Insurance Licensing Chapter 1 Flashcards
Transfer the risk
When a consumer purchases insurance they transfer risk of loss to an insurance company (carrier).
What is a pure risk?
one that will result in either a loss or no change status and there is no possibility for gain.
Speculative risk
may result in a loss, gain, or no change in status.
loss
reduction, decrease ,or disappearance in value that affects someone’s property or financial position. A loss is the basis for a claim under an insurance contract.
Exposure
Exposure, or loss exposure, is the condition of being at risk for a loss, whether or not an actual loss occurs. People and property are at risk of loss purely by existing.
Peril
is the cause of loss.Fire, lightning, wind, death, and disability are common perils covered by various insurance policies
Fire
lightning
hail theft
Hazard
is a specific condition that increases the probability or likelihood that a loss will occur from a peril. Three types of hazards:physical,moral,and morale includes
icy parking lot
Arson
smoking
bungee jumping
Physical hazard
A physical condition that increases the probablility of loss.Physical hazards may often be seen, heard, felt, tasted, or smelled.
Examples: Flammable material stored near a furnace or an icy sidewalk
Moral hazard
Dishonest tendencies that increase the probability of a loss, including certain characteristics and behaviors of people. Moral hazards are most closely related to some form of lying, cheating, or stealing. Moral hazards are intentional, so these losses are not covered.
Examples: An insured burns down their own house or fakes an injury to collect the insurance payout.
Morale Hazard
An attitude of indifference toward the risk of loss that increases the probability of a loss occurring.
Example: The driver of a car stops at a convenience store to pick up a few items and leaves the car unlocked with the key in the ignition. This action increases the probability that the car may be stolen.
Risk sharing
means distributing or pooling a risk among several risk-takers with similar loss exposures who agree to cover each other for their losses. Risk sharing reduces the severity of the loss for any one party.
Risk Transfer
involves shifting a risk to another party. Obtaining an insurance policy, the most common means of managing risk, is an example of risk transfer because the policy makes the insurer responsible for paying covered losses.
Risk Avoidance
is the elimination of risk by not participating in activities that involve a chance of loss. Never operating a motor vehicle or not owning a car eliminates the risk of being at fault for an auto accident, but avoiding risks may also eliminate the possibility of enjoying life’s advantages. Avoidance is not always an effective method of managing risk, in which case other methods must be used.
Risk Reduction
involves minimizing the risks we cannot completely avoid. For example, installing fire sprinklers may reduce damage in the event of a fire. Reduction is usually not a complete solution to most risks, however, since it cannot completely account for the element of chance.
Risk Retention
means maintaining responsibility for a loss, like with self-insurance, whereby an organization sets aside funds to pay potential losses
Insurable Risks
There must be a large number of homogeneous (like) units with comparable exposures to help accurately predict future lossesThe chance of loss must be statistically calculable, and the premium must be affordable for the consumer
The loss must be uncertain, accidental, and due to chance
The loss must be measurable, meaning it is definite and verifiable in terms of amount, cause, place, and time
The loss must cause a financial hardship
Law of large numbers
The law of large numbers is a probability theory stating that the larger the number (sample size) of units with the same or similar exposures, the greater the accuracy in predicting losses. This helps the insurer determine the premium it needs to charge to cover the number of predictable losses. A large number of units with the same or similar exposures is referred to as homogeneous units.
Adverse Selection
is the principle that people will seek insurance more frequently for risks that are hard to insure. This is because there is a higher probability that these losses will occur and they may occur more frequently, compared to average risks that have a lower probability of loss. This creates an imbalance, since insurance companies aim to spread out the high risks with the average risks.
Reinsurance
Essentially, reinsurance can be thought of as insurance for insurers. It is a device used by insurers to spread their risk and limit the loss they will face in the event of a large claim or catastrophic loss, which helps stabilize profits, increase the insurer’s ability to underwrite risks, and build confidence with consumers and investors. At least two insurers are involved: the primary or ceding insurer, which is the insurance company that transfers the risk, and the reinsurer, which is the insurance company that accepts the transfer and shares the risk.
If an insurance company wants to transfer all or part of the risk it has accepted, it would buy which of the following types of insurance?
Reinsurance
Treaty reinsurance
enables an insurer to cede an entire class of risks automatically to a reinsurer, such as ceding all of its Homeowners contracts
Facultative reinsurance
enables the ceding insurer and reinsurer to negotiate coverage in order to transfer a single risk, allowing the reinsurer to accept or reject individual risks at its discretion
Residual Market
Those with higher risks that are rejected by the voluntary market may be eligible for coverage through residual markets, which are last-resort coverage sources. Residual markets often exist to provide basic property insurance on real property, state-required personal auto liability coverage, or Workers’ Compensation coverage.
Private Insurer
carriers are non-governmental entities and typically write insurance on a for-profit basis
Government Insurer
Examples of government insurance are the Social Security and Medicare programs, the National Flood Insurance Program (NFIP), Federal Crop insurance, and Terrorism Risk insurance.
Stock Insurance Company
A stock company is owned by its stockholders, or shareholders. The stockholders elect a board of directors to manage the company and the board then elects officers to handle the day-to-day activities. Stockholders share in the company’s profits and may receive taxable corporate dividends when and if declared by the directors, though dividends are not guaranteed. Traditionally, stock insurers issue nonparticipating policies, since the policyholders are not entitled to dividends.
Mutual Insurance Company
A mutual company is owned by policyholders, who may be referred to as members. A board of directors is elected by the members to manages the company, and officers elected by the board handle the day-to-day operations. When and if declared by the board, members may receive non-taxable dividends as a return of any divisible surplus. These dividends are not guaranteed and are considered a return of premium based on any surplus at the end of the year once all claims and operating expenses have been paid. Because policyholders may receive dividends, mutual insurers typically issue participating policies.
Which type of insurer is owned by its policyholders?
Mutual insurance company
Fraternal Insurers
Fraternal benefit societies are primarily social organizations that engage in charitable and benevolent activities that provide primarily life insurance to its members. They are usually organized on a nonprofit basis. Membership is typically drawn from members of a given religious denomination or lodge, order, or society, and that membership is a requirement to participate.
Reciprocal Insurance Company
A reciprocal insurance company is an unincorporated, group-owned insurer whose main activity is risk sharing. It is an aggregation of individuals, firms, businesses, and corporations that exchange insurance on one another’s risks. Each member is known as a subscriber, and each subscriber assumes a part of the risk of all other subscribers. The exchange of insurance is effected through an attorney-in-fact. If premiums collected are insufficient to pay losses, an assessment of additional premium can be made.
Risk Retention Groups (RRGs)
A risk retention group is a corporation whose primary activity consists of assuming and spreading the liability exposure of its group members. Membership is limited to risks with similar liability exposures through a common business, trade, product, service, premises, or operation. Risk retention groups are licensed as a liability insurance company under the laws of a particular state and may insure members of the group in any other state. Each member assumes a portion of risk. A risk retention group is managed by an attorney-in-fact.
Examples include groups associated with amusement or theme parks, go-karts, and waterslides, as well as medical and dental professionals, engineers, and accountants.
Risk Purchasing Groups
A risk purchasing group purchases liability insurance only for its group members and only to cover similar or related liability exposures. A risk purchasing group is different from a risk retention group in that a purchasing group does not assume its own risks like an RRG. Instead, the purchasing group purchases insurance from an insurer or a risk retention group, which assumes the risk.
Lloyd’s Associations
Technically, Lloyd’s associations are not insurance companies. Instead, they are composed of groups of underwriters, each of which specializes in insuring a particular type of risk, and brokers to form syndicates, which will then offer coverage for higher than average risks. Participants are individually liable only for the risks they assume.
Syndicates are groups of underwriters and brokers that form:
Lloyd’s associations
Self-Insurers
Groups and associations with specific underwriting needs may find self-insuring against loss more cost effective than paying premiums for insurance. Larger employers with stable cash flows may choose to self-fund some of their group insurance needs, or for their workers who may be entitled to Workers’ Compensation benefits.
Captive Insurance Company
A captive insurance company, also called a captive, is a form of self-insurance where large corporations create their own insurance entity that is owned and controlled by the parent corporation. In other words, the insurer is owned and controlled by its insureds. Most Fortune 500 companies utilize captives.There are financial benefits to creating captives, such as certain tax advantages, but these companies will have additional administrative, overhead, and personnel costs.
State laws dictate how captives may be formed. Captives are commonly allowed to be incorporated as a stock insurer, mutual insurer, reciprocal insurer, nonprofit corporation, or limited liability company (LLC).
Insurer Domicile
Domicile refers to the jurisdiction (state, district, territory, or country) where an insurer is formed or incorporated. There are three kinds of insurer domiciles: domestic, foreign, and alien.
Domestic Insurer
An insurer organized under the laws of this state, whether or not it is admitted to do business in this state.
Foreign Insurer
An insurer not organized under the laws of this state, but in one of the other states or jurisdictions within the United States, whether or not it is admitted to do business in the state or jurisdiction.
Alien Insurer
An insurer organized under the laws of any jurisdiction outside of the United States, whether or not it is admitted to do business in this state. In the state of Kansas, an insurer organized under Kansas law would be a domestic insurer, an insurer organized under Missouri law would be a foreign insurer, and an insurer organized under Canadian law would be an alien insurer.
An insurance company that is organized under the laws of a different state within the United States is known as
Foreign Insurer
Insurer Admittance
An admitted, or authorized, insurer is authorized to transact insurance in a given state, and will be granted a certificate of authority from that state’s department of insurance. Admitted insurers may be domestic, foreign, or alien insurers.
Non-admitted (Unauthorized) Insurers
A non-admitted insurer is not authorized to transact insurance in a given state, either by failing to comply with state requirements or by not seeking admission. Generally, non-admitted insurers cannot do business on risks located in a given state.
example of non admitted insurer
surplus lines insurer, which can insure risks in states it is not admitted in when coverage cannot be obtained from admitted insurers, usually because the risk is too great or too difficult to underwrite. Surplus lines insurance is transacted through licensed surplus lines brokers, and each state regulates the procurement of surplus lines insurance.
Insurer Management
The Actuarial Department gathers and interprets statistical information to determine the probability of a loss. This information is used to determine premium rates used by the insurer. A rate is the dollar amount charged for a particular unit of insurance, such as $5 per $1,000 of insurance coverage. The rates established by actuaries are kept in the insurer’s rating manuals.
Underwriting Department
is responsible for selecting risks and selecting the specific rate that applies to those risks in order to determine the actual policy premium for an applicant. The premium is the total cost for the amount of insurance purchased by an insured.
Which insurance company department selects the risks that the insurance company will insure?
Underwriting
Underwriting
The underwriter’s primary responsibility is the selection of risks (persons or property) to be insured. Importantly, underwriting protects the insurer against adverse selection, as underwriters can identify risks that are more likely than average to suffer losses. In other words, the goal of the underwriter is to select risks whose future losses fall into the normal range of expected losses. Ideally, underwriters want to balance the number of insureds in different risk classifications: too many low-risk clients and the insurer may not generate enough profits, and too many high-risk clients may cause the insurer to pay more claims than it is able to pay.
To select risks, underwriters check for insurability, meaning the applicant is able to meet the insurer’s underwriting requirements. The producer is the field underwriter who makes an initial decision about an applicant’s ability to meet those requirements, and line and staff underwriters are employed by the insurer to evaluate applications and manage the risk-selection process.
The underwriter determines the classification of the risk and, if accepted by an insurer, the risk’s premium rate.
Underwriting Factors
The insurance application is the primary source of information about the purchaser needed for the insurer to underwrite a risk, and it will become part of the insurance contract. When evaluating a risk, underwriters also examine:
The nature of the risk
What hazards are present
The applicant’s claim history
Other factors that may affect the type of risk being insured
Depending on the insurance being applied for, property and casualty underwriters may also take the following information into account:
Construction, including the materials used to construct the building, the age and location of the building, and the quality of the systems within the building
Occupancy of the building, meaning who occupies it and how it is used
Protection available for the building, such as the presence of fire sprinklers
Exposures around the building, such as unfenced swimming pools or environmental risks
Driving record and traffic violations based on motor vehicle reports
Credit-based insurance score, using credit information obtained through consumer reports. Some states limit or prohibit the use of credit scores when underwriting risks.
Property underwriters may use all of the following factors to evaluate a risk, except:
Martial status
Premium Assumptions
An adequate premium must be charged for the risk based on the same factors used in evaluating the risk. Premiums are calculated based on the appropriate rate selected by the underwriter.
Since insurers cannot know in advance the actual costs of providing insurance, underwriting allows the insurer to gather information about applicants to make educated estimates of costs and compare that to the insurer’s ability to pay those costs. Premium rates are considered inadequate when they do not cover projected losses and expenses, and rates must not be excessive or unfairly discriminatory.
Educated estimates
Since insurers cannot know in advance the actual costs of providing insurance, underwriting allows the insurer to gather information about applicants to make educated estimates of costs and compare that to the insurer’s ability to pay those costs. Premium rates are considered inadequate when they do not cover projected losses and expenses, and rates must not be excessive or unfairly discriminatory.
