Risk Management & Terminology Flashcards
Risk
Represents possibility of a loss - or a negative deviation from a desired outcome (ex. possible loss to house)
Peril
Cause of that loss (ex. fire in home)
Hazard
Increases potential for loss (ex. oily shop rags piled in corner)
Static Risk
- Result from factors other than changes in economy (ex. earthquakes and floods)
- tend to occur with regularity and can be insured
Dynamic Risk
- Result of changes in the economy (ex. changes in business cycle or inflation)
- Insurers typically do not cover
Fundamental Risks
Affect large group of people (ex. recession & earthquakes)
Particular risks
affect individuals or small groups of people
Pure Risk
- Involves only chance of loss or no loss. Otherwise, there is no chance of gain (ex. possibility of house burning is pure risk because no gain).
- Pure risks are insurable
Speculative risk
Involves both chance of loss and gain (ex. gambling)
Risk Management Strategies (Risk Control & Risk Financing)
Risk Control
Seeks to minimize risk of loss, and includes risk avoid and reduction.
Risk Financing
Pays costs of losses incurred. Includes risk retention and risk transfer
Risk retention
situation where potential loss is small and could be covered out of pocket. It is also possible that cost of transferring is high, so no reasonable alternative.
Risk transfer
Primarily insurance but can also be accomplished through waivers or subcontracting. With insurance, risk of loss is transferred to an insurance company in exchange for relatively small cost (premium)
Risk Management Matrix
Advantages & Disadvantages of Risk Avoidance and Reduction
- advantages are savings in premiums and potential liability claims
- disadvantages are that it is not always possible to avoid a risk and sometimes the lifestyle choices a client would have to make (ex. not driving) is challenging
Risk Retention
- how much risk clients decide to retain could influence size of emergency fund, cash flow planning, life and disability coverage, and investment model
- sometimes clients may be unable to transfer risk to insurance company
Self-Insurance
- used to define business use of risk retention. Large businesses use risk retention
- Method of risk retention
- Has several requirements: 1) organization should have enough homogeneous exposure units to make losses somewhat predictable 2) adequate funds must be accumulated to cover plan losses 3) self-insurer must be able to administer insurance functions, such as analysis of potential claims, disbursement of payments to providers, objective determination of claim validity, as efficiently as insurance company would 4) self-insurer must be able to competently manage investment of self-insurance fund
Pricing analysis
Anticipated losses are one of most important pricing factors. Two critical assumptions are used in evaluating these loss statistics: elements of an insurable risk have been met and adverse selection can be controlled
Elements of Insurable Risk
- must be sufficiently large number of homogenous exposure units to make losses reasonably predictable (law of large numbers)
- loss resulting from risk must be definite and measurable
- loss must be fortuitous or accidental
- loss must not be catastrophic to company
Law of large numbers
Must be a large number of similar potential losses so that insurer can reasonably apportion expected financial loss.
Insured people and/or property must also be widely distributed geographically. Otherwise, single peril may cause a catastrophic loss.
Liability of Insurer - 7 factors that insurance companies use to limit insurer’s liability covering losses
- insurable interest
- actual cash value of loss
- policy limits or face value
- other insurance
- coinsurance
- deductible
- subrogation
Insurable interest
Exists when interested party will suffer financial loss if insured loss occurs. For property and casualty insurance (e.g., home and auto), insurable interest must exist both at the time the policy was issued and at the time of the loss. For life insurance, insurable interest must be present at the time the policy was issued, and does not need to be present at the time of a claim.
Actual Cash Value (ACV)
Used with property losses. It’s the replacement cost minus depreciation
Policy limits or face value
Max amount that will be paid when insured loss occurs.
Other Insurance
when loss occurs, and there is more than one insurance policy covering the same loss, the insured will not profit from the loss. Either one policy is considered primary with the other paying for any uncovered loss, or the policies pay prorated shares of the loss.
Coinsurance
May be splitting of costs, or may refer to a minimum percentage of insurance that is required to avoid being penalized for inadequate property insurance when there are partial losses.
Deductibles
Retained risk. Portion of insured losses that insured is expected to pay before insurance company pays anything.
Subrogation
Right of an insurance company that has paid for a loss to recover its payments if it is determined that a different insurance company or person is responsible & required to pay.
Risk management plan - 3 components
1) social insurance
2) public insurance
3) private insurance
Social insurance
Mandatory insurance administered by gov’t, with benefits mandated by law. Purpose is to protect people form large fundamental risks. (ex. social security, medicare, worker’s comp)
Public Insurance
Designed to enhance public trust in financial institutions. Mandatory and administered by government or quasi-governmental institutions (ex. FDIC, PBGC, SIPC)
Private Insurance
Marketed by private insurance companies (disability, health, LTC, etc.)
Insurance Producers
Individuals tht provide insurance company’s products and services. Major types include: independent agents, captive agents, career agents, producing general agents, brokers, surplus-line or excess-line brokers or agents, and solicitors
Independent Agents
Generally represent several insurance companies doing business under American or independent agency insurance system.
- decide where they will place business, dividing policies they sell among various companies they represent while (ideally) basing that on needs of client & suitability
Captive Agents
Sell P&C insurance for companies known as direct writers. Represent only one company most often (some may allow agents to place business w/ other companies only after they’ve declined the business)
Career Agents
Usually life insurance agents in general agency or company owned office. Career agents often choose this form of operation because of the support provided by the agency and the company. Career agents have production requirements in order to maintain their career agent contracts.
Producing general Agents (PGAs) are also called personal producing general agents. Such agents:
- generally produce majority of income by selling insurance personally
- do not have specified territories
- have authority to hire agents to work for them if they wish
- PGA contracts usually contain no prohibition against representing other insurers, although the insurer often does require a minimum dollar amount of new business premium production in order for the PGA to keep the contract. PGAs are often found in the life insurance field with companies that do not have their own agencies.
Brokers
Indviduals who are licenses with and represent many insurance. Broker is agent of insurance buyer.
Companies that do not maintain extensive field forces of their own may sell their
products using agents of other companies through what are called “brokerage contracts.” This may be their primary or even sole distribution system. Many companies that do maintain their own field forces look at brokerage business as a way to increase the amount of insurance they sell without having to increase their overhead for training and provide support services to additional agents. Clients benefit from this practice because brokers have the products of a large number of companies available to them instead of the products of a single company.
Surplus-Line, Excess-Line Broker or Agents
Surplus-and excess-line brokers and agents handle any type of insurance that cannot be purchased using normal distribution channels within a given state. An individual may not be able to obtain coverage from an admitted (in-state) insurer. A surplus-line agent has the authority to go outside the state and place the business with a surplus-line (nonadmitted) insurer if the necessary coverage cannot be obtained from an insurer admitted in the state. These are found almost exclusively in the property and casualty field.
Broker
represents a prospective insured and generally cannot bind the prospective insured to an insurance contract. The knowledge, actions, and assertions of the broker are between the broker and the client. The insurer is neither bound by them nor deemed to have any notice of them. Therefore, while the broker can bind herself, the broker cannot bind the insurer. Because of this, the insurer would not have legal liability arising from actions between the broker and the prospective insured
Agent
It is important to understand that an agency relationship is established in situations in which one person acts on another’s behalf. Acts of an insurance agent within the scope of express, implied, or apparent authority are considered acts of the insurer. Therefore, the insurer is legally liable for the acts of its agents performing their duties, even if agents make fraudulent statements unknown to or unauthorized by the insurer. Under the doctrine of apparent authority, the courts have ruled that agents have powers that the public expects them to have.
Express Authority
Specifically conferred on agent. Is stated in agent’s contract with insurer. The insurer may specify the types of policies, the types of coverage, and the amount of insurance that the agent may write.
Implied Authority
authority not expressly granted, but that which the agent is assumed to have in order to transact the insurer’s business. In other words, an agent has authority to perform all incidental acts that are necessary to fulfill her duties. For example, even if the agent’s contract does not expressly state that the agent has the authority to collect premiums, that authority is implied and collecting premiums is allowed (in fact, it is required to do the agent’s job). Implied authority is sometimes confused with apparent authority, and the terms may even be used synonymously (but incorrectly) by some. Implied authority is derived between the relationship of the insurer (i.e., principal) and the agent. For example, if an agent repeatedly exceeds her binding authority, and the insurer does not take any action, then they have essentially given implied authority to that conduct.
