Basic Insurance Concepts and Principles

Distribution of exposures

A profitable distribution of exposures (or spread of risk) exist when poor risk are balanced with preferred risk, with "average" or "standard" risk in the middle. The purpose behind distributing risk in this manner is to protect ensure from adverse selection. This is one of the key principles of insurance.

Avoidance

Avoidance is eliminating exposure to a loss.

Agency contracts

Contract that is held between an insurer and an agent/producer, containing the expressed authority given to the agent/producer, and the duties and responsibilities to the principal. An agent who is in violation of the agency contract may be held personally liable to the insurer.

Important risks

Important risk include those exposures in which the losses would lead to major changes in the persons desired lifestyle or profession

Person

In the law, a person is a legal entity which acts on behalf of itself, accepting legal and civil responsibility for the actions it performs and making contracts in its own name.

Adverse selection

Insurance companies drive to protect themselves from adverse selection, the insuring of risk that are more prone to losses than the average risk. Poorer risk tend to seek insurance or file claims to a greater extent than better risk. Insurance companies have an option to refuse or restrict coverage for bad risk, or charge them a higher rate for insurance coverage.

Insurer

Is the principal

Moral

Moral hazards are tendencies towards increased risk. Moral hazards involved evaluating the character and reputation of the proposed insured. Moral hazards refer to those applicants who may lie on an application for insurance, or in the past, have submitted fraudulent claims against an insurer.

Morale

Morale hazards are similar to moral hazards, except that they arise from a state of mind that causes indifference to loss, such as carelessness. Actions taken without forethought may cause physical injuries.

Insured

Person covered by the policy of insurance who may or may not be the applicant or policy owner.

Physical

Physical hazards are individual characteristics that increase the chances of the cause of loss. Physical hazards exist because of a physical condition, past medical history, for a condition at birth, such as blindness.

Purchase of Life Insurance

Policyowner (pays premium to insurance company)--> Insurance company (issues policy to policyowner, pays benefit to beneficiary) --> Beneficiary (Receives benefit upon insured's death).

Pure risk

Refers to situations that can only result in a loss or no change. No opportunity for financial gain. Pure risk is the only type of risk insurance companies are willing to accept.

Retention

Risk retention is the plan assumption of risk by and insured through the use of deductibles, co-pays men's, or self-insurance, it is also known as self-insurance when the insured except the responsibility for the lost before the insurance company pays. The purpose of retention is to reduce expenses and improve cash flow, to increase control of claim reserving and claims settlements, and to fund for losses that cannot be insured.

Death benefit

The amount paid when a claim is issued against a policy of insurance.

The loss must be statistically predictable

This enables insurers to estimate the average frequency and severity of future losses and to set appropriate premium rates.

Insurance policy

A contract between a policy owner (and/or insured) and an insurance company which agrees to pay the insured or beneficiary for the loss caused by specific events.

Legal hazard

A legal hazard describes a set of legal or regulatory conditions that affect an insurers ability to collect premiums that are commensurate with (equal to in value) The exposure to loss that the insurer must bear.

Agent/producer

A person who acts for another person or entity with regard to contractual arrangements with third parties; a legal representative of an insurance company. The classification of producer usually includes agents and brokers; agents are the agents of the insurer.

Hazards

Are conditions or situations that increase the probability of an insured loss occurring. Hazards are classified as physical hazards, moral hazards, or morale hazards. Conditions such as lifestyle and existing health, or activities such as scuba diving, are hazards and may increase the chance of a loss occurring.

Perils

Are the causes of loss insured against in an insurance policy.

Exposure

Exposure is a unit of measure used to determine rates charge for insurance coverage. In life insurance, all of the following factors are considered in determining rates: The age of the insured, medical history, occupation, and sex.

The loss cannot be catastrophic

Insurers typically will not ensure risk that will expose them to catastrophic losses.

Speculative risk

Involves the opportunity for either loss or gain. An example of speculative risk is gambling. These types of risks are not insurable.

Homogeneous

Is a large number of units having the same or similar exposure to loss. The bases of insurance is sharing risk among the members of a large homogeneous group with similar exposure to loss.

Applicant (proposed insured)

Is a person who requests or seeks insurance from an insurer

Indemnity

Is a pro vision in an insurance policy that states that in the event of loss, and insured or a beneficiary is permitted to collect only the exact of the financial loss, and is not allowed to gain financially because of the existence of an insurance contract. The purpose of insurance is to restore, but not let an insured or a beneficiary profit from the loss.

Insurance

Is the legal agreement, or contract, where by the two parties involved agree to the limits of the indemnification, the circumstances under which it will occur and what things of value (consideration) will be exchanged by the parties to the contract.

Risk

Is the uncertainty or chance of a loss occurring

Insurable interest

Is to purchase insurance, the policy owner must face the possibility of losing money or something of value in the event of loss. A valid insurable interest may exist between the policy owner and the insured when the policy is ensuring any of the following: policy owners own life, the life of a family member, the life of a business partner, key employee, or someone who has a financial obligation to the policy owner. Insurable interest must exist between the policy owner and then insured at the time of application however once a life insurance policy has been issued, the insurer must pay the policy benefit, whether or not and insurable interest exist.

Policyowner

Person who is entitled to exercise the rights and privileges in the policy and who may or may not be the insured.

Persons

Persons include individual human beings, associates, organizations, corporations, partnerships, and trusts.

Premium

The money paid to the insurance company for the policy of insurance.

Beneficiary

The person who receives the benefits from the policy of insurance

Utmost good faith

The principle of utmost good faith implies that there will be no fraud, misrepresentation or concealment between the parties. As it pertains to insurance policies, both the insurer and insured must be able to rely on the other for relevant information. The insured is expected to provide accurate information on the application for insurance, and the insurer must clearly and truthfully describe policy features and benefits, and must not conceal or mislead the insured.

Transfer

Transfers the risk of loss from an individual or business entity to an insurance company, which in turn spreads the costs of unexpected losses to many individuals. If there were no insurance mechanism, the cost of a loss would have to be borne solely by the individual who suffered the loss.

Unimportant risk

Unimportant risk include those exposures in which the possible losses could be met out of current assets or current income without exposing undue financial strain or lifestyle changes.

The loss must be definite and measurable

And insurable risk must involve a loss that is definite as to cause, time, place, and amount. And insurer must be able to determine how much the benefit will be and when it becomes payable. Since insurance policies are legal contracts, it helps if the conditions are as exact as possible.

The insurance must not be mandatory.

And insurer must not be required to issue a policy to each applicant applying for coverage. The insurer must have the ability to acquire that certain underwriting guidelines be met. Which are the following: be able to identify the definition of insurable events, and be able to identify and apply the definition of insurable interest, the principle of indemnity and utmost good faith.

Insurable events

Any contingent or unknown event, whether past or future, which may damn if I pay person having an insurable interest, or create a liability against him, may be insured against. The more predictable and lost becomes, the more insurable it becomes. The more unpredictable and loss, the less insurable it becomes.

Sharing

Sharon is a method of dealing with risk for a group of individual persons or businesses with the same or similar exposure to loss to share the losses that occur within that group. A reciprocal insurance exchange is a formal risk sharing arrangement.

Reduction

Since we usually cannot avoid risk entirely, we often attempt to lessen the possibility of severity of loss. Reduction would include actions such as installing smoke detectors in our homes, having an annual physical to detect health problems early, or perhaps making a change in our lifestyles.

Insurer (principal)

The company who issues a policy of insurance.

Law of large numbers

The law of large numbers states that the larger the number of people with a similar exposure to loss, the more predictable actual loss will being this law forms the basis for statistical prediction of lost upon which insurance rate are calculated.

Accidental loss

The loss must be due to chance. In order to be insurable, a risk must involve the chance of loss that is outside the insured's control.

Life insurance

A coverage upon a person's life, and granting, purchasing or disposing of annuities

Critical risks

Critical risk include all exposures in which the possible losses are of that magnitude that would result in financial ruin to the insured, his or her family, and/or to his or her business