Principles of Insurance (Lesson 1) Flashcards
What type of risk is insurance used to protect against
pure risk
What does insurance involve
the transfer of loss and the sharing of losses with others
What is a pure risk
- there is a chance of loss or no loss
What is a speculative risk
- there is a chance of profit, loss, or no loss
- undertaken by entrepreneurs
- is a voluntary risk and not insurable
What is a subjective risk
- differs based upon an individuals perception of risk
What is an Objective risk
- does not depend on an individuals perception but is measurable and quantifiable
- measures the variation of an actual loss from expected loss
What is the definition of a probability of Loss
- chance of a loss occurring
- measure of the long run frequency with which an event occurs
- Useful measure for insurers because it quantifies the expected cost of claims
What is the definition of severity
- actual dollar amount of loss
- more important than the probability of a loss
What is the definition of 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
- law of large numbers helps reduce objective risk
What is a peril
- the actual cause of a loss
What is a hazard
- a condition that increases the likelihood of a loss occurring
What are the three types of hazards
- Moral
- Morale
- Physical
What is a moral hazard
- a character flaw
- may lead to filing a false claim
What is morale hazard
- the indifference created because a person is insured
What is a physical hazard
is a tangible condition that increases the probability of a peril occurring
What is adverse selection
- is 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 of insured
How is adverse selection managed
- through underwriting
- denying insurance on the front end
- raising premiums on the back end
What are the requirements for an insurable loss
- a large number of similar exposure units
- losses must be accidental from insureds viewpoint
- losses must be measurable and determinable so that the insurer can accurately forecast actual losses
- losses must not pose a catastrophic risk for the insurer
- Premiums must be affordable
- cannot insure moral hazards
Insurable risks are CHAD
- not Catastrophic
- Homogeneous exposure
- Accidental
- measurable and Determinable
What are elements of a valid contract
(A legal contract requires COALL)
- Must be legal and competent parties
- offer and acceptance
- Must be legal consideration
- contract must pertain to a lawful purpose
Is signing an application and making the first months premium payment considered a valid contract?
Yes as long as the applicant is insurable. Example of a conditional acceptance by the insurer
What is the principle of indemnity
- insured is only entitled to compensation to the extent of the insureds financial loss
- individual cannot profit from an insurance contract
What is the subrogation clause
- insured cannot receive compensation from both the insurer and a third party for the same claim
- the insurer steps into the shoes of the insured to recoup any restitution from the 3rd party or the 3rd parties insurer
What is the principle of insurable interest
- insured must have an emotional or financial hardship resulting from damage, loss, or destruction
Property liability insurance
- Insured must have insurable interest at time of policy inception and at time of loss
Life insurance
- the insured only needs an insurable interest at the time of policy inception
What is a void contrat
void contract was never valid and thus never came into existence
What is a voidable contract
a contract that is a valid contract that allows cancelation by one of the parties however the other party is bound by agreement
What is a warranty
- is a promise made by the insured to the insurer
- A breach of warranty is grounds for avoidance
What are representations
- statements made by the insured to the insurer during the application process
- must be a material misrepresentation to void an insurance contract
- EX: misrepresenting age on a life insurance contract is not material misrepresentation the insurer will simply adjust your death benefit up or down
What is concealment
when the insured is silent about a fact that is material to the risk
What does adhesion mean
- policy is basically take it or leave it
- no negotiations over terms and conditions
- any ambiguities in an insurance contract are found in favor of the insured
What does aleatory mean
- money exchanged may be unequal
- small premiums large benefit
What does unilateral mean
- only one promise is made by the insurer which is to pay in the event of a loss
- insured is not obligated to pay premiums, but if premiums are not paid there is no promise by the insurer
What does conditional mean
- 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
What is a waiver
Occurs when a party relinquishes a known right
What is estoppel
takes place when a party is denied assertion of a right to which they are otherwise entitled
What are waiver provisions
insurer may seek to avoid liability associated with a loss due to their agent offering policy changes not authorized by the company
What is the Parol evidence rule
- once the contract is placed in written form all previous and prior understanding may not contradict the written contract
- contract reflects the complete understanding of both parties
What is reformation
- contractual remedy in which the contract is revised to express the original intent of all parties
What is recission
- deems a contract void from inception
What is an agent
- legal representative of the insurer
- agent enters into agreements on behalf of the insurer
What is a general agent
- represents one insurer such as state farm or allstate
What is an independent agent
- represents multiple unrelated insurers
What is a broker
- represents the policy owner not the insurance company
An agents authority to legally bind the insurer arises from these three types of authority
- Express Authority
- Implied Authority
- Apparent Authority
What is express authority
- given through the agency or written agreement
- insurer is responsible for acts of an agent based on express authority
What is implied authority
- authority that the public perceives and a valid agency agreement exists
- 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 mislead
- Is based upon the agents business card, letterhead, and insurance company sign on the door
What is apparent authority
- apparent authority is when the insured believes that agent has authority to act on the behalf of the insurer when in fact no authority actually exists
- could be inferred based on business cards or a sign on the wall but the agency agreement actually expired
- is basically when no authority actually exists
What are conditions of an insurance contract
details the duties and rights of the insured and insurer
What are declarations of an insurance contract
includes the name of the insured, description of the property, amount of coverage, amount of premium, term of the policy, and inception/termination date
What are exclusions of an insurance contract
- section outlines specifically what will not be covered
What are riders and endorsements of an insurance contract
- are written additions to an insurance contract
- 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
- take precedence over conflicting terms in policy
Is regulation done for insurance at the state or federal level
State
What does the legislative branch do
- provides for licensing of agents and enacts laws and requirements for doing business in a particular state
What does the judicial branch do
- rules on constitutionality of laws passed by the legislative branch
- render decisions and interpretations regarding policy terms
What does the executive or state insurance commissioner do
- administers, interprets, and enforces insurance laws
- state insurance commissioner does NOT make law
What are the goals of state insurance regulation
- protect the insured
- maintain and promote competition
- maintain solvency of insurers
What is the replacement cost of insured property
- is the current cost of replacing property with new materials of like kind
What is the actual cash value of insured property
- essentially replacement cost less depreciation
- can impose serious financial burden on the insured
- almost all auto policies are ACV
What is the agreed upon value of insured property
- value that is determined jointly by insured and insurer
- typically used for art and antiques
What is a deductible
- stated amount the insured must pay before the insurer will make payments
- are a form of retaining risk
What are copayments
- insured pays a portion of the losses incurred
- typical is 80/20, insured is responsible for 20% of expenses about deductible
What is Coinsurance
- Homeowners policy requires the insured to cover at least a stated precentage of the property value
(Actual Coverage / Coinsurance Requirment) x Loss - Deductible
What is the formula for coinsurance
80% x Replacement cost
(Individual Loss Exposure and How to Eliminate)
Dying Too Soon
- Not able to meet financial goals for family
- Life insurance mitigates this risk
(Individual Loss Exposure and How to Eliminate)
Living to Long
- outliving the funds saved for retirement
- Annuities can mitigate this risk
(Individual Loss Exposure and How to Eliminate)
Disability
- results in inability to work
- Disability insurance can mitigate this risk
What are the three ratings agencies for insurance
- AM Best (A++)
- Moody’s
- Standard and Poor’s
What does the national association of insurance commissioners (NAIC) do
- Provides a watch list of insurance companies based upon financial ratio analysis
- Ratios measure the financial health of insurance companies
- No regulatory power over the insurance industry but is involved in accrediting state insurance regulatory offices
- issues model legislation that state legislatures may or may not adopt
Does the NAIC have regulatory power
no
What are the six steps of risk management (DIEDIE)
- Determine the objectives of the risk management program
- Identify the risks to which the client is exposed to
- Evaluate the identified risks as to probability of occurrence and potential loss
- Determine alternatives for managing risks and select the most appropriate alternatives for each
- Implement the program
- Evaluate, monitor, and review
When should risk transferring be used
when risk is severe but frequency is low
When is retention or reduction appropriate
financial risk is low and frequency is high because it would be to expensive to insure
What are the four underwriting policy ratings for insureds
- Preferred
- Standard
- Rated
- Decline
What rating provides the lowest premium
Preferred
What is Preferred rating
- provides the lowest premium
- insured exceeds the requirements for a standard rating
What is standard rating
- rating reflects an average risk for the insurance company
What is rated rating
- will require higher premiums
What is Decline rating
- insurance company will not accept the risk of issuing a policy
What are factors effecting premiums
- Health
- Family health history
- Risk factors
- Credit rating
- Driving record
