Principles of Insurance (L1) Flashcards
Insurance
- Used as protection against financial loss
- Only used to protect against “Pure Risk”
- Pure Risks simply create either a financial loss or no loss
○ EXAMPLE: House fires, auto accidents, and personal illness - Involves the transfer of loss and the sharing of losses with others.
Pure Risk
- Chance of Loss or NO Loss
○ Death
○ Auto accident
○ House fire
Speculative Risk
○ Chance of Profit, Loss, or No Loss
○ Generally undertaken by ENTREPENUERS
○ Generally VOLUNTARY Risk and NOT MEASURABLE
Subjective Risk
Differs based upon an Individuals 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
Understanding Risk
Perils
○ Actual cause of a loss
○ Fire, wind, tornado, earthquakes, burglary, and collision
Hazard
- A condition that increases the likelihood of a loss occurring
- 3 TYPES of hazards
○ Moral
○ Morale
○ Physical
Moral Hazard
Character Flaw (leads to filing a false claim)
Morale Hazard
The indifference created because a person is insured
Physical Hazard
A tangible condition that increases the probability of a peril occurring
Adverse Selection
- The tendency of persons 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
- Managed through:
○ Underwriting
○ Denying insurance on the front end
○ Raising premiums on the back end
Insurable Losses
Legal Principles of All Contracts
Elements of a Valid Contract (COALL)
○ One party must make an offer and the other party must accept that offer
§ “in-force” = policy is delivered and first premium is paid
○ There must be legal competency of all parties involved in a contract
§ 18 years or older
○ There must be legal consideration. Consider is whatever is being exchanged (money, services, or property)
○ The contract must pertain to a lawful purpose
Legal Principles of Insurance Contracts
The Principal of Indemnity
Subrogation Clause
The Principle of Insurable Interest
Void contract
Voidable Contract
The Principal of Indemnity
○ Insured in only entitled to compensation to the extent of the insured’s financial loss
○ Insured CANNOT make a profit from an insurance contract
Subrogation Clause
○ Insured CANNOT receive compensation from both the insurer and a third party for the same claim.
○ Insurer “steps into the shoes” of the insured to recoup any restitution from the 3rd party or 3rd party’s insurer
The Principle of Insurable Interest
- Insured must have ab emotional or financial hardship resulting from damage, loss, or destruction
- Property and Liability Insurance
○ The insured must have insurable interest at time of policy
INCEPTION and at TIME OF LOSS - Life Insurance
○ The insured only needs an insurance interest at the time of
policy inception - Life insurance policies are consider long-term investments
Void vs Voidable
- Void contract
○ Was never valid and thus never came into existence
○ It is NOT enforceable contract since it lacks one of the four
elements of COALL - Voidable Contract
○ A valid contract that allows cancellation by one of the parties
however the other party is bound by agreement
Principal of Utmost Good Faith
Distinguishing Characteristics of Insurance Contracts
Adhesion
Aleatory
Unilateral
Conditional
Adhesion
- “take it or leave it” insurance policy.
○ There are no negotiations over terms and conditions - Any ambiguities in an insurance contract are found in favor of the insured
Aleatory
- The money exchanged may be UNEQUAL.
○ Small Premiums but the insured may receive a Large Benefit
Unilateral
- Only 1 promise is made by the insurer which is to pay in the event of a loss.
- Insured is NOT obligated to pay premiums
○ If premiums are NOT paid, then there is 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
Contract Rights and Provisions
Contracts: Dispute Remedy
Law of Agency
- Agent
○ A legal representative of the insurer - General Agent
○ Represent ONE insurer - Independent Agent
○ Represents multiple, unrelated insurers - Broker
○ Represents the policy owner, NOT the insurance company
Express Authority
○ Given through 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
○ 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
○ When the insured believes that agent has authority to act on behalf of the insurer when in fact, no authority actually exists.
○ Apparent Authority could be inferred based on business cards or a sign on the wall, but the agency agreement actually expired
○ If an agent represents that insured can pay premium late, but is wrong, then the insurer is still responsible
Insurance Industry Regulations
Valuation of Insurance Losses
Important Features on Insurance Contracts
Individual Loss Exposure and Insurance Contracts
- Perils that can REDUCE/ELIMINATE the ability to earn
○ Dying too soon
○ Living to long
○ Disability - Perils that can Destroy/Deplete Existing Assets
○ Damage to Property
○ Legal Liability for injuries inflicted upon others
National Association of Insurance Commission (NAIC)
6 steps of Risk Management
Risk Management Guidelines
- Avoidance for the most serious type of risks
- Risk transfer is using insurance where the financial risk is severe, but her 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.
General Insurance UNDERWRITING
