Definitions (Chapter 2)

Question 1

Law of Large Numbers

Answer 1

is a basic principle of insurance that the larger the number of individual risks combined into a group the more certainty there is in predicting the degree or amount of loss that will be incurred in any given period.

Question 2

Risk

Answer 2

is the uncertainty regarding loss; the probability of loss occurring for an insured or prospect.

Question 3

Peril

Answer 3

is the immediate specific event causing loss and giving rise to the risk.

Question 4

Speculative risk

Answer 4

is a type of risk that involves the chance of both loss and gain; it is not insurable.

Question 5

Pure risk

Answer 5

is type of risk that involves the chance of loss only; there is no opportunity for gain; insurable.

Question 6

Risk Avoidance

Answer 6

occurs when individuals evade risk entirely. It is the act of not doing something that could possibly cause a loss or the inactivity of participation in an event that may potentially cause a loss situation. An example would be driving an automobile. If you never leave the house you completely avoid the possibility of getting into an accident.

Question 7

Risk Reduction

Answer 7

takes place when the chances of loss are lessened. Changing one’s lifestyle to minimize a known risk is an example of risk reduction. You decide you cannot stay in the house all day, every day, so avoiding the risk of an auto accident is not possible. You decide to reduce the risk by only using public transportation.

Question 8

Risk Transfer

Answer 8

is the act of shifting the responsibility of risk to another in the form of an insurance contract. Through the insurance contract, the burden of carrying the risk and indemnifying the financial loss is transferred from the individual to the insurance company. Purchasing insurance does not eliminate risk entirely, however, it is one of the most effective ways of transferring risk.

Question 9

Adverse Selection

Answer 9

is selection ‘against the company’. Tendency of less favorable insurance risks to seek or continue insurance to a greater extent than others. Also, tendency of policy owners to take advantage of favorable options in insurance contracts.

Question 10

Reinsurance

Answer 10

is the acceptance by one or more insurers, called reinsurers, of a portion of the risk underwritten by another insurer who has contracted for the entire coverage.

Question 11

Hazard

Answer 11

is any factor that gives rise to a peril.

Question 12

Moral Hazard

Answer 12

is the effect of personal reputation, character, associates, personal living habits, financial responsibility, and environment, as distinguished from physical health, upon an individual’s general insurability.

Question 13

Morale Hazard

Answer 13

is hazard arising from indifference to loss because of the existence of insurance.