(Ch1) General Insurance

Sharing

(i.e. risk sharing) 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. EX: A reciprocal insurance exchange is a formal risk-sharing arrangement

*Concepts*: The application of make up while driving: ______ Collision with the other vehicle: ______

Application of make-up while driving: *Morale Hazard* (related to *attitude*) The collision with the other vehicle: *Peril* (causes the *loss*)

List the Methods of Handling Risk (5)

Avoidance Retention Sharing Reduction Transfer

Ceding insurer vs Assuming insurer

with regards to *reinsurance*: *CEDING*: The originating company that procures insurance on itself from another insurer is called the *ceding insurer* (because it cedes, or gives, the risk to the reinsurer) *ASSUMING*: The other insurer is called the *assuming insurer*, or reinsurer, because it is *assuming* the risk for the ceding insurance company.

Facultative reinsurance vs Reinsurance treaty

with regards to *reinsurance*: *FACULTATIVE REINSURANCE*: When reinsurance is purchased on a *specific policy* *REINSURANCE TREATY* When an insurer has an *automatic reinsurance agreement* between itself and the reinsurer in which the reinsurer is bound to *accept all risks* ceded to it. Treaties are usually negotiated for a period of a year or longer.

It is known as self-insurance when.....

(NOTE: Self-insurance is type of risk retention) the insured *accepts* the *responsibility for* the *loss* before the insurance company pays.

List the Risk Management Key Terms (5 main terms)

*Loss* *Risk* (pure & speculative) *Hazard* (physical, moral, & morale) *Peril* (life, health, property, & casualty) *Exposure*

(List) Characteristics that pure risks must have to be insurable: (i.e. Elements of Insurable Risks)

Insurable risks involve the following losses: (1) Due to chance (2) Definite and measurable (3) Statistically predictable (4) not catastrophic (5) randomly selected and large loss exposure

Adverse selection

Insurance companies strive to protect themselves from this. The tendency of *risks with higher probability of loss* to *purchase* and *maintain insurance more often than* the risks who present *lower probability*. (i.e. refers to an insurance company's coverage of life insurance applicants whose risk as policyholders, due to their way of life, is significantly higher than the company perceives)

Describe what it means for an *insurable risk* to be *statistically predictable*

One of the qualifications for a risk to be considered insurable: Insurers must be able to *estimate* the *average frequency and severity of future losses* and *set* appropriate *premium rates*. *EX*: In life and health insurance, the use of mortality tables and morbidity tables allows the insurer to project losses based on statistics.

Describe what it means for an *insurable risk* to be *Due to chance*

One of the qualifications for a risk to be considered insurable: a loss that is *outside the insured's control*. *EX*: a tornado tearing down your house and/or killing you

What factors are considered in determining rates for life insurance?

The *age* of the insured; *Medical history*; *Occupation*; and *Sex*.

Exposure

a *unit of measure* used to *determine* *rates charged* for insurance coverage. *EX*: In life insurance, all of the following factors are considered in determining rates: The age of the insured; Medical history; Occupation; and Sex.

Avoidance

(i.e. *risk avoidance*) One of the methods of dealing with risk that means *eliminating exposure to a loss*. *EX*: if a person wanted to avoid the risk of being killed in an airplane crash, he/she might choose never to fly in an airplane. *Pro*: effective, but *Con*: seldom practical.

Retention

(i.e. *risk retention*, *active retention*, or *risk assumption*) A method of dealing with risk by *intentionally or unintentionally keeping* a *portion of risk* for the insured's account; i.e. the *amount of responsibility assumed* but not reinsured by the insurance company. (you are assuming responsibility) the *planned assumption of risk* by an insured through the use of deductibles, co-payments, or self-insurance. EX: my family's high deductibles on health insurance lower the premiums they have to pay (it is *retention*) Purpose: 1. To reduce expenses and improve cash flow; 2. To increase control of claim reserving and claims settlements; and 3. To fund for losses that cannot be insured.

Pure Risk vs Speculative Risk

*PURE*: refers to situations that can *only* *result* *in* a *loss* *or* *no* *change*. There is *no* *opportunity* for financial gain. Pure risk is the only type insurance companies are willing to accept. (the risk is *beyond one's control*) *EX*: a drunk driver running a red light while you are going through the intersection *SPECULATIVE*: involves the opportunity for either loss or gain. *Example*: gambling. These types of risks are not insurable.

How and why do insurance companies protect themselves from *adverse selection*?

*WHY*: Called as such in reference to its adverse effects on an insurance company, *adverse selection* unknowingly *opens insurance providers to high amounts of risk* exposure without fair premium compensation. *HOW*: To protect themselves from adverse selection, insurance companies have an option to refuse or restrict coverage for bad risks, or charge them a higher rate for insurance coverage.

Hazard (define--general term)

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

*Physical* Hazard

*individual characteristics* that *increase* the chances of the *cause of loss* (i.e. *peril*). Physical hazards exist because of a physical condition, past medical history, or a condition at birth, such as blindness

*Moral* Hazard

*tendencies towards increased risk*. Involves evaluating the *character* and *reputation* of the proposed insured. *EX*: refers to those applicants who may lie on an application for insurance, or in the past, have submitted fraudulent claims against an insurer.

Describe what it means for an *insurable risk* to be *randomly selected and large loss exposure*

One of the qualifications for a risk to be considered insurable: There must be a sufficiently *large pool of* the *insured* that *represents* a *random selection of risks* in terms of *age, gender, occupation, health and economic status,* and *geographic location*.

Describe what it means for an *insurable risk* to be *Definite and measurable*

One of the qualifications for a risk to be considered insurable: a loss that is *specific* as *to* the *cause, time, place* and *amount*. An insurer must be able to determine how much the benefit will be and when it becomes payable. *EX*: Car wreck; plane crash; tree falling on your car or home.

Reduction

(i.e. risk reduction) a method of dealing with risk; the attempt to *lessen* the *possibility* or *severity of* a *loss*. *EX*: actions such as installing smoke detectors, having an annual physical, or change in life-style

*Concepts* Flow Chart explaining how the following terms are related: (Hazards, Insurance, Loss, & Perils)

*Hazards* --> *Perils* --> *Loss* --> *Insurance* (1) *Hazards* (conditions and actions that *increase* *risk* or probability of loss) (2) *Perils* (the actual *causes of loss*) (3) *Loss* (Reduction of value; *basis for claim*) (4) *Insurance* (*Transfer* of loss; *protection*)

Tell what the following types of insurance insure against: Life insurance Health insurance Property insurance Casualty insurance

*LIFE*-- insures against the *financial loss* caused by the *premature death of* the *insured*; *HEALTH*-- insures against the *medical expenses* and/or *loss of income* caused by the insured's *sickness* or *accidental injury*; *PROPERTY*-- insures against the *loss of physical property* or the loss of *its income-producing abilities*; *CASUALTY*-- insures against the *loss* and/or *damage of property* and resulting *liabilities*.

Moral Hazard vs Morale Hazard

*MORAL*--*character/reputation* have tendencies towards increased risk (i.e. lies) *MORALE*--*attitude/indifference* to loss (i.e.

Transfer

*Most effective way to handle risk* is to transfer it so that the *loss* is *borne* by *another party*. EX: *Insurance* is the *most common* method--risk moves *from individual/group to* an *insurance company* There are *several ways to transfer risk*, such as *hold harmless agreements* and other *contractual agreements*, but the safest and most common method is to purchase *insurance coverage*.

Purpose of risk retention:

1. To reduce expenses and improve cash flow; 2. To increase control of claim reserving and claims settlements; and 3. To fund for losses that cannot be insured.

homogeneous (related to Exposure)

A large number of *units* having the *same or similar exposure to loss* The *basis of insurance* is *sharing risk among* the members of a large homogeneous *group with similar exposure to loss*

Describe what it means for an *insurable risk* to be *not catastrophic*

One of the qualifications for a risk to be considered insurable: Insurers need to be reasonably certain their *losses will not exceed specific limits*. *EX*: That is why insurance policies usually *exclude coverage for loss caused by war or nuclear events*: There is *no statistical data* that allows for the development of rates that would be necessary to cover losses from events of this nature.

Insurance

a *contract* in which *one party* (the insurance company) *agrees to indemnify* (make whole) the *insured party against loss, damage or liability* arising from an unknown event. Though the purchasing of insurance *will not eliminate* the *risk* of death or illness, *it* *relieves* the insured of the financial *losses* these *risks bring*. *EXAMPLE*: In life insurance, the policy protects survivors from losses suffered after an insured's death.

Reinsurance

a *contract* under which one insurance company (*the reinsurer*) *indemnifies another insurance company for part or all of its liabilities*. The *purpose* of reinsurance is to *protect insurers against catastrophic losses*. The originating company that procures insurance on itself from another insurer is called the *ceding insurer* (because it cedes, or gives, the risk to the reinsurer). The other insurer is called the *assuming insurer*, or reinsurer. When reinsurance is purchased on a *specific policy*, it is classified as *facultative reinsurance*. When an insurer has an *automatic reinsurance agreement* between itself and the reinsurer in which the reinsurer is bound to *accept all risks* ceded to it, it is classified as a *reinsurance treaty*. Treaties are usually negotiated for a period of a year or longer.

*Morale* Hazard

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. *Concept EX*: People drive less cautiously bc they have car insurance (which means they don't have to pay all of the expenses of an accident) *EX*: Texting while driving or applying makeup while driving

Law of Large Numbers

states that the *larger the number* of people *with* a *similar exposure to loss*, the *more predictable* actual *losses will be*. This law *forms the basis* for statistical prediction of loss *upon which insurance rates are calculated*. *EX*: When an insurance company issues a policy on a 35 year old male, the company really has no way of knowing or accurately predicting when he will die. However, the Law of Large Numbers looks at a large group of similar risks - 35 year old males of similar lifestyles and health conditions - and makes some conclusions based on statistics of past losses. This allows the insurance company to have a general idea about the predicted time of death for this type of insured and to set the premiums accordingly.

Loss

the *reduction, decrease, or disappearance of value* of the person or property insured in a policy, *caused by a* named *peril* . Insurance provides a means to *transfer* loss.

Risk

the *uncertainty or chance of* a *loss occurring*. The two types of risks are *pure* and *speculative*, only pure risk is insurable.

Peril

the* causes of loss* insured against in an insurance policy (i.e. The cause of a possible loss.) *EX*: earthquake, fire, tornado, hurricane, theft, etc. NOTE: Insurance is what anticipates/protects against perils, transferring the cost of the loss to the insurance agency.