Principles of Risk and Insurance

Question 1

Law of large numbers

Answer 1

as the number of independent events increases. the likelihood grows that the actual results will be close to the expected results. For this to work the insurer needs a large number of similar (homogeneous) units
Insurance entails pooling of risks and transferring them to an insurance company to replace uncertainty with certainty

Question 2

Adverse Selection

Answer 2

There should be the same proportion of good and bad risks in the group insured as there were in the one from which the statistics were taken. the tendency of the poorer than average risks to seek insurance to a greater extent than the average or better than average risks must be reduced

Question 3

Morbidity

Answer 3

the incidence and severity of sickness and accidents in a well defined class or classes of persons

Question 4

mortality table

Answer 4

a statistical table showing the probable rate of death at each age, usually expressed as so many per thousand

Question 5

Self-insurance

Answer 5

is a formal program of risk retention.
the self insurance business performs most functions of an insurance company for its own risks. This requires a large number of similar potential losses, the ability to predict overall losses with a reasonable degree of accuracy and the establishment of a formal fund for future losses and their possible fluctuations.
primary used by but not limited to large companies

Question 6

Advantages of self insurance to a company

Answer 6

• the company can avoid the cost associated with commercial insurance
• reserves for future claims can be invested in short term money market type instruments. The company can use its earnings to offset the costs

Question 6

Disadvantages of self insurance to a company

Answer 6

the greatest disadvantage is that it can leave the company exposed to a catastrophic loss. The company must duplicate the services provided by an insurance company
the company may have to pay income taxes on reserves held for future claims at year end

Question 7

Risk Control

Answer 7

• Risk avoidance
• Risk diversification
• Risk reduction

Question 8

Risk Financing

Answer 8

• Risk retention
• Risk transfer

Question 9

Basic Rules of Risk Management

Answer 9

• coverage for potential catastrophes should be purchased first (life, disability, health, homeowners, and auto)
• Severity is more important than probability
• high probability will mean high premiums or a decline of coverage by the carrier

Question 10

Guidelines for risk management

Answer 10

• high severity, low frequency: transfer
• high severity, high frequency: avoidance
• low severity, high frequency: retention and reduction
• low severity, low frequency: retention

Question 11

Principle of indemnity

Answer 11

a principle underlying insurance contracts (besides LI) under which the insurer seeks to reimburse the insured for approximately the amount lose no more and no less

Question 12

Contract requirements

Answer 12

COALL
- there must be an agreement preceded by offer and acceptance
- consideration
-legal capacity
- - not incompetent or incapacitated
- - minors for necessities only
- contract for lawful purpose

Question 13

Unilateral

Answer 13

Only one of the parties to an insurance contract (insurer) makes a binding promise that if broken breaches the contract

Question 14

Adhesion

Answer 14

contract is accepted “as is” or not at all. It is not a regulated contract
- agents cannot change the contract, only CEO, VP, secretary, etc

Question 15

Special note on adhesion

Answer 15

because insurance policies are generally contracts of adhesion is in the event of ambiguity in the terms, the courts are likely to rule in favor of the insured and against the insurer

Question 16

Aleatory contract

Answer 16

with insurance, the amount of dollars spent by the parties is typically unequal

Question 17

recission

Answer 17

contract is deemed null from its beginning due to fraud, misrepresentation, concealment, or mutual mistakes as to a material of fact

Question 18

reformation

Answer 18

when the contract between the parties fails to express the original intent of the parties, the contract can be amended

Question 19

Collateral source rule

Answer 19

in tort liability the plaintiffs measure of damage should not be mitigated by payments received from sources other than the negligent parties

Question 20

Subrogation

Answer 20

when an insurer pays a claim it takes over the legal rights its insured had against a negligent third party

Question 21

policy ownership

Answer 21

the policy can be owned by the insured, applicant owner, any party with insurable interest
- the owner can transfer the policy to someone else, receive cash values or dividends, borrow against cash value, or change the beneficiary
- at death of insured the beneficiary becomes the owner of the policy

Question 22

Beneficiary designations

Answer 22

a change of ownership does not automatically change the beneficiary

Question 23

Insurable risks

Answer 23

CHAD
- must be sufficiently large number of homogeneous exposure units to make losses reasonably predicable
- loss must be produced by the risk must be definite and measurable
- loss must be fortuitous and accidental
- loss must be not catastrophic to the insurance company

Question 24

Method to control losses

Answer 24

• avoidance of risk : instead of purchasing it, rent it
• diversification : store assets at different locations
• reduction of risk : install sprinklers
• retention of risk : deductibles, co insurance, self insurance
• transfer - insurance

Question 25

Parts of the insurance contract

Answer 25

“dont read contracts, roll the DDICE”
- Declarations : factual statements that identify person, property, specific to transaction
- Definitions : explain key policy terms
- Insuring agreements : basic promise of insurance company
- Conditions : duties and rights of parties
- Exclusions : when insurer will not pay