Chapter 2: Nature of Insurance, Risk, Perils & Hazard Flashcards
What is insurance?
The transfer of risk from one part to another through a legal contract.
Risk Pooling
*AKA Loss Sharing
*Spreads risk by spreading the cost of possible losses over a large number of people
*Transfers risk from an individual > group
Principle of Indemnification
*The goal of an action is to restore an insured to the same financial position tha he or she was in prior to the loss. The insured will not profit or gain.
Law Of Large Numbers
AKA Spread The Risk
*Larger groups provide an increased degree of accuracy in loss predictions.
*Actuaries use it to predict the total amount of expected loss in a risk pool -
Adverse Selection
*The tendency for higher-than-average risks to seek out insurance.
What is insurance underwriting designed to do?
*Designed to ensure that insurance carriers are fairly compensated for the actual risks they undertake when issuing insurance contracts.
Profitable Distribution of Exposure
*Exists when the number of preferred risks is balanced with poor risk, and the average risks are in the middle.
What are 2 ways to reduce the chance of adverse selection?
*Insuring large groups of individuals
*Competent underwriting
Perils
An immediate specific event that causes loss
Property Insurance
Covers loss by fire, lightning, windstorm hail, earthquake, and vandlism
Liability Insurance
Covers the insured’s legal responsibility to indemnify a third-party harmed due to the insured’s negligence
Accident and health insurance policies
Cover losses caused by illness and accidents
Life Insurance and Annuities
Covered peril is mortality. Life insurance > premature death. Annuities > delayed death.
Named Perils vs Special Perils
*Named Perils: insurance contracts that cover specified or named perils individually list those perils that they cover.
*Special Perils: Do not name the perils they cover; instead they list those perils that they exclude.
Loss
An unintended, unforeseen reduction or destruction of financial or economic value.
Direct Loss
Result when a person or property is damaged, destroyed or killed by a peril without any intervening cause.
Indirect Loss
AKA Consequential Loss
A loss that is a consequence of or results from a diret loss.
Accident
Unforeseen, unexpected, unintended and sudden event. Occurs at specific time and place.
Occurrence
Any event that causes a loss. This includes accidents, injuries, illness as well as losses caused by repeated or continuous exposure to conditions.
Loss Exposure
The risk of possible loss. Basically, any situation that presents the possibility of a loss.
Homogeneous Exposure Units
*Similar objects of insurance exposed to the same group of perils.
*The larger the number of homogenous units, the easier it is to predict loss.
What are the 3 types of Hazards?
*Physical Hazards
*Moral Hazards
*Morale Hazards
Physical Hazards
Physical or tangible conditions existing in a manner that makes a loss more likely to occur.
Moral Hazards
Make the loss more likely to occur due to the dishonest character of the insured.
Morale Hazards
*Result from the personal or subjective thought process of the insured.
*Arise from a state of mind related to the indifference of an insured to whatever loss may occur.
Risk
The potential or uncertainty for loss
Speculative Risk
*A risk that presents the chance for both loss and gain.
*Non-insurable
Pure Risk
A potential for loss only with no possibility of gain.
Insurable
Elements of an insurable risk (6)
1) Loss must be due to chance/accidental
2) Loss must be definite and measurable
3) Loss must be predictable
4) Loss cannot be catastrophic
5) Number of loss exposure units to be insured must be substantial
6) The premium cost must be economically feasible
What the 3 Risk Classifications?
Standard Risk
Substandard Risk
Preferred Risk
Standard Risk
*Average potential for loss
*Predetermined standard premium
Substandard Risk
*Judged to be a poor risk by the insurance company
*Increased premium or lower benefit or declined
Preferred Risk
*Better than average risk for the insurance company
*Lower than average premium
Risk Management
The process of analyzing exposures that create risk and designing programs to handle them
How is risk management accomplished (4)?
1) Detecting the potential loss exposure
2) Selecting a method or tool to reduce risk
3) Executing action
4) Reviewing the measures taken, periodically.
Risk Avoidance
A risk can be avoided by eliminating the activity or condition that exposes one to a type of loss or specific perils.
Risk Reduction
Process by which one takes deliberate actions to reduce the likelihood of a loss
Risk Retention
A conscious strategy in which one maintains a certain amount of reserves to address unexpected expenses causes by insurable losses
Risk Transfer
A legal contract that transfers risk from one party to another
Reinsurance
Transferring risk from one insurer to one or more other insurers.
Risk Sharing
Spreads risk among multiple parites
Prevention
Taking actions to eliminate damage or loss
