Principles of Insurance Flashcards
definition of insurance
- involves the transfer of loss and the sharing of losses with others
- used as a protection against financial loss
what type of risk is insurance used to protect someone against?
pure risk
pure risk - definition
with pure risk, there is a chance of loss or no loss
pure risk - examples
death, auto accident, house fire
speculative risk
there is a chance of profit, loss, or no loss
generally undertaken by entrepreneurs, is voluntary, and is not insurable
subjective risk
differs upon an individual’s perception of risk
objective risk
does not depend on an individual’s perception, but is measurable and quantifiable
measures the variation of an actual loss from expected loss
probability of loss
the “chance” of a loss occurring
measure of the long-run frequency with which an event occurs
the higher probability of loss may result in a decline of coverage
severity of loss
the actual dollar amount of the loss
what is more important: probability of loss or severity of loss?
severity of loss
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 results will equal true and thus will be predictive of future results
perils - definition
the actual cause of a loss
perils - examples
fire, wind, tornado, earthquake, burglary, collision
hazard - definition
a condition that increases the likelihood of a loss occurring
3 types of hazard
- moral hazard
- morale hazard
- physical hazard
moral hazard
a character flaw
a character flaw would lead to a filing of a false claim
morale hazard
the indifference created because a person is insured
laziness
physical hazard
a tangible condition that increases the probability of a peril occurring
ex: icy or wet roads, poor lighting
adverse selection
the tendency of persons with higher-than-average risks to purchase or renew insurance policies
how is adverse selection managed?
underwriting
denying insurance on the front end, and raising premiums on the back end
requisites for an insurable risk
- large number of similar exposure units
- losses must be accidental
- losses must be measurable and determinable
- losses must not pose a catastrophic risk for the insurer
- premiums must be affordable
elements of a valid contract
- one party must make an offer and the other party must accept that offer
- there must be legal competency of all parties involved in a contract
- there must be legal consideration
- a contract must pertain to a lawful purpose
what does it mean that there must be legal competency of all parties involved in a contract?
all parties must be 18 years or older, otherwise the contract is voidable by the minor
what does it mean that there must be legal consideration with a contract?
a promise to pay (insurer) and actual payment of a premium (insured)
consideration is whatever is being exchanged (could be money, services, or property)
what does it mean that a contract must pertain to a lawful purpose?
the contract cannot promote illegal actions
the principle of indemnity
an insured is only entitled to compensation to the extent of the insured’s financial loss
insured can’t make a profit from a contract
subrogation clause
the insured cannot receive compensation from both the insurer and a third party for the same claim
the principle of insurable interest
an insured must have an emotional or financial hardship resulting from damage, loss, or destruction
when must an insured have insurable interest for a property and liability insurance contract?
at the time of inception and at the time of loss
when must an insured have insurable interest for a life insurance contract?
at the time of inception
void vs voidable
void = contract was never valid and thus never came into existence
voidable = a valid contract that allows cancelation by one of the parties while the other party is bound by the agreement
warranty
a promise made by the insured to the insurer
representation
statements made by the insured to the insurer during the application process
when will a misrepresentation of information void an insurance contract?
when it is a material misrepresentation
is a misrepresentation of age for a life insurance contract considered a material misrepresentation?
no
concealment
when the insured is silent about a fact that is material to the risk
adhesion
an insurance policy is “take it or leave it”
there are no negotiations
when there are ambiguities in an insurance contract, who is favored in the final decision of whether a claim should be paid? the insured or the insurer?
the insured is found in favor due to adhesion
aleatory
the money exchanged in an insurance contract may be unequal
small premium paid by insured vs large benefit paid out by insurer
unilateral
only one promise is made by the insurer which is to pay in the event of a loss
insured is not obligated to pay the premiums
conditional
the insured must abide by the terms and conditions of the insurance contract
what are the 4 distinguishing characteristics of an insurance contract?
- adhesion
- aleatory
- unilateral
- conditional
agent
a legal representation of the insurer
3 types of agents
- general agent
- independent agent
- broker
general agent
represents one insurer (ex: State Farm agent, Allstate agent)
independent agent
represents multiple, unrelated insurers
broker
represents the policy owner, not the insurance company
express authority
given through an agency or written agreement
insurer is responsible for acts of an agent based on express authority
implied authority
authority that the public perceives, and a valid agency agreement exists
insurer is still responsible even if a client is misled
apparent authority
when the insured believes that agent has the authority to act on behalf of the insurer when in fact, no authority actually exists
insurer is still responsible
features of insurance contracts
- conditions
- declarations
- exclusions
- riders/endorsements
conditions
details the duties and rights of the insured and insurer
declarations
includes name of the insured, description of the property, amount of coverage, amount of premium term of the policy, inception/termination dates
exclusions
this section outlines specifically what will NOT be covered
riders and endorsements
written additions to an insurance contract, making it possible to customize an insurance contract that may be limited in coverage under the normal terms and conditions
how is the insurance industry regulated?
at the STATE level
what role does the legislative branch play in the insurance industry?
provides for licensing of agents, enacts laws and requirements for doing business in a particular state
what role does the judicial branch pay in the insurance industry?
rules on constitutionality of laws passed by the legislative branch
render decisions and interpretations regarding policy terms
what role does the executive branch play in the insurance industry?
administers, interprets, and enforces insurance laws
replacement cost
the current cost of replacing property with new materials of like kind
actual cash value (ACV)
replacement cost less depreciation
agreed-upon value
a value that is determined jointly by insured and insurer
when is agreed-upon value typically used in an insurance policy?
for art and antiques
deductible
a stated amount the insured must pay before the insurer will make payments
copayments
insured pays a portion of the losses incurred
common is an 80/20 copayment clause with health insurance, where the insured pays 20% of expenses above the deductible
coinsurnace
a homeowners policy requires the insured to cover at least a stated percentage of the property value
coinsurance formula for how much the insurer pays
(face value / coinsurance) x loss - deductible
what are the 3 main insurance rating agencies?
- A.M. Best’s
- Moody’s
- Standard and Poor’s
what does NAIC stand for?
National Association of Insurance Commissioners
what does the NAIC do?
provides a watch list of insurance companies based upon financial ratio analysis
issues “model legislation” that state legislatures may or may not adopt
has NO regulatory power
when to use avoidance as a risk management strategy?
for the most serious types of risks
when to use risk transfer as a risk management strategy?
when the financial risk is severe but the frequency is low
use insurance for this
when to use risk retention as a risk management strategy?
when the financial risk is low and the frequency is high
