss must be due to chance (accident). outside of insured’s control. ex. getting a cold.

Loss must be definite and measurable. can document time, place, amount, and when payable.

Loss must be predictable. can estimate the average frequency and severity.

loss cannot be catastrophic. must be reasonable.

loss exposure to be insured must be large. law of large numbers to help insurance company predict loss.

loss must be randomly selected. avoid adverse selection.

Question 21

Homogeneous exposure units

Answer 21

similar objects of insurance that are exposed to the same group of perils. For example, insuring a large number of homes in the same geographical area against hail damage.