Module1

Question 1

What is insurance?

Answer 1

Insurance is a method of handling pure risk by spreading it over a large number of similar individuals.

Insurance is a contract in which an insurance company provides a guarantee of compensation for specified loss, damage, illness or death in return for a payment of a premium from an insured group.

Question 2

What is the law of large numbers?

Answer 2

Law of large numbers: what will happen in a large group of similar individuals can be predicted.

By using law of large numbers, insurers can calculate their probable losses and establish accurate premium rates to cover losses and operating expenses.

Question 3

What are risk pools?

Answer 3

Law of large numbers: what will happen in a large group of similar individuals can be predicted. These large groups are risk pools.

Question 4

What is the principle of indemnity?

Answer 4

Insurance contracts are governed by the principle of indemnity. This principal assumes that that an insured who has suffered a loss, should only be restored to the approximate financial condition that existed prior to the loss [no better, no worse].

If an insured makes a profit from their loss, the principal of indemnity has been violated.

Overinsurance also violates the principle of indemnity.

Question 5

What is insurable interest?

Answer 5

Insurable interest refers to the financial interest an individual, company, or organization must have in the property, liability, or person being insured. If no risk of financial loss is present, no insurable interest exists thus eliminating the need for insurance coverage.

Question 6

With property or casualty [liability insurance], when must insurable interest exist?

Answer 6

With property or casualty [liability insurance], insurable interest must exist at the time of the loss.

Question 7

With life or health insurance, when must insurable interest exist?

Answer 7

With life or health insurance, insurable interest must exist at the time that the policy is purchased.

Question 8

What is risk?

Answer 8

Risk is the possibility that a loss may occur and is the reason that people buy insurance.

Question 9

Are all risks insurable?

Answer 9

FOR THE PURPOSE OF THE STATE EXAM: NOT ALL RISKS ARE INSURABLE

Question 10

What are the seven characteristics of an insurable risk?

Answer 10

• The loss must be definite and definable
  
  • The loss must be accidental
  • The insurance company should be able to calculate the
    chance of the loss
  • The law of large numbers should apply
  • The loss must be great enough to create economic
    hardship
  • The insurance must be offered at a reasonable cost
  • The loss must not be catastrophic in nature

Question 11

What is the diff between pure risks and speculative risks?

Answer 11

PURE RISKS: there is ONLY the possibility of loss, there is no possibility for financial gain. Pure risks are INSURABLE.

SPECULATIVE RISKS: the possibility of financial gain, or profit, exists with these types of risks and thus ARE NOT INSURABLE.

Most risks are neither completely “pure” nor completely “speculative.”

Question 12

What are static risks?

Answer 12

STATIC RISKS are risk factors that are historical factors which do not frequently fluctuate, they result from a “static” or “unchanging” environment.

Static risks tend to be associated with long term risk, such as an area that floods every 100 yrs.

STATIC RISKS are PURE RISKS because they may or may not occur, and are therefore, insurable.

Question 13

What are dynamic risks?

Answer 13

DYNAMIC RISKS are associated with change [example: a new and fatal virus erupting into society].

DYNAMIC RISKS ARE NOT INSURABLE.

Question 14

What are fundamental risks?

Answer 14

FUNDAMENTAL RISKS are risks that affect entire groups of people or property within society.

Examples are floods, earthquakes, terrorism, and economic collapse.

Fundamental risks are insurable through flood insurance, earthquake insurance, unemployment insurance, or other types of insurance that are offered by government agencies or heavily subsidized by the government.

Question 15

What are particular risks?

Answer 15

PARTICULAR RISKS are risks that affect only the individual person or family, and not the entire community / society. These risks arise from a situation that occurs simultaneously with another specific event that increases the chance of a loss.

For example: being at home when a burglar breaks in increases the chances that they can get injured or killed by the burglar.

Particular risks are usually insurable.

Question 16

What is a peril?

Answer 16

A peril is what causes the loss.

Example: a commercial building catches fire and is damaged. The fire is the peril that caused the loss.

Question 17

What is a hazard?

Answer 17

A hazard is a condition that increases the probability or likelihood that a loss will occur.

Example: a frayed electrical cord increases the likelihood that an electrical fire may occur.

Question 18

What are the three types of hazards?

Answer 18

1. Physical hazard
2. Moral hazard
3. Morale hazard

Question 19

What is a physical hazard?

Answer 19

PHYSCAL HAZARD: the material, structural, environmental, or operational features of an insured risk that may create or increase the opportunity for injury or damage.

Examples of physical hazards include defective building materials, exposure to toxic chemicals, or a slippery sidewalk.

Question 20

What is a moral hazard?

Answer 20

MORAL HAZARD is a condition that increases the probability that a person will intentionally cause, create, or inflate a loss. A moral hazard is generally an act created out of intent and can be calculated or even premeditated.

A moral hazard provides incentive for one party to take risks that another party will pay for.
Interestingly, insurance can create a moral hazard.

Example: a man will con’t smoking because he purchased life insurance and he knows that his family will be protected if he were to get something like lung cancer.

Question 21

What is a morale hazard?

Answer 21

MORALE HAZARD is a condition of inattention to, or disregard for, one’s own life, health, or property by engaging in behavior that increases the frequency or severity of a loss.

Example: an insured who has the option to drive on a paved road but doesn’t because she knows that her insurance policy will cover the damage to her car.