Nature of Insurance, Risk, Perils, and Hazards

Type of risk treatment that involves accepting a risk and confronting it if it occurs. For example, you would retain the risk of getting injured in a car accident by driving without insurance.

Risk Retention (Self Insure)

ELEMENTS OF INSURABLE RISK

1. Due to chance 2. Definite and measurable 3. Predictable 4. Not catastrophic 5. Loss exposure to be insured must be large-Ideally, common enough that the insurer can pool many homogeneous, or similar, exposure units (law of large numbers). 6. Randomly Selected-Fair proportion of good and poor risks (adverse selection).

Treatment of Risk - how people deal with risk:

1.Avoidance 2.Reduction 3.Retenention 4.Transfer 5.Risk Pooling

ECONOMIC BASIS OF INSURANCE

1.Human Life Value Approach 2.Need Based Value Approach

The selection "against the company' Tendency of less favorable insurance risks to seek or continue insurance to a greater extent than others. Also, tendency of policy owners to take advantage of favorable options in insurance contracts.

Adverse selection

A condition or situation that creates or increases a chance of loss. For example, icy roads, driving while intoxicated, improperly stored toxic waste.

Hazard

Is any factor that gives rise to a peril.

Hazard

Are similar objects of insurance that are exposed to the same group of perils. For example, insuring a large number of homes in the same geographical area against hail damage.

Homogeneous exposure units

A method of determining the financial value of a person's life based on computing the current value of a person's future earnings for a certain period of time. For example,if the main income earner of the family makes $50,000 a year and the family would like to make sure they are protected for 10 years in the event something happens to the main income earner.$50,000 (current income) X 10years (protection) = $500,000 insurance policy.

Human Life Value Approach:

The larger the amount of exposures that are combined into a group, the more certainty there is to the amount of loss incurred in any given period.

Law of Large Numbers

Is a basic principle of insurance that the larger the number of individual risks combined into a group, the more certainty there is in predicting the degree or amount of loss that will be incurred in any given period.

Law of large numbers

Is the unintentional decrease in the value of an asset due to a peril.

Loss

Any situation that presents the possibility of a loss.

Loss exposure

Type of Hazzard that effects of personal reputation, character, associates, personal living habits, financial responsibility, and environment, as distinguished from physical health, upon an individual's general insurability.

Moral hazard

Type of hazard arising from indifference to loss because of the existence of insurance.

Morale hazard

A method of determining a person's financial value based on the amount of money needed for current and future expenses. These expenses include final expenses,spouse's income,mortgage,college education,retirement, charity donations, etc. For example, a family would like to ensure they can take care of 5 years of annual expenses if something were to happen to the main income earner,and they have an average of $60,000 worth of expenses per year.$60,000 (expenses) X 5 years (protection) = $300,000 insurance policy.

Needs Based Value Approach:

An immediate, specific event which causes loss, such as an earthquake or tornado. Perils can also be referred to as the accident itself.

Peril

The immediate specific event causing loss and giving rise to risk.

Peril

Types of Hazzards

Physical- Poor health, overweight, blind. Moral- Dishonesty, drugs, alcohol abuse. Morale- Careless attitude - reckless driving, jumping off a cliff, stealing, racing motorcycles, carefree, careless lifestyle. This attitude causes an indifference to loss.

The Law of Large Numbers allows:

Prediction of individual and group losses based on past experience An increased degree of accuracy in predicting losses in large groups

Involves making an insured whole by restoring them to the same condition as before a loss.

Principle of Indemnity

Is the only insurable risk and present a potential for loss only, such as injury's, illness, and death.

Pure Risk

Type of risk that involves the chance of loss only; there is no opportunity for gain; insurable.

Pure risk

Insurers deal with catastrophic loss through this ,which is defined as a contractual arrangement that transfers exposure from one insurer to another insurer.

Reinsurance

Is the acceptance by one or more insurers, called reinsurers, of a portion of the risk underwritten by another insurer who has contracted for the entire coverage.

Reinsurance

The potential for loss

Risk

The uncertainty regarding loss; the probability of loss occurring for an insured or prospect.

Risk

Occurs when individual evades risk entirely. It is the act of not doing something that could possibly cause a loss or the inactivity of participation in an event that may potentially cause a loss situation. An example would be driving an automobile. If you never leave the house you completely avoid the possibility of getting into an auto accident.

Risk Avoidance

Type of risk treatment that involves avoiding the risk all together. For example, you can avoid the risk of getting injured in a car accident by never leaving the house.

Risk Avoidance

Type of risk treatment that involves a large group of people spread a risk for a small certain cost. It transfers risk from an individual to a group. An example of Risk sharing would be, doctors pooling their money to cover malpractice exposures

Risk Pooling (Loss sharing)

Spreads risk by sharing the possibility of loss over a large number of people. It transfers risk from an individual to a group.

Risk Pooling/Loss sharing

Takes place when the chances of loss are lessened. Changing one's lifestyle to minimize a known risk is an example of risk reduction. You decide you cannot stay in the house all day, every day, so avoiding the risk of an auto accident is not possible. You decide to reduce the risk by only using public transportation.

Risk Reduction

Type of risk treatment that involves taking precautions; minimizing severity of a potential loss. For example, you can reduce the risk of getting injured in a car accident by taking public transportation.

Risk Reduction

Being aware of the risks involved and taking precautions for financial protection. You decide that public transportation cannot get you everywhere you want to go when you want to go there. Now you must decide what limits to put on your financial responsibility by choosing your deductible. The auto policy's deductible is an illustration of ----- Risk. Through the deductible, the insured retains part of the risk, the part that you are responsible for. One way to handle is through self-insurance.

Risk Retention

The act of shifting the responsibility of risk to another in the form of an insurance contract. Through the insurance contract, the burden of carrying the risk and indemnifying the financial loss is transferred from the individual to the insurance company. Purchasing insurance does not eliminate risk entirely; however, it is one of the most effective ways of transferring risk.

Risk Transfer

Type of risk treatment that involves making someone else responsible for a loss. For example, buying auto insurance transfers the cost associated with a car accident from the driver to the insurance company. Buying Insurance is the best way.

Risk Transfer (Transference)

Is a risk that presents both the chance for loss or gain. Gambling is an example are not insurable.

Speculative Risk

Type of risk that involves the chance of both loss and gain; it is not insurable.

Speculative risk