Lesson 1 of Insurance: Principles of Insurance Flashcards
Insurance!
- Insurance is used as a protection against financial loss.
- Insurance is only used to protect against “Pure Risks.”
- Planners need to address risk exposure in the client plan.
- Pure risks simply create either a financial loss or no loss.
- For example: house fires, auto accidents, and personal illness.
- Insurance involves the transfer of loss and the sharing of losses with others.
- Identify and transfer risk where possible.
- Home, liability, auto, life, disability, health, business, pet ownership
Types of Risk!
- Pure
- Speculative
- Subjective
- Objective
Pure Risk
- With Pure Risk, there is a chance of loss or no loss.
-
For example:
- Death
- Auto accidents
- House fire
Speculative Risk
- With speculative risk, there is a chance of profit, loss, or no loss.
- Speculative Risk is generally undertaken by entrepreneurs.
- Speculative risk is generally voluntary risk and not insurable.
Subjective Risk
- Subjective risk differs based upon an individual’s perception of risk.
-
FOR EXAMPLE:
- Tom movies to Dunwoody, Georgia. His neighbors told him that the police department has a reputation for writing speeding tickets. As a result, Tom buys a radar detector because he perceives there to be a significant risk of getting a speeding ticket.
Objective Risk
- Objective Risk does not depend on an individual’s perception but is measurable and quantifiable.
- Objective Risk measures the variation of an actual loss from expected loss.
-
FOR EXAMPLE:
- Statistics published for the number of speeding tickets written per driver living in a city would confirm or disprove the subjective risk perceived by Tom in the previous example.
Understanding Risk!
- Probability of Loss
- Severity
- Law of Large Numbers
Probability of Loss
- The probability of a loss incurring is the “chance” of a loss incurring.
- It is the measure of the long-run frequency with which an event occurs.
- The probability of a loss is a useful measure for the insurer because it quantifies the expected cost of claims.
- A higher probability of loss may result in a decline of coverage.
Severity
- Severity is the actual dollar amount of the loss.
- Severity is more important than the probability of a loss.
-
EXAMPLE:
- Building a house on the beach increases the probability of a loss occurring due to a hurricane. If the house of built on the beach and it cost $750,000 for the land and $250,000 to build the house, the maximum severity of a loss due to a hurricane would be $250,000 or the cost to build the house.
Law of Large Numbers
- The Law of Large Numbers specifies that when more units are exposed to a similar loss the PREDICTABILITY of such a loss to the entire pool increases.
- The more exposures, the more likely that the result will equal true results and thus will be predictive of future results.
- The Law of Large Numbers helps to reduce objective risk.
Causes of Insured Loss
Perils
Hazard:
- Moral
- Morale
- Physical
Adverse Selection
Perils
Perils are the actual cause of a loss.
FOR EXAMPLE:
- Fire
- Wind
- Tornado
- Earthquake
- Burglary
- Collision
Hazard
A hazard is a condition that increases the likelihood of a loss occurring.
There are three types of hazards:
- Moral
- Morale
- Physical
Moral Hazard
- A moral hazard is a character flaw.
- A character flaw would lead to filing a false claim.
-
FOR EXAMPLE:
- A famous running back for Ohio State claimed his car was broken into and $10,000 worth of CDs were stolen. There certainly wasn’t $10,000 worth of CDs in his car and thus is an example of false claim.
Morale Hazard
Morale Hazard is the indifference created because a person is insured.
FOR EXAMPLE:
- Beth goes to the convenience store to get milk for her baby. Beth leaves her keys in the car and leaves the car running while goes into the store, not concerned that her car may get stolen because she has car insurance.
E in the end for IndifferencE and moralE.
Physical Hazard
A physical hazard is a tangible condition that increases the probability of a peril occurring.
FOR EXAMPLE:
- Icy or wet roads
- Poor lighting
- Defective Equipment
EXAMPLE:
- Leaving a banana peel on the porch.
Adverse Selection
Adverse selection
- is the tendency of a person with higher-than-average risks to purchase or renew insurance policies.
Premiums are dependent upon a balance between favorable and unfavorable risks in the pool.
Adverse Selection is managed through
- underwriting,
- denying insurance on the front end, and
- raising premiums on the back end.
Someone who would probably need insurance, like overweight disabled.
EXAM QUESTION:
The underwriter of an insurance company is charged with the responsibility of achieving a profit within the risk parameter of the company. Which of the following is the underwriter’s greatest challenge?
A) Setting Premiums
B) Managing Adverse Selection
C) Making sure the profit margins are correct
D) Motivating salespeople
Answer: B
Managing adverse elections may be accomplished before the contract is issued by using credit scores, physicals, claims history, etc, or on the back end of the property, automobile health, and dental insurance by raising premiums.
Insurable Losses!
Requisites for an Insurable Risk
Requisites for an Insurable Risk
- A large number of similar (homogenous) exposure units. (Law of Large Numbers)
- Losses must be accidental from the insured’s viewpoint.
- Losses must be measurable and determinable so that the insurer can accurately forecast actual losses.
-
FOR EXAMPLE:
- It’s easy to determine the value of a house or auto, but it’s difficult to determine the amount of cash in a wallet; therefore, coverage is limited.
-
FOR EXAMPLE:
- Losses must NOT pose a catastrophic risk for the insurer. (Insurance Company)
- An insurer cannot provide coverage that would cause it to become financially insolvent.
- Premiums must be affordable
- Cannot insure moral hazards because premiums would skyrocket.
Exam Tip for Insurable Risks
Are CHAD
- Not catastrophic
- Homogenous exposure units,
- Accidental
- Measurable and Determimable.
Exam Question
Which of the following is not a requisite for an insurable risk from an insurer’s perspective?
A) Law of Large Numbers
B) Losses must be accidental, measurable, and determinable
C) Losses must not pose a catastrophic risk for the insured.
D) The premiums must be affordable
Answer: C
Losses must not pose a catastrophic risk for the insurer. The insured wants to transfer catastrophic risks.
Legal principles of all Contracts!
Elements of a Valid Contract
Elements of a Valid Contract
One party must make an offer and the other party must accept the offer.
- The signing of an insurance application and paying the first premium can be considered an offer and acceptance.
- This would be considered a conditional receipt as long as the insured qualifies for the policy.
- Once the policy is actually delivered and the first premium is paid, the contract is fully in force.
There must be legal competency of all parties involved in a contract.
- Both parties must be 18 or older. Otherwise, the contract is voidable by the minor.
There must be legal considerations.
- Consideration is whatever is being exchanged.
- It can be money, services, or property.
- A promise to pay (insurer) and actual payment of a premium (insured).
The contract must pertain to a lawful purpose.
- Insurance contracts that promote actions that are illegal are invalid.
EXAM TIP to Remember Elements of a Valid Contract
A legal contract requires COALL!
- Competent parties
- Offer and Acceptance
- Legal Consideration
- Lawful Purpose
Legal Principles of Insurance Contract!
- The Principle of Indemnity
- Subrogation Clause
- The Principle of Insurable Interest
- Void versus Voidable
The Principle of Indemnity
- An insured is only entitled to compensation to the extent of the insured’s financial loss.
- An insured cannot make a profit from an insurance contract.
Subrogation Clause
- The insured cannot receive compensation from both the insurer and a third-party claim.
- If the insured collects compensation from their insurance company, they lose the right to collect compensation from the third party.
- The insurer “steps into the shoes” of the insured to recoup any restitution from the 3rd party or the 3rd party’s insurer.
The Principle of Insurable Interest
- An insured must have an emotional or financial hardship from damage, loss, or destruction.
-
Property and Liability Insurance
- the insured must have an insurable interest at the time of policy INCEPTION and at the TIME OF LOSS
-
Life Insurance
- the insured only needs an insurable interest at the time of policy INCEPTION
- Rule of Thumb: Insurable interest if Blood, Marriage or Business
- Life insurance policies are considered long-term investments.
EXAMPLE of Life Insurance policy
Sally was married to Harry for 20 years. Sally was a stay-at-home mom for most of the marriage. Sally and Harry recently divorced. Although Sally may no longer have an insurable interest in Harry, if Sally had to surrender her life Insurance policy on Harry, it could cause financial hardship. She may not have any savings or personal retirement savings.
Sally would have Life Insurance, Insurale Interest because it is only for Time of Policy Inception. .
Void Contract
- A void contract was never valid and thus never came into existence.
- It is not an enforceable contract since it lacks one of the four elements of COALL.
-
FOR EXAMPLE:
- A contract to sell heroin in the United States is a void contract since it is established for an unlawful purpose.
Voidable Contract
A voidable contract
- is a valid contract that allows cancelation by one of the first parties however the other party is bound by agreement.
FOR EXAMPLE:
- If a minor enters into an agreement to purchase a car the contract is valid but voidable by the minor (not a competent party).
- The car dealership, however, bound by the contract.
EXAM QUESTION
Mike is injured in an auto accident caused by Tim. Mike collects bodily injury payments from his insurance company and sues Tim to recover as well. Tim’s insurance company also pays Mike for the same injuries. Which of the following has been violated?
A) Subjective Risk
B) Adverse Selection
C) Adhesion
D) Subrogation
Answer: D
The subrogation clause in an insurance contract prevents from Mike collecting both his insurance company and a third party party in the same claim.
The Principles of Good Faith!
- Warranty
- Representation
- Concealment
Warranty
- A warranty is a promise made by the insured to the insurer.
- A breach of warranty is grounds for avoidance.
-
EXAMPLE:
- A college football player who is drafted in the first round typically agrees not to participate in activities that could result in physical injury, such as riding a motorcycle. Kellen Winslow, a first-round draft pick a few years ago agreed to such terms, but shortly into his contract, he was involved in a motorcycle accident. The injuries were so severe that he was unable to play for an entire year. Because he violated a warranty in his contract, the team was entitled to recoup a portion of his $6 million signing bonus.
Representation
Representations are statements made by the
- insured to the insurer during the application process.
There must be a MATERIAL “misrepresentation” to
- avoid an insurance contract.
Misrepresenting age on a life insurance application is
- not material misrepresentation and the insurer will simply adjust your death benefit up or down based on your actual age.
Concealment
- When the insured is silent about a fact that is material to the risk.
EXAM QUESTION
Dave is 42 years old and applying for a life insurance policy, In order to receive a lower premium, Dave indicates that he is 34 on the insurance application. Which of the following is the insurance company to do when they determine Dave’s right age?
A) Avoid the contract
B) Void the contract
C) Pay Dave’s beneficiary a lesser face value that is based on the premiums paid and Dave’s correct age.
D) Refund the premiums and deny any claim by Dave’s beneficiary.
Answer: C
Misstating age is a misrepresentation but not a material misrepresentation and the insurance company will still pay the beneficiary. The amount will just be reduced based on the actual premiums paid by the insured and the insured’s correct age.
Distinguishing Characteristics of Insurance Contracts!
- Adhesion
- Aleatory
- Unilateral
- Conditional
Adhesion
- An insurance policy is basically “take it or leave it.” There are no negotiations over terms and conditions.
- As a result, any ambiguities in an insurance contract are found in favor of the insured.
Aleatory
- The money exchanged may be unequal.
- In other words, there’s a small premium, but the insured may receive a large benefit.
Unilateral
- Only one promise is made by the insurer which is to pay in the event of a loss.
- The insured is not obligated to pay premiums.
- If the premiums are not paid, there there’s just no promise by the insurer.
Conditional
- The insured must abide by the terms and conditions of the insurance contract. If the terms and conditions are not followed, the insurer may not pay a claim.
EXAMPLE:
- After a heavy rainstorm, Eric notices a small leak in his ceiling. Eric places a small plastic cup underneath the leak and decides that he will call his roofer upon returning from a three-week vacation that he starts tomorrow. Upon his return, the small leak turned into a large leak to the point where his ceiling in the living room and attached garage collapsed on his car, ruined his entertainment center and electronic equipment causing $30,000 in damage. The insurance adjuster determines that Eric did not take appropriate steps to minimize the loss when he first discovered the leak and denies Eric’s insurance claim. Eric has violated a condition of the contract.
EXAM QUESTION
Randy’s house slid down a hill in California after a heavy storm and is a total loss. The relevant part of the insurance contract states “Earthquake is a general exclusion.” Which party is likely to win in court and why?
A) The insurance company because of the stated exclusion.
B) Randy because the contract is adhesive.
C) The insurance company because homeowner’s policies does not cover mudslides.
D) Randy because of the aletory principal.
Answer: B
Randy will win because ambiguities are decided in favor of the insured under principal of adhesion.
Contract Rights and Provisions!
- Waiver
- Estoppel
- Waiver Provisions (applies to insurance)
Waiver
- Occurs when a party relinquishes a known right.
- Give up the right
Estoppel
- This takes place when a party is denied an assertion of a right to which they are otherwise entitled.
EXAMPLE:
- Consider an insured who causes a car accident. The insured agent says ‘Your auto insurance premiums won’t increase because of one accident.”. The insurer could be “estopped” from raising premiums at the next opportunity because of the informal agreement between the insured and insurance agent.
Waiver provisions (applies to insurance)
- An insurer may seek to avoid liability associated with a loss due to their agents offering policy changes not authorized by the company.
Contracts: Dispute Remedy!
- Parol evidence rule
- Reformation
- Rescission
Parol Evidence Rule
- Once the contract is placed in written form, all previous and prior understandings may NOT contradict the written contract.
- Essentially the parol evidence stipulates that the contract reflects the complete understanding of both parties.
Reformation
- Contractual remedy in which the contract is revised to express the original intent of all parties.
Rescission
- Deems a contract void from inception.
- Inception - is like the starting point.
Agent!
- An agent is a legal representative of the insurer.
- An agent enters into agreements on behalf of the insurer.
-
Three types of Agents:
- General
- Independent
- Broker
General Agent
- A general agent represents one insurer,
- such as a State Farm or Allstate insurance agent.
Independent Agent
- An independent agent represents multiple, unrelated insurers.
Broker
- A broker usually represents the policy owner, not the insurance company.
Types of Authority!
An agent’s authority to legally bind the insurer arises from three types of authority.
- Express Authority
- Implied Authority
- Apparent Authority
Express Authority
- Given through an agency or written agreement.
- Insurer is responsible for acts of an agent based on express authority.
Implied Authority
The authority that the public perceives, and a valid agency agreement exists.
- This stems directly from the Expressed Authority granted by an agreement, and it’s what the client sees when the authority is granted. (Cannot exist without Express Authority).
Example:
- The actual delivering of an insurance contract and accepting a premium is an example of implied authority.
- Insurer is still responsible even if a client is misled.
Apparent Authority
Apparent Authority is when the
- insured believes the agent has the authority to act on behalf of the insurer when in fact, no authority actually exists.
- This stems directly from when there is NO Expressed Authority granted. Even though the client sees the collateral, this is only apparent authority, as the representative should not have the marketing pieces. (Cannot exist if there is EXPRESS AUTHORITY)
- The apparent authority could be inferred based on business cards or a sign on the wall, but the agency agreements actually expired.
- If an agent represents that insured can pay the premium late but is wrong, then the insurer is still responsible.
Example of Authority
- Jason walks into Tom’s insurance company office looking for auto insurance. Tom has a business card, stationery and a sign on the front door reading, “Mega Insurance Company?” Jason believes Tom has the authority to write an insurance policy based upon “Implied Authority” from the business cards, stationery, and office door sign.
- Tom pulls out his agency agreement with Mega Insurance Company which gives Tom “Express Authority” to write policies on behalf of Mega Insurance Company. Jason decides to pay Tom $1,000 for a new auto policy.
- Unfortunately, Tom’s agency agreement was terminated the prior day. Because of “Apparent Authority,” Mega Insurance Company will have to honor Jason’s auto policy, even though Tom was not authorized to write the auto policy.
Exam Question
Scott is 22 and just started his first job with Rest in Peace Life Insurance Company. Scott is scheduled to take the state insurance exam at 9:00 a.m. on Saturday. The exam is computerized and if passed, automatically issues the State License. Scott has an important appointment with his Uncle Carlos at 1:00 p.m. on Saturday to sell Carlos $10M of universal variable life insurance. On Friday, just before 5:00 p.m. Scot’s boss gives him a wrapped gift and tells him not to open it until after he passes the exam, which she is confident he will do. Scott goes ahead and opens the present on Friday night and calls his friends to celebrate getting his “Rest in Peace” business cards. Scott goes out with his friends Friday night, gets drunk, and misses the Saturday exam. However, he goes to Carlos’ house, takes his application, and gets a check from Carlos for the first year premium. Unfortunately, Carlos is hit by lightening while playing golf Saturday afternoon and dies. Which of the following is correct?
A) Carlos’ beneficiary will collect $10M because of explicit authority and that the check was given to the agent.
B) The policy is not issued because Scott is not licensed to sell life insurance.
C) Carlos’ beneficiary will not receive anything because the check, while issued, was given to an unlicensed agent.
D) Presuming Carlos meets normal underwriting standards, his beneficiary will collect $10M under apparent authority.
Answer: D
Even though not licensed, Scott can still bind “Rest In peace” because he should not have applications and business cards.
Important Features of Insurance Contracts!
- Conditions
- Declarations
- Exclusions
- Riders and Endorsements
Conditions
Details the duties and rights of the
- insured and
- insurer
Declarations
Includes:
- The name of the insured
- description of the property
- amount of coverage
- amount of premium
- term of the policy
- Inception/termination dates
Exclusions
Section outlines specifically cover what will not be covered
- Exclusions may exclude perils such as war, earth movement, and flood
- Exclusions can also exclude the cost of a private hospital room when a semi-private will do.
- Exclusions may exclude specific items such as cash, collectibles, or business property.
- This helps keep premiums down.
Riders and Endorsements
Riders and endorsements are written additions to an insurance contract.
- They make it possible to customize an insurance contract for items that may be limited in coverage under the normal terms and conditions of a contract.
- Riders and endorsements take precedence over conflicting terms in policy.
- Ensure it states if a rider was elected, and what is attributable to that rider (dollars and benefits)
- Take Precedence to terms and conditions.
Regulating the Insurance Industry!
- Regulation is done at the State level, NOT at the Federal^ level.
- IRS, SEC, and ERISA have oversight (when applicable)
-
Subheaders:
- Legislative Branch
- Judicial Branch
- Executive or State Insurance Commissioner
- Goals of State Insurance Regulation
^ IRS, SEC and ERISA have oversight (when applicable)
Legislative Branch
- Provides for licensing of agents
- enacts laws and requirements for doing business in a particular state.
Judicial Branch
- The judicial branch rules on the constitutionality of laws passed by the legislative branch.
- They also render decisions and interpretations regarding policy terms.
Executive or State Insurance Commissioner
- Administers, interprets, and enforces insurance laws.
- Is a member of NAIC
- The State Insurance Commissioner does NOT make law!
Dictate how insurance is transacted within their state.
Goals of State Insurance Regulation
- Protect the insured
- Maintain and promote competition
- Maintain solvency of insurers
Valuation of Insured Losses!
- Replacement Cost
- Actual Cash Value (ACV)
- Agreed Upon Value
Replacement Cost
- Replacement cost is the current cost of replacing property with new materials of like kind.
For Purposes of Exam - This is a GOOD THING
On exam scenario based: Get Endorsement for REPLACEMENT COST.
Actual Cash Value (ACV)
- ACV is essentially replacement cost, less depreciation.
- ACV can impose serious financial burden on the insured.
- Almost all auto policies are ACV.
For Purposes of Exam - this is NOT GOOD
Agreed Upon Value
- A value that is determined jointly by the insured and insurer.
- Typically used for art and antiques.
Example of Actual Cash Value (ACV)
Kevin buys a plasma television for $8,000. Three years later it’s stolen and it’s 50% depreciated. The same plasma television is now selling for $6,000, how much does Kevin receive from his insurance company?
Replacement Cost = $6,000
Less: Depreciation (6,000*.50) = <3,000>
Cash to Insured = $3,000
$8,000 is not important to this question at all.
Exam Question of Actual Cash Value
Brandon purchased a home theater system for $10,000 two years ago. The replacement cost is $8,000. The home theater system was destroyed in a fire. Brandon’s insurance company estimates that the home theater system was 40% depreciated. How much will Brandon receive if the home theater system is covered under actual cash value?
A) $2,000
B) $2,700
C) $3,200
D) $4,800
Answer: D
$8,000 - (.40 X $8,000) = 8,000 - 3,200 = $4,800
If Brando owed a $500 deductible, he would actually receive
4,800 - 500 = $4,300
Important Features of Insurance Contracts!
- Deductibles
- Copayments
- Coinsurance
Deductibles
- A stated amount the insured must pay before the insurer will make payments.
- Deductibles will help eliminate small claims and reduce premiums.
- They are used mainly for property, health, and auto policies.
- Deductibles are a form of RETAINING risk.
Copayments
- Copayments are in addition to deductibles and are common with health insurance.
- Insured pays a portion of the losses incurred.
- Typically a health insurance policy will contain a $500 deductible and an 80/20 copayment clause.
- Insured is responsible for 20% of expenses above deductibles.
Coinsurance
- homeowners policy requires the insured to cover at least a stated percentage of the property value.
-
If coverage meets or exceeds the coinsurance requirement (usually 80%), then the insurer pays less of the
- face value of the policy,
- replacement cost, or
- actual expenditures.
-
If coverage is less than the coinsurance requirement, the insurer pays
- the greater of the actual cash value or the following formula
Coinsurance Requirement is 80% unless they say differently.
Coinsurance Formula
- (Face Value ÷ Coinsurance) x Loss - Deductible
- Coinsurance = 80% x Replacement Cost
Face Value is the Amount of Coverage Purchased
Coinsurance Example
Raj owns a house with a replacement value of $300,000 and is 50% depreciated. He purchased $200,000 of homeowners insurance with a coinsurance requirement of 80% and a $500 deductible. Raj experiences a $100,000 loss. What will the insurance company pay?
In this question, if they gave you value of land you would subtract the replacement cost or $300,000 by the value of land.
The Coverage is less than 80%. (200,000/300,000) = 66.6%
Greater of:
ACV
= (100,000 x 0.5)
= $$50,000
OR
[ $200,000 ÷ (0.8 x $300,000)] x $100,000 - $500
= 200,000 ÷ 240,000 x 100,000 - 500 = $82,833
They will pay $82,833.
Individual Loss Exposures and Insurance Coverages!
Perils that can Reduce/Eliminate the Ability to Earn
- Dying too soon
- Living too long
- Disability
Perils that Can Destroy/Deplete Existing Assets
- Damage to property
- Legal liability for injuries inflicted upon others
Company Selection
- Industry Ratings
Dying too soon
- Not able to meet financial obligations for your family such as education, debt repayment, or retirement.
- Life insurance can mitigate against the risk of dying too soon.
Living too long
- Superannuation is outliving the funds saved for retirement
- Annuities can mitigate the risk of superannuation.
Disability
- An unexpected illness or accident resulting in the inability to work.
- Disability insurance can mitigate this risk.
Damage to property
- Natural disasters, accidents, and crime can damage property
- Both direct (loss of house due to fire) and indirect loss (hotel expenses while the house is being repaired) can be the result of damaged property.
- Homeowners, renters insurance, and a personal auto policy can mitigate these risks.
Legal liability for injuries inflicted upon others
- Liability judgments and legal defense can be costly.
- Personal savings and other assets can be seized to satisfy judgments. Wages can be garnished if no assets are available to satisfy a judgment.
- A personal liability insurance policy mitigates these risks.
Company Selection
Industry Ratings:
- the financial strength of insurers is vitally important to understand prior to obtaining coverage from them.
- Several companies publish reports on insurers covering a range of areas such as management, use of reinsurance, licenses, the nature of the operations, and an overall quality rating.
- It is important to review the reports issued by multiple rating agencies before placing business with that career.
Rating Agencies!
Used to Help Planner Evaluate Insurance Companies.
- A.M. Best’s
- Moody’s
- Standard and Poor’s
A.M. Best’s
- Highest rating: A++ to A/A-
- Lowest Rating: C/C- to D
Moody’s
- Highest rating: Aaa to Aa1/Aa2
- Lowest Rating: B1/B2/B3 to Caa
Standard and Poor’s
- Highest rating: AAA to BBB
- Lowest Rating: BB and Lower CC
National Association of Insurance Commissioners (NAIC)!
- Provides a watch list of insurance companies based upon financial ratio analysis.
- Ratios measure the financial health of insurance companies.
- NAIC has NO regulatory power over the insurance industry, but is involved in accrediting state insurance regulatory offices.
- NAIC issues “model legislation” that state legislatures may or may not adapt.
EXAM TIP:
- Be sure to know the NAIC has no regulatory power over the insurance industry.
- Regulation occurs at the state level.
Steps in Risk Management
- Determine the objectives of the risk management program.
- Identify the risks to which the client is exposed.
- Evaluate the identified risks as to the probability of occurrence and potential loss.
- Determine alternatives for managing risks, and select the most appropriate for each.
- Implement the program
- Evaluate, monitor, and review (control).
EXAM TIP:
- D-I-E-D-I-E: Don’t insure everything (squared)
Risk Management Guidelines!
- Avoidance for the most serious type of risks.
- Risk transfer is using insurance where the financial risk is severe and frequency is low.
- Retention or reduction is appropriate where the financial risk is low and frequency is high because it would be too expensive to insure.
EXAMPLES:
- Dings in your car, minor injuries/illnesses, and deductibles.
Avoidance
Most serious type of risk.
- Severity: High
- Frequency: High
Example:
- Likelyhood of dying by dropping off of a plane is extremely high. So don’t do that.
Risk Transfer (Insurance)
Financial loss could be severe but doesn’t happen often.
- Severity: High
- Frequency: Low
Example:
- Tree landing on your head
Retention/Reduction
Minimal financial loss, too expensive to insure
- Severity: Low
- Frequency: High
Examples:
Risk Reduction: Wearing a Helmet
Retention: Deductibles
Retention
Minor injuries, illnesses, car door dings
Healthcare policy deductible
- Severity: Low
- Frequency: Low
Practice Question
Joe’s daughter is 16 years old and he recrntly bought her a 1970 VW Bug for $1,000. Which of the following risk management strategies should Joe use to manage the risk property loss due to a collision?
a) Risk Avoidance
b) Risk Reduction
c) Risk Transfer
d) Risk Retention
Answer: D
“Risk of Property Loss”
Law states you need liability loss not property loss.
$1,000 is the car not worth to get the transfer.
Exam Tip
- Contextual variables within each question may change the order of importance.
- How to provide adequate protection while keeping premiums at a reasonable rate.
One key point to keep in mind:
- is the amount of emergency fund the client has available to self-insure, including covering deductibles.
Premiums at a REASONABLE RATE: The deudctible needs to be less than or equal to the deductible.
Risk Management Guidelines Exam Question
Which of the following methods of dealing with risk does NOT match its action?
A) Risk Avoidance: Wearing a hard hat on a construction site.
B) Risk Reduction: Installing a sprinkler system in a building
C) Risk Transfer: Carrying automobile insurance
D) Risk Retention: Health insurance policy deductibles
A - Risk avoidance
Avoidance would mean not going anywhere near a construction site.
General Insurance Underwriting!
Insurance companies issue one of four underwriting policy ratings for insureds:
- Preferred
- Standard
- Rated
- Decline
Factors effecting premiums
Preferred
- This rating provides the lowest policy premiums.
- Insureds receiving this rating exceed the requirements for a standard rating.
- For life insurance, disability, and long-term care, these individuals have above-average ratings in underwriting factors.
- See factors affecting premiums.
Standard
- This rating reflects an average risk for the insurance company.
Rated
- There is a scale for rated policies.
- The scale represents health issues (for non-property and casualty policies),
- the insurance company will accept a greater amount in premium in return for providing the insurance.
Decline
- Insurance companies will not accept the risk of issuing a policy.
Factors affecting premiums
- Health
- Family health history
- Risk factors (high-risk activities such as sky diving, scuba diving, etc)
- Credit rating
- Driving record
