Chapter 2 Summary Flashcards
The Nature of Insurance
an insurance policy is the transfer of risk from one party to another in exchange for a fee (premium) using a legal contract.
insurance companies take one person’s risk of loss and spread it among all parties who are participating in the insurer’s risk pool, as evidenced by the payment of premiums.
The “Principle of Indemnification” is financial. Any insurance contract that’s based on this principple intends to restore insureds to their original financial position after they suffer losses.
the same principle stipulates that insureds will not profit or gain from their loss. In other words, they will not recieve more than they lost.
Indemnity
the amount needed to restore the insured’s financial status.
indemnifying
the act of restoring the amount needed to restore the insured’s financial status.
law of large numbers
the greater the number of homogenous loss exposure, the more accurate the prediction of the aggregate risk within an insurance pool.
adverse selection
the tendency for high than average risks to seek out insurance more frequently than lower risks.
peril
the immediate and specific cause of a loss
insurance policies that cover specified or named perils will individually list the perils that they cover. if the peril that causes a loss is not listed, then the loss is not covered.
insurance policies that use special or open peril definition of covered perils will cover losses that result from any cause (peril) whih is not explicitly excluded in the policy.
loss
an unintended (by the insured) loss of financial or monetary value
occurrence
the event that causes a loss. an occurence takes place at a specific time or place or develops over time before it makes itself known. an accident is an occurence, but not all occurrences are accidents.
other occurences such as illness, repetitive motion injuries, or exposure to toxins may cuse an indentifiable loss, but it’s not possible to determine the exact moment that the loss occured.
accident
a type of occurence but its unexpected and unintended. an accident happens at a specific time and place and causes a measurable loss.
direct loss
occurs when people are harmed, or a covered peril damages property.
indirect loss or “consequential loss”
results from direct loss, such as the loss of revenue when a business shuts down to rebuild after a fire. Disability insurance also covers a consequential loss- the loss of income when a person cannot work because of an illness or injury (direct loss)
loss exposure
the risk of a possible loss. basically, any situation that presents the possibility of a loss. in some cases, the term is used to refer to a loss exposure unit.
homogeneous exposure units
individual entities that are exposed to the same group of perils. their similarities allow them to be grouped together so that the same actuarial assumptions can be applied when pricing coverage
hazard
a physical condition, a way of acting, or a way of thinking that increases the likelihood that a loss will occur.
types of hazards
Physical hazards- physical or tangible conditions that make a loss more likely to occur, such as the increased risk of disability if a person has chronic back problems.
moral hazards
make the loss more likely to occur due to the dishonest character of the insured or harmful acts that are done intentionally. cigarette smoking is an example of a legal action that’s considered a moral hazard. Falsifying the circumstances of an automobile insurance claim to avoid paying a deductible or being held liable is both illegal and evidence of a moral hazard.
morale hazards
arise from a state of mind that’s indifferent to the possibility of loss because of the existence of insurance.
risk
the uncertainty regarding the occurance of a loss
speculative risks
not insurable as they result in financial gains as well as losses
pure risks
insurable because there’s only the potential for loss
insurable risks must include…
an insurable loss must be due to chance (accidental), which means the cause must be outside an insured’s control.
an insurable loss must be predictable (calculable). There must be a sufficient number of homogeneous loss exposures.
an insurable loss cannot be catastrophic. If the potential loss is too large or unpredictable, an insurer cannot financially survive after paying a claim.
An insured consumer must have a substantial loss exposure to make the option of buying insrance economically reasonable.
the premium cost must be affordable.
risk classifications
standard risks- have an average potential for loss.
substandard risks- have a higher than average potential for loss.
preferred risks- have a lower than average potential for loss.
risk managers analyze existing loss exposures and create programs that manage the risk using one or more of the following risk mnagement tools
risk avoidance- eliminates situations that expose a person to risk
risk reduction- accepts the existence of a risk but takes actions to reduce the likelihood or severity of a loss, LOSS PREVENTION is a form of risk reduction. the insured takes actions that eliminates damage or loss.
risk retention
occurs when a person accepts a degree of risk and creates a reserve to pay for it if needed
risk transfer
the practice of transferring risk from one party to another and is the basis of insurance.
risk sharing
spreads risk among multiple parties that each assumes a portion of the covered losses.
risk pooling
spreads risk by distributing the anticipated cost of future losses among many individuals; transfers the risk of loss from an individual group.
reinsurance
a form of risk transfer between insurance companies
the ceding primary insurer transfers excess risk (risk in excess of its retention limit for a single exposure) to a reinsurance carrier that assumes the risk after recieving a premium from the primary carrier
