Chapter 2: Nature of Insurance, Risk, Perils & Hazard

Question 1

What is insurance?

Answer 1

The transfer of risk from one part to another through a legal contract.

Question 2

Risk Pooling

Answer 2

*AKA Loss Sharing
*Spreads risk by spreading the cost of possible losses over a large number of people
*Transfers risk from an individual > group

Question 3

Principle of Indemnification

Answer 3

*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.

Question 4

Law Of Large Numbers

Answer 4

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 -

Question 5

Adverse Selection

Answer 5

*The tendency for higher-than-average risks to seek out insurance.

Question 6

What is insurance underwriting designed to do?

Answer 6

*Designed to ensure that insurance carriers are fairly compensated for the actual risks they undertake when issuing insurance contracts.

Question 7

Profitable Distribution of Exposure

Answer 7

*Exists when the number of preferred risks is balanced with poor risk, and the average risks are in the middle.

Question 8

What are 2 ways to reduce the chance of adverse selection?

Answer 8

*Insuring large groups of individuals
*Competent underwriting

Question 9

Perils

Answer 9

An immediate specific event that causes loss

Question 10

Property Insurance

Answer 10

Covers loss by fire, lightning, windstorm hail, earthquake, and vandlism

Question 11

Liability Insurance

Answer 11

Covers the insured’s legal responsibility to indemnify a third-party harmed due to the insured’s negligence

Question 12

Accident and health insurance policies

Answer 12

Cover losses caused by illness and accidents

Question 13

Life Insurance and Annuities

Answer 13

Covered peril is mortality. Life insurance > premature death. Annuities > delayed death.

Question 14

Named Perils vs Special Perils

Answer 14

*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.

Question 15

Loss

Answer 15

An unintended, unforeseen reduction or destruction of financial or economic value.

Question 16

Direct Loss

Answer 16

Result when a person or property is damaged, destroyed or killed by a peril without any intervening cause.

Question 17

Indirect Loss

Answer 17

AKA Consequential Loss
A loss that is a consequence of or results from a diret loss.

Question 18

Accident

Answer 18

Unforeseen, unexpected, unintended and sudden event. Occurs at specific time and place.

Question 19

Occurrence

Answer 19

Any event that causes a loss. This includes accidents, injuries, illness as well as losses caused by repeated or continuous exposure to conditions.

Question 20

Loss Exposure

Answer 20

The risk of possible loss. Basically, any situation that presents the possibility of a loss.

Question 21

Homogeneous Exposure Units

Answer 21

*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.

Question 22

What are the 3 types of Hazards?

Answer 22

*Physical Hazards
*Moral Hazards
*Morale Hazards

Question 23

Physical Hazards

Answer 23

Physical or tangible conditions existing in a manner that makes a loss more likely to occur.

Question 24

Moral Hazards

Answer 24

Make the loss more likely to occur due to the dishonest character of the insured.

Question 25

Morale Hazards

Answer 25

*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.

Question 26

Risk

Answer 26

The potential or uncertainty for loss

Question 27

Speculative Risk

Answer 27

*A risk that presents the chance for both loss and gain.
*Non-insurable

Question 28

Pure Risk

Answer 28

A potential for loss only with no possibility of gain.
Insurable

Question 29

Elements of an insurable risk (6)

Answer 29

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

Question 30

What the 3 Risk Classifications?

Answer 30

Standard Risk
Substandard Risk
Preferred Risk

Question 31

Standard Risk

Answer 31

*Average potential for loss
*Predetermined standard premium

Question 32

Substandard Risk

Answer 32

*Judged to be a poor risk by the insurance company
*Increased premium or lower benefit or declined

Question 33

Preferred Risk

Answer 33

*Better than average risk for the insurance company
*Lower than average premium

Question 34

Risk Management

Answer 34

The process of analyzing exposures that create risk and designing programs to handle them

Question 35

How is risk management accomplished (4)?

Answer 35

1) Detecting the potential loss exposure
2) Selecting a method or tool to reduce risk
3) Executing action
4) Reviewing the measures taken, periodically.

Question 36

Risk Avoidance

Answer 36

A risk can be avoided by eliminating the activity or condition that exposes one to a type of loss or specific perils.

Question 37

Risk Reduction

Answer 37

Process by which one takes deliberate actions to reduce the likelihood of a loss

Question 38

Risk Retention

Answer 38

A conscious strategy in which one maintains a certain amount of reserves to address unexpected expenses causes by insurable losses

Question 39

Risk Transfer

Answer 39

A legal contract that transfers risk from one party to another

Question 40

Reinsurance

Answer 40

Transferring risk from one insurer to one or more other insurers.

Question 41

Risk Sharing

Answer 41

Spreads risk among multiple parites

Question 42

Prevention

Answer 42

Taking actions to eliminate damage or loss