Insurance Flashcards
Risk
When we talk about risk in finance, we are talking about the chance that you could lose assets (like money, home, or car), or lose your earning potential (not make as much as you expected).
For example, if you invest your money in a company, there is a chance that the company might not do well and you could lose your money. This would be a loss of an asset.
Another example of a risk would be a construction worker who gets hurt on the job. If the injury is bad enough, the worker might not be able to do the same kind of work anymore and might have to find a new job that pays less money. This would be a loss of earning potential because the worker will no longer be making as much money as they were able to.
Risk and return
In general, the higher the risk, the higher the potential return. This is because investors are willing to take on more risk in order to potentially earn more money.
For example, a stock that is considered risky might have the potential for a higher return than a stock that is considered less risky.
However, it is important to remember that there is no guarantee of a higher return, and there is always the chance of loss.
Risk management
Risk management is the process of identifying, analyzing, and responding to risk. This involves looking at the potential risks involved in a financial decision, figuring out how likely they are to happen, and deciding how to respond.
For example, if you are considering investing in a company, you might look at the potential risks involved, such as changes in the economy or competition from other businesses.
You might then decide to invest a smaller amount of money or to invest in a different company with less risk.
Risks in finance
- Unemployment: the risk of losing your job and not being able to earn money
- Illness, injury, or disability: the risk of not being able to work and earn money because of a health problem
- Liability: the risk of being sued or held responsible for something that causes financial loss
- Property damage: the risk of damage to your home or other property that causes financial loss
- Theft: the risk of someone stealing your money or other assets
- Fraud: the risk of someone tricking you into giving away your money or other assets
- Identity theft: the risk of someone using your personal information to steal your money or other assets
- Inflation: the risk of the value of money going down, making it harder to buy the things you need
- Market fluctuations: the risk of the value of investments going up and down
Correlated and independent risks
Some risks are correlated, meaning that they are related to each other. For example, if you lose your job, you might also be at risk for not being able to pay your bills or for losing your home. Other risks are independent, meaning that they are not related to each other. For example, the risk of identity theft is not related to the risk of property damage.
Insurable and non-insurable risks
Some risks are insurable, meaning that you can buy insurance to protect against the potential financial loss. For example, you can buy homeowners insurance to protect against the risk of damage to your home, or you can buy health insurance to protect against the risk of illness or injury. Other risks are not insurable, meaning that there is no way to protect against potential financial loss. For example, there is no way to insure against the risk of inflation or market fluctuations.
Strategies of risk management
- Avoiding risk
- Reducing risk
- Retaining risk
- Transferring risk
(Not all of these will always be possible)
Avoiding risk: meaning, advantages, disadvantages
The first strategy for managing risk is to simply avoid it altogether. This can be done by choosing not to engage in activities that are risky, or by taking steps to prevent risky situations from occurring. For example, if you are concerned about the risk of getting into a car accident, you might choose to walk or take public transportation instead of driving.
Advantages:
- Avoiding risk is the safest option, as it eliminates the possibility of loss or harm altogether.
Disadvantages:
- It may not always be possible or practical to avoid risk. For example, you might not be able to avoid driving if you live in a rural area without access to public transportation.
- Avoiding risk can also limit your opportunities and prevent you from taking advantage of potentially beneficial situations.
Retaining risk: meaning, advantages, disadvantages
The third strategy for managing risk is to retain it, or to accept the possibility of loss or harm and be prepared to deal with the consequences. This can be done by setting aside money in an emergency fund, or by developing a plan for how to handle a potential loss. For example, if you work for yourself, you might save money in case you don’t have a lot of work or if a project gets cancelled. This way, you can still pay for things you need even if you don’t have a lot of work.
Advantages:
- Retaining risk can allow you to take advantage of potentially beneficial situations, without avoiding or reducing the risk.
- This strategy can also be more cost-effective than transferring risk, as it does not require you to pay for insurance or other forms of protection.
Disadvantages:
- Retaining risk means that you will be responsible for dealing with the consequences of a potential loss or harm.
- It may also require you to have access to financial resources or other forms of support in order to cope with a potential loss.
Reducing Risk
Another strategy for managing risk is to take steps to reduce the chance or impact of a potential loss. This can be done by implementing safety measures, using protective equipment, or taking other precautions. For example, you might choose to wear a helmet when riding a bike or to install smoke detectors in your home to reduce the risk of injury or fire.
Advantages:
- Reducing risk can help to minimize the potential for loss or harm, without completely avoiding the activity or situation.
- This strategy can be more practical and realistic than avoiding risk altogether.
Disadvantages:
- It may not be possible to completely eliminate the risk, even with precautions in place.
- Reducing risk can also require an investment of time, money, or effort.
Transferring Risk
The final strategy for managing risk is to transfer it to someone else, typically through the use of insurance or other forms of protection. For example, you might choose to purchase car insurance to transfer the risk of an accident to the insurance company.
Advantages:
- Transferring risk can provide you with financial protection in the event of a loss or harm.
- This strategy can also help to reduce your overall level of risk, as you will not be solely responsible for dealing with the consequences of a potential loss.
Disadvantages
- Transferring risk can be expensive, as you will need to pay for insurance or other forms of protection.
- It may also not be possible to transfer all of the risk, as insurance policies often have exclusions or limitations.
Insurance
Insurance is a type of contract that transfers the risk of something bad happening to an insurance company. In exchange for paying a fee or premium, the insurance company promises to help cover the costs of the unexpected event.
When people have insurance, they are less likely to worry about the costs associated with a bad situation because they know they will have help paying for it.
Key players involved in an insurance transaction
- The insured (You)
- The insurer (insurance company)
- The agent: The person who helps you buy the insurance policy. They represent either the insurance company or work independently to find the best policy for you.
- The underwriter: The person at the insurance company who decides how much risk they’re willing to accept and how much to charge for the premium.
How does insurance work?
Insurance works by spreading the risk of financial loss among many people. This is called pooling and diversifying risk. Imagine a group of 100 people who all buy insurance policies. Chances are, not all of them will have a bad event happen at the same time. So, the insurance company can use the money from everyone’s premiums to help pay for the losses of the few people who do experience a problem. This way, everyone in the group has some protection against unexpected events.
Insurance premiums
The amount the insured pays to the insurance company in order to have coverage
