Chapter 2 Nature of Insurance, Risk, Perils and Hazards

Which of these statements regarding insurance is false?

As the number of insured units increases, the number of losses decreases

How people deal with risk?

Avoidance, reduction, retention, transfer, sharing

Transfer

Buying insurance is the best way to transfer risk. Incorporation is a risk transfer Most effective way to handle risk --transfered to another party

Hazard

Condition or situation that creates or increases a chance of loss -ex icy roads, driving while intoxicated

Avoidance

Dont do anything, elimination of a hazard for example -avoiding risks as possible

Sharing

Each party assume a portion of the risk receiving benefits under the system --share the losses that occur in that group

Reduction

Minimizing the severity of a potential loss ex smoke alarms, stop smoking

Elements of insurable risk

Not all risk is insurable --insurance companies will insure only pure risk --must be due to chance randomly selected

Types of hazards

Physical: Poor health, overweight, blind Moral: Dishonesty, drugs, alcohol abuse Morale: Carless attitude-reckless driving stealing, carefree

Risk

Potential for loss

Risk management

Process of analyzing exposures that create risk and designing programs to handle them

Retention

Self insure, Used when losses are highly predictable and the worst possible loss is not serious --individuals have financial ability to fund losses by themselves when they occur

Peril

Something that can cause financial loss, EX earthquake, tornado. The accident itself

Law of Large numbers

States that larger groups provide an increased degree of accuracy in loss predictions based on past experience. --higher exposure more likely event can be predicted --insurance companies use this to calculate rates. --form the foundation upon which insurance is based and allow for its successful operation

Adverse selection

Tendency for a poorer than average risk to seek out insurance. EX person who takes 12 prescriptions is a poor risk

Loss

Unintentional decrease in the value of an asset due to a peril

Reinsurance contract

catastrophic loss is through reinsurance, which is defined as spreading risk from one insurer to one or more other insurers. ---An insurer has a contractual agreement which transfers a portion of its risk exposure to another insurer

Principle of indemnity

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

Risk pooling

loss sharing, spreads risk by sharing the possibility of loss over a large number of people

Which of the following can be defined as a cause of a loss?

peril

Speculative risk

presents the chance for both loss and gain, EX gambling these risks are not covered by insurance companies

Which of the following describes the act of insuring a risk against possible loss?

risk transfer

Homogenous exposure units

similar objects of insurance that are exposed to the same grounds as perils

An insurable risk requires

that the chance of loss be calculable

Pure risk

the only insurable risks and present a potential for loss only with no possibility of gain EX: injury, illness, death --a situation that can result in a loss, no opportunity for financial gain