Principles of Risk and Insurance Flashcards
Define “Risk”
Possibility of loss that is contrary to our desires or expectations
Define “Peril”
A peril is the direct cause of a loss
(e.g. Fire that burns down the house)
Define “Hazard”
A condition or act that increases the possibility that a loss may occur
(e.g. faulty wiring that causes fire)
4 types of hazards
Physical Hazard, Moral Hazard, Morale Hazard, & Legal Hazard
What is a “Moral Hazard?”
Refers to people with dishonest tendencies, character defects, bad reps, etc
What is a “Morale Hazard?”
Carelessness or indifference to a loss (e.g. not fixing broken stuff)
What is a “Pure Risk?”
No potential for gain
What is a “Speculative Risk?”
Potential for gain AND loss
3 Primary classifications of Risk Exposure for individuals and families
- Personal
- Property
- Liability
3 Primary classifications of Risk Exposure for Businesses and Business Owners
- Owner or Employee
- Property
- Liability
What is “Risk Control?”
Risk Control attempts to minimize the cost of certain risks.
3 Types of Risk Control
- Risk avoidance
- Risk Reduction
- Risk Diversification
What is “Risk Financing?”
Planning for guaranteed availability of funds to pay for financial losses that are projected to occur or possibility of loss too expensive to ignore
A few examples of “Risk Retention” strategy
Emergency fund, insurance deductibles, co-insurances, etc.
What is “Passive Retention?”
Risk may be retained either because the person has a callous disregard for the risk OR is ignorant of it.
What is “Active Retention?”
Individual is aware of risk and plans to embrace all or part of the risk
What is a “Risk Transfer?”
Transferring risk to another party
4 Uninsured (non-insurance) Risk Transfer strategies
- Hedging
- Contractual agreements
- Warranties/Guarantees
- Subcontracting
What is Subcontracting?
A primary contractor doesn’t want to assume the risk of some aspect of a contract that needs to be completed to satisfy a contract -> subcontractor
Name the severity and frequency of the MOST INSURABLE Risk
High Severity; Low frequency
Give some examples of Social Insurance
-Medicare
-Medicaid
-Social Security
-Unemployment insurance
-Freddie Mac, Fannie Mae, Sallie Mae
List 6 Risk Management Process Steps
- Determine client risk management objectives
- Identify Risk Exposures
- Evaluate Risk Exposures
- Selection of risk management
- Implementation
- Evaluation and review
True or False
Risk Management is concerned with both speculative and pure risk
False; Pure Risk ONLY
What is an “Aleatory” contract?
Someone will end up taking a loss…
(i.e. premiums will be more than coverage OR coverage and claim payment will be more than premiums)
What is a “Conditional” contract?
Both parties must abide by contractual conditions
What are “Contracts of Utmost Good Faith?”
Everyone needs to be honest…
NO concealment or misrepresentation
What is a “Unilateral Contract?”
Only insurer has committed to a legally enforceable promise when issuing an insurance policy
(i.e. insured can cancel any time; insurer cannot)
What is a “Contract of Adhesion?”
Contract is imbalanced in favor of one party over the other, because on party has all the bargaining power
(i.e. if there’s ambiguity, courts generally rule in favor of the insured)
What is “Indemnity?”
The restoration of the insured to his or her previous financial condition
What is the “Law of Large Numbers?”
As the number of units in a group increase, the more closely the actual loss within the group for a given time period will approach the expected losses
What is “Underwriting?”
Process that determines whether or not an applicant is insurable, and if so, under what conditions and premium level
What does underwriting primarily guard against?
Adverse Selection
What is “Adverse Selection?”
Tendency of individuals/businesses that have higher risks per type of insurance to be more inclined to apply for and retain their insurance.
All insurable risks must possess at least SOME of these characteristics (8 things)
- Large risk groups/law of large numbers
- Identifiable & Measurable loss
- Fortuitous or accidental losses
- Loss cannot be catastrophic
- Economically affordable premiums
- Pure Risk
- Low frequency; high risk
- Random selection vs Adverse Selection
A valid insurance contract must include…(6 things)
- Offer & Acceptance
- Consideration
- Legal Object or Purpose
- Competent parties
- Legal Form
- A voidable insurance contract
“Insurable Interest” Explained
To be a policy owner, you need to be incentivized to protect insured thing
(e.g. my own life, my own house, my spouse’s life, etc)
4 most significant characteristics of insurance contracts
- Principle of Indemnity
- Doctrine of Insurable Interest
- Doctrine of Actual Cash Value
- Subrogation Rights
What does “Estoppel” mean?
If an agent tells a client something that is not necessarily true
(e.g. skydiving won’t affect your disability insurance premium)
they have to follow through on that.
Subrogation Rights Explained
If a third party causes the loss, insurer has priority rights of recovery against responsible 3rd party
What is a “Waiver?”
Intentional relinquishment by an insurer of a known legal right
Describe the differences between Agents and Brokers
Agents represent companies
Brokers represent applicant/insured
7 basic parts of an Insurance Policy
- Declarations
- Definitions
- Insuring Agreement
- Exclusions
- Conditions
- Miscellaneous Provisions
- Endorsements & Riders
Describe the “Declarations” part of an insurance policy
1st or 2nd page; contains
-name of insurer
-name of insured
-property/activity being insured
-amount of coverage provided
-premium
-dates
-policy number
-etc
Describe the “Definitions” part of an insurance policy
A section for defining terms (e.g. accidental death, total disability, etc)
Describe the “Insuring Agreement” part of an insurance policy
Explains promises & obligations of the insurer to the owner of the policy
Typically called “Named Perils” or “Open Perils” agreement
Describe the “Exclusions” part of an insurance policy
Lists perils not covered in policy agreement
Describe the “Endorsements” part of an insurance policy
They clarify some aspect of the policy in response to varied state laws
-may alter exclusions or policy conditions
-may enhance or expand coverage under certain conditions
Describe the “Riders” part of an insurance policy
Added to life insurance and expand coverage for an extra premium
(e.g. once you become disabled, you can waive life insurance premiums)
What is an “Open Perils” Agreement?
Covers ALL perils EXCEPT those specifically excluded
aka All Risk Perils
What is a “Named Perils” Agreement?
Covers ONLY those perils NAMED in the policy
aka Specified Perils
Primary cost-control provisions in insurance policies (4 things)
- Benefit limits
- Deductibles
- Insurance to Value Provisions
- Coinsurance Provision
What is a “Straight Deductible?”
Requires the insured to pay a certain amount of money per occurrence before the insurer will make a payment
(i.e. Subtracts the deductible amount from each separate occurrence of loss.)
What is an “Aggregate Deductible?”
Paid throughout the policy year; insured will pay any losses up to the aggregate amount of the deductible, and insurance pays the rest
3 most commonly used provisions when you have multiple insurances covering the same loss
- Pro-rata liability
- Contribution by equal shares
- Primary & Excess
What does “Pro Rata Liability” mean?
Each insurer covers its share of loss in proportion to insurance provided
(e.g. Providing 10% coverage; pay 10% of loss)
What does “Contribution by Equal Shares” mean?
Multiple insurance companies split payouts down the middle (according to coverage amounts)
What does “Primary and Excess Clause” mean?
One insurance policy is PRIMARY (coverage applied first); Other(s) applied second as Excess (coverage covers remaining if any)
