Chapter 3 - ratemaking, underwriting, rating Flashcards
Define rate.
- the price of insurance for a period of one year
Define premium.
- is arrived at by multiplying the rate times the amount of insurance purchased.
- it is the total cost of an insurance policy or a portion of that policy.
What is ratemaking?
- the process of establishing rate for each class of insurance
- is carried out by actuaries who are highly trained professionsals
- they may be employed insurers or an organization that specializes in determining advisory rates
What principles are required to determine premiums?
- law of averages (law of large numbers)
- theory of probability.
Define law of large numbers.
- the principle that the reliance to be placed upon a given probability is increased when the number of trials or cases is increased
Define theory of probability.
- relates to the likelihood of an occurrence, expressed by the ratio of the number of actual occurrences to that of possible occurrences
- # of actual occurrences/# of possible occurrences = probability or chance of event happening
- usually spoken of as the chance that the event will happen
What factors is the reliability of predictions dependant on?
1) size of sample
- more reliable with larger size
2) time period over which sample was taken
- more reliable results with longer time periods
3) conditions in the past relative to future conditions
- predictions of events in the future based on past events tend to be reliable
What are the steps in rate determination?
1) classifcation of risks established on:
a) types of objects insured
b) hazards of exposure
2) Gather statistics on past losses
- validity depends on loss data covering a number of losses over a period of time
- used to predict future
3) Determine pure premium (premium required to meet the losses that occur)
4) Determine total premium
- pure premium + loadings, repair costs, inflation, overhead, profit, expenses (such as cost of production)
5) Determine rate
What do loadings (for trends in accidents) include?
- increases in unexplained fires
- more auto theft
- increases in severe weather disturbances
What does cost of production include?
- brokers
- commissions
- promotion
- advertising
What does overhead include?
- providing for business premises
- equipment
- office supplies
- staff salaries
- taxes
Define chance.
- the probability of an event occurring
- may be represented as a fraction
- numerator is the # of times event happens
- denominator is the # of times event may possibly happen
- stats on losses suffered by a large # of people, the # of losses suffered by a similar group can be predicted with reasonable accuracy.
What are policies referred as when they name the perils they insure?
- named-peril policy
What are policies referred as when they are a combination of fire and casualty?
- multi-peril
What does an all risks policy entail?
- may sound all inclusive but include exclusions for certain events or perils
What are crime coverages made up of?
- burglary, robbery, theft, hold-up, dishonesty, embezzlement, and forgery are perils clearly defined in fidelity and burglary insurance which makes up the crime coverages
What does boiler and machinery insurance cover?
- breakdown and explosions
What does auto insurance cover?
- all perils
- collisions
- upset
- fire
- theft
Define negligence.
- is the doing of something a reasonable person would not do or not doing something a reasonable person would do
What is physical hazard?
- refers to the subject matter of insurance aka the physical features of a risk
ex) construction of property, location in relation to water supplies for firefighting, existence of fire and burglar alarms, age, make and model of a vehicle
What is a moral hazard?
- relates to the conditions attributable to the human element
- grows out of attitudes
- depends on the character of insured
- includes dishonesty and fraud
What are examples of preventative measures used to remove or reduce a physical hazard?
- non-skid wax
- fasten down loose flooring
- clean and maintain heating systems
- correct overfusing
- sprinklers, fire extinguishers, smoke alarms installation
- burglar alarm, safe, vault, guard, procedures on how to handle money
What is the subject of an insurance contract?
- risk
- may be accepted or rejected based on level
What is an application?
- request for insurance
What does an underwriter do?
- looks at both the risk and the applicant
decides whether to: - accept risk
- reject risk
- accept risk subject to certain conditions
What will underwriters base their decision on?
1) personal info about applicant
2) details of physical hazard and exposures to risk under consideration
3) special factors pertaining to the class of risk or type of insurance
Define exposure.
- is the danger of loss arising from what happens to another risk close by
- is also the sum total of values insured under a policy, aka, the total amount the insurer could become liable for under a policy
What are the reasons for rejecting a risk?
1) insurer may not insure that class of insurance
2) the risk may be too hazardous and has an almost certain potential for loss
3) risk may be substandard
- the potential for improving it exists, but the applicant is not prepared to carry out suggested improvements
Define retention.
- is the amount an insurer retains for its own account not including reinsurance
Define reinsurance.
- is the process whereby an insurer may share its risk with another insurer by paying to that insurer a portion of the premium it receives for the risk.
- its a mean of spreading the risk further
What depends on the amount an insurer will cover?
1) concentration of values
- of this AND other nearby risks
- if the risk involves coverage against loss by fire or is sibject to catastrophic loss possibility
2) reinsurance facilities
- available to reduce the risk to average proportions and to keep amount of retention within the maximum limit laid down in overall company policy by the directors
Define loading.
- is an additional charge included in an insurance rate to reflect a hazard not contemplated in the basic rate of the class
What are factors for risk selection?
- subject
- application
- exposure
- info from technical services
Define casualty insurance.
- is loosely used to describe an area of insurance not particularly or directly concerned with life insurance, fire insurance, or auto insurance.
- most frequently it refers to liability, crime, and plate glass insurance but may include surety as well
Define inland marine insurance.
- refers to coverages for almost anuthing that is not insured under a property or casualty policy.
- includes such diverse items as movable property such as contractors equipment, tools, accounts receivable policies, property in transit (except sea voyages)
- but also includes bridges, wharves, tunnels, power transmission lines and pipelines because they are instruments of transportation (and are also referred to as real property)
Define rating.
- is applying the established rates to the specific items that are to be insured.
