Chapter 2: Nature Of Insurance

Question 1

Define Risk Pooling

Answer 1

AKA: Loss Sharing

Transfers risk from an individual to a group

Question 2

Define Law of Large Numbers

Answer 2

Large groups produce an increased accuracy in loss prediction

Question 3

Define Risk

Answer 3

Potential for loss

Question 4

Define Peril

Answer 4

Something that causes financial loss (immediate specific event)

Question 5

Define loss

Answer 5

Unintentional decrease in value of an asset

Question 6

Define Loss exposure

Answer 6

Any situation that could lead to a loss (having no smoke detectors)

Question 7

Define homogeneous units

Answer 7

Similar insurance objects that are exposed to the same kind of peril

Question 8

Name and describe the two types of risks

Answer 8

Speculative Risk: Presents chance for both loss and gain. Example is gambling. Not covered by insurance

Pure Risk: Risk with no potential for gain. Like injury, illness or death. Covered by insurance

Question 9

Name and describe the three treatments of risk

Answer 9

Avoidance: Elimination of hazard (don’t drive or take risks)

Reduction: Minimizing the severity of a loss (smoke alarms)

Retention: Self Insure - loss is predictable and not that bad (person can pay for the loss themselves)

Transfer: Buying insurance is transferring risk

Sharing: Each party assumes portion of risk

Question 10

Name the 6 Characteristics of an insurable risk

Answer 10

• Accident
• Definite and measurable
• Predictable
• Cannot be catastrophic
• Insurance company must be able to predict loss (client needs to have taken measures to minimize loss exposure, like having up to dat electrical work)
• Loss must be random

Question 11

Define Risk Management

Answer 11

Analyzing exposure to risks and taking measures to minimize them

Question 12

Define Principle of Indemnity

Answer 12

Restoring the asset to the same condition as before a loss

Question 13

Define Adverse Selection

Answer 13

Insurers need to minimize adverse selection

• Poor risks could cost the insurance company a lot of money and compromise their ability to pay claims
• A person who takes 12 prescriptions is a poor risk

Question 14

Define a Hazard

Answer 14

A condition or situation that creates or increases a chance for loss

Question 15

What are the three types of hazards?

Answer 15

Physical: Overweight, poor health, blind….

Moral: Drugs/alcohol abuse

Morale: Reckless driving, stealing, racing…