The Fundamental Principles of Insurance

Question 1

What is the main purpose of insurance?

Answer 1

paying claims to policyholders should they cover a loss or damage covered by the terms of insurance.

Insurance is a method of risk transfer.

Question 2

Definitions of ‘risk’

Answer 2

• the possibility of something unfortunate happening
• the possibility of a loss
• a peril occurring
• the subject-matter of insurance

Question 3

Name 2 different attitudes to risk?

Answer 3

1. Risk seeking = people who are willing to carry certain risks themselves
2. Risk averse = people happier to minimise the risk to which they are exposed (by transferring the risk by means of insurer)

Question 4

What are the components of risk management?

Answer 4

(IAR)
1. identification
2. analysis
3. risk control

Question 5

Define frequency and severity?

Answer 5

1. Frequency = how often it will happen
2. Severity = how serious it will be if it does happen

Question 6

What are the 6 categories of risk?

Answer 6

Financial and non-financial.
Pure and speculative.
Particular and fundamental.

Question 7

Provide an example of each category of risk.

Answer 7

Financial - Damage to a car.
Non-financial - pandemics, floods, reputation.
Pure - travelling in an aircraft.
Speculative - the national lottery.
Particular - theft of personal possessions.
Fundamental - famine, economic recession.

Question 8

Name the risks that are insurable.

Answer 8

Those that are: financial, pure and particular.

Question 9

What is the concept of pooling risks?

Answer 9

By pooling risks the losses of the few are met by the contributions of the many who are exposed to similar potential losses.

Question 10

What is the law of large numbers?

Answer 10

when there is a large number of similar situations, the actual number of events tends towards the expected number. Allows insurers to calculate likely losses and charge a premium.

Question 11

Define Peril and Hazard.

Answer 11

• Peril = that which gives rise to a loss.
• Hazard = that which influences the operation or effect of the peril. E.g. lack of sprinklers.

Question 12

What are the types of hazard and give examples.

Answer 12

• Physical hazard = a physical and measurable characteristic. E.g. properties construction.
• Moral hazard = arises from the attitude and behavior of people. E.g. Carelessness, dishonesty.

Question 13

What features do insurable risks have?

Answer 13

They are financial, pure, and particular, but also:
1. fortuitous (accidental)
2. Insurable interest (financial relationship)
3. Not against public policy (legal)
4. Homogenous exposures (similar risks)

Question 14

Name the primary functions of insurance (3).

Answer 14

1. Spreading the risk
2. Providing a degree of certainty
3. Transferring risk

Question 15

Name the secondary functions of insurance (4).

Answer 15

1. Companies don’t need to a ‘safety net’ of £
2. Companies can expand business
3. Protects jobs
4. Losses are reduced in size and number

Question 16

Reasons for compulsory insurance and examples?

Answer 16

1. provides funds for compensation
2. in response to national concerns
3. reputation of profession
   E.g.
   - Employers’ Liability Insurance
   - Motor insurance
   - PI insurance

Question 17

What is an equitable insurance premium?

Answer 17

Each insured joining a pool pays an equitable (fair) contribution to the pool. Ensures successful operation of the pooling system.

Question 18

What is a a financial risk?

Answer 18

A risk that is capable of financial measurement and one that you can acquire insurance for.

Question 19

What is a non-financial risk

Answer 19

A risk that is not capable of financial-measurement and cannot be insured.

Question 20

What is a pure risk?

Answer 20

A risk where there is a possibility of a loss but NOT of a financial gain. This risk is insurable.

Question 21

What is a speculative risk?

Answer 21

A risk where there is a possibility of making both a gain and a loss. This risk is not insurable.

Question 22

What is a particular risk?

Answer 22

A risk that affects individuals and not the entire community. These risks are insurable.

Question 23

What is a fundamental risk?

Answer 23

A risk that is so widespread in its affect that it is uninsurable. It arises from social, economic, political, or natural causes.

Question 24

Define risk management.

Answer 24

The identification, analysis and economic control of those risks which can threaten the assets or earning capacity of an enterprise.