Principles of Insurance

Question 1

definition of insurance

Answer 1

• involves the transfer of loss and the sharing of losses with others
• used as a protection against financial loss

Question 2

what type of risk is insurance used to protect someone against?

Answer 2

pure risk

Question 3

pure risk - definition

Answer 3

with pure risk, there is a chance of loss or no loss

Question 4

pure risk - examples

Answer 4

death, auto accident, house fire

Question 5

speculative risk

Answer 5

there is a chance of profit, loss, or no loss

generally undertaken by entrepreneurs, is voluntary, and is not insurable

Question 6

subjective risk

Answer 6

differs upon an individual’s perception of risk

Question 7

objective risk

Answer 7

does not depend on an individual’s perception, but is measurable and quantifiable

measures the variation of an actual loss from expected loss

Question 8

probability of loss

Answer 8

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

Question 9

severity of loss

Answer 9

the actual dollar amount of the loss

Question 10

what is more important: probability of loss or severity of loss?

Answer 10

severity of loss

Question 11

law of large numbers

Answer 11

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

Question 12

perils - definition

Answer 12

the actual cause of a loss

Question 13

perils - examples

Answer 13

fire, wind, tornado, earthquake, burglary, collision

Question 14

hazard - definition

Answer 14

a condition that increases the likelihood of a loss occurring

Question 15

3 types of hazard

Answer 15

1. moral hazard
2. morale hazard
3. physical hazard

Question 16

moral hazard

Answer 16

a character flaw

a character flaw would lead to a filing of a false claim

Question 17

morale hazard

Answer 17

the indifference created because a person is insured

laziness

Question 18

physical hazard

Answer 18

a tangible condition that increases the probability of a peril occurring

ex: icy or wet roads, poor lighting

Question 19

adverse selection

Answer 19

the tendency of persons with higher-than-average risks to purchase or renew insurance policies

Question 20

how is adverse selection managed?

Answer 20

underwriting

denying insurance on the front end, and raising premiums on the back end

Question 21

requisites for an insurable risk

Answer 21

• 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

Question 22

elements of a valid contract

Answer 22

• 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

Question 23

what does it mean that there must be legal competency of all parties involved in a contract?

Answer 23

all parties must be 18 years or older, otherwise the contract is voidable by the minor

Question 24

what does it mean that there must be legal consideration with a contract?

Answer 24

a promise to pay (insurer) and actual payment of a premium (insured)

consideration is whatever is being exchanged (could be money, services, or property)

Question 25

what does it mean that a contract must pertain to a lawful purpose?

Answer 25

the contract cannot promote illegal actions

Question 26

the principle of indemnity

Answer 26

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

Question 27

subrogation clause

Answer 27

the insured cannot receive compensation from both the insurer and a third party for the same claim

Question 28

the principle of insurable interest

Answer 28

an insured must have an emotional or financial hardship resulting from damage, loss, or destruction

Question 29

when must an insured have insurable interest for a property and liability insurance contract?

Answer 29

at the time of inception and at the time of loss

Question 30

when must an insured have insurable interest for a life insurance contract?

Answer 30

at the time of inception

Question 31

void vs voidable

Answer 31

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

Question 32

warranty

Answer 32

a promise made by the insured to the insurer

Question 33

representation

Answer 33

statements made by the insured to the insurer during the application process

Question 34

when will a misrepresentation of information void an insurance contract?

Answer 34

when it is a material misrepresentation

Question 35

is a misrepresentation of age for a life insurance contract considered a material misrepresentation?

Answer 35

no

Question 36

concealment

Answer 36

when the insured is silent about a fact that is material to the risk

Question 37

adhesion

Answer 37

an insurance policy is "take it or leave it" there are no negotiations

Question 38

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?

Answer 38

the insured is found in favor due to adhesion

Question 39

aleatory

Answer 39

the money exchanged in an insurance contract may be unequal small premium paid by insured vs large benefit paid out by insurer

Question 40

unilateral

Answer 40

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

Question 41

conditional

Answer 41

the insured must abide by the terms and conditions of the insurance contract

Question 42

what are the 4 distinguishing characteristics of an insurance contract?

Answer 42

1. adhesion 2. aleatory 3. unilateral 4. conditional

Question 43

agent

Answer 43

a legal representation of the insurer

Question 44

3 types of agents

Answer 44

1. general agent 2. independent agent 3. broker

Question 45

general agent

Answer 45

represents one insurer (ex: State Farm agent, Allstate agent)

Question 46

independent agent

Answer 46

represents multiple, unrelated insurers

Question 47

broker

Answer 47

represents the policy owner, not the insurance company

Question 48

express authority

Answer 48

given through an agency or written agreement insurer is responsible for acts of an agent based on express authority

Question 49

implied authority

Answer 49

authority that the public perceives, and a valid agency agreement exists insurer is still responsible even if a client is misled

Question 50

apparent authority

Answer 50

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

Question 51

features of insurance contracts

Answer 51

- conditions - declarations - exclusions - riders/endorsements

Question 52

conditions

Answer 52

details the duties and rights of the insured and insurer

Question 53

declarations

Answer 53

includes name of the insured, description of the property, amount of coverage, amount of premium term of the policy, inception/termination dates

Question 54

exclusions

Answer 54

this section outlines specifically what will NOT be covered

Question 55

riders and endorsements

Answer 55

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

Question 56

how is the insurance industry regulated?

Answer 56

at the STATE level

Question 57

what role does the legislative branch play in the insurance industry?

Answer 57

provides for licensing of agents, enacts laws and requirements for doing business in a particular state

Question 58

what role does the judicial branch pay in the insurance industry?

Answer 58

rules on constitutionality of laws passed by the legislative branch render decisions and interpretations regarding policy terms

Question 59

what role does the executive branch play in the insurance industry?

Answer 59

administers, interprets, and enforces insurance laws

Question 60

replacement cost

Answer 60

the current cost of replacing property with new materials of like kind

Question 61

actual cash value (ACV)

Answer 61

replacement cost less depreciation

Question 62

agreed-upon value

Answer 62

a value that is determined jointly by insured and insurer

Question 63

when is agreed-upon value typically used in an insurance policy?

Answer 63

for art and antiques

Question 64

deductible

Answer 64

a stated amount the insured must pay before the insurer will make payments

Question 65

copayments

Answer 65

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

Question 66

coinsurnace

Answer 66

a homeowners policy requires the insured to cover at least a stated percentage of the property value

Question 67

coinsurance formula for how much the insurer pays

Answer 67

(face value / coinsurance) x loss - deductible

Question 68

what are the 3 main insurance rating agencies?

Answer 68

1. A.M. Best's 2. Moody's 3. Standard and Poor's

Question 69

what does NAIC stand for?

Answer 69

National Association of Insurance Commissioners

Question 70

what does the NAIC do?

Answer 70

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

Question 71

when to use avoidance as a risk management strategy?

Answer 71

for the most serious types of risks

Question 72

when to use risk transfer as a risk management strategy?

Answer 72

when the financial risk is severe but the frequency is low use insurance for this

Question 73

when to use risk retention as a risk management strategy?

Answer 73

when the financial risk is low and the frequency is high