Chapter 3 Ratemaking, Underwriting, and Rating

Question 1

Define rate

Answer 1

Is the price of a unit of insurance for a period of one year.

It is expressed in dollars and cents or as a percentage.

Question 2

Define premium

Answer 2

- is the total cost of an insurance policy.

- is calculated by multiplying the rate times the amount of insurance purchased.

Question 3

Define Law of Large Numbers

Answer 3

**- is the principle that the reliance to be placed upon a given probability is increased when the number of trials or cases is increased. **

Question 4

Define Theory of Probability

Answer 4

- relates to the likelihood of an occurrence.

- expressed by the ratio of the number of actual occurrences to that of possible occurrences.

Question 5

Define ratemaking.

Answer 5

- Is the process of establishing rates for each class of insurance.

Question 6

Define chance.

Answer 6

- is the probability of an event occurring.

- expressed by the ratio of the number of times the event actually happens to the number of times it could possibly happen.

Question 7

What THREE (3) factors affect the accuracy of predictions?

Answer 7

1. The size of the sample

2. Time period over which sample was taken

3. Conditions in the past relative to future conditions

Question 8

What is the difference between the probability and the uncertainty of an event occurring?

Answer 8

- The future can be predicted more accurately for a group of risks than for one risk.

- It can be more accurately predicted when based on past experience over a long period of time as opposed to a short term.

Question 9

List the steps required in the ratemaking process, describe what each entails, and explain why each one is necessary.

Answer 9

1. Classify risks - according to types of objects insured and hazards of exposure.
2. Gather statistics on past losses - the larger the group and the greater time period observed, the more stable the results.
3. Determine pure premium - is the premium required to meet the losses that occur.
4. Determine total premium
5. Determine rate

Question 10

What is the difference between named peril policies and multi-peril policies?

Answer 10

Named-peril policies - name the perils insured against

Multi-peril policies - are a combination of fire and crime insurance

Question 11

Define negligence.

Answer 11

- is the doing of something a reasonable person would not do or

- not doing something a reasonable person would do.

Question 12

What is a hazard?

Answer 12

• is a condition that may cause a peril to occur.

Question 13

What is the difference between a physical hazard and a moral hazard?

Answer 13

Physical hazard - refers to the physical features of a risk. It is readily identified and measured and can be removed or reduced by preventive methods.

Moral hazard - relates to the conditions attributable to the human element. It is more difficult to identify and impossible to eliminate or reduce it.

Both are conditions that may cause a peril to occur

Question 14

What is the subject of insurance contracts?

Answer 14

Risk

Question 15

Discuss the TWO (2) meanings of exposure as they relate to insurance.

Answer 15

1. Exposure - is the danger of loss, particularly fire, arising from what happens to another risk close by.

2. Exposure - is also the sum total of values insured under a policy (the total amount an insurer could become liable for under the policy)

Question 16

What factors will determine the amount an underwriter may be willing to insure on a given risk?

Answer 16

1. the concentration of values of this and nearby risks

2. reinsurance facilities available to reduce the risk to average proportions

Question 17

What is an insurer’s retention?

Answer 17

-is the amount an insurer retains for its own account not including reinsurance.

Question 18

Define reinsurance.

Answer 18

- is the process whereby an insurer may share its risk with another insurer (a reinsurer) by paying to that insurer a portion of the premium it receives for the risk.

Question 19

Who carries out the rating function?

Answer 19

Underwriters and rating clerks

Question 20

How are loadings and deductions (or credits) used in rating?

Answer 20

**Loadings are applied to basic rates to reflect features inferior or **

superior (credits) to the average risk of that class.

Question 21

What is the difference between ratemaking and rating?

Answer 21

Ratemaking - is the process of establishing rates for each class of insurance.

Rating - is applying the established rates to the specific items that are to be insured.

Both are factors in the determining the cost of insurance.