Basic Insurance Concepts and Principles

Loss (not in bank)

-Reduction of Value -basis for a claim

Know this!

A risk is a chance that a LOSS will occur, a hazard increases the PROBABILITY of a loss; a PERIL is the cause of a LOSS

The insurance must not be mandatory (ideally insurable risk)

An insurer must not be required to issue a policy to each applicant applying for coverage. The insurer must have the ability to require that certain underwriting guidelines be met

Hazards

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

Perils (not in bank)

Cause of loss

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

The loss must be due to chance (accidental)(ideally insurable risk)

In order to be insurable, a risk must involve the chance of loss that is outside the insured control

Know This!!!

Insurable interest must exist at the time of application

The loss cannot be catastrophic (ideally insurable risk)

Insurers typically will not insure risks that will expose them to catastrophic losses. Insurers need to be reasonably certain that the losses will not exceed certain limits. Typically, insurance policies exclude coverage for loss caused by wars or nuclear events because there is no statistical data that allows for the development of rates that would be necessary to cover these vents should they occur

Speculative Risk

Involves the opportunity for either loss or gain. Example: Gambling This is not insurable

Pure Risk

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 of risk that insurance companies are willing to accept. This insurable!!!!!!

Insurance

TRANSFER of risk. Insured's losses are transferred over to the insurer

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The policy owner must have insurable interest in the life of the insured

Insurable Interest

To purchase insurance, the policy owner must face the possibility of losing money or something of value in the event of loss. This is called insurable interest. In life insurance, insurable interest must exist between the policy owner and the 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 insurable interest exists.

The loss must be definite and measurable (ideally insurable risk)

an insurable risk must involve a loss that is definite as to cause, time, place and amount. An 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 exact as possible

Physical Hazard

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

Morale Hazards

are similiar 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 Video: girl putting on makeup while driving

Moral Hazards

are tendencies towards increased risk. Moral hazards 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 fradulent claims against an insurer.

Critical Risk

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

Important Risk

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

Unimportant Risk

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

Adverse Selection

insurance companies strive 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. 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

Sharing (Risk management techniques) "STARR"

is a method of dealing with risk for a group of individuals 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

Indemnity (sometimes referred to as reimbursement)

is a provision in an insurance policy that states that in the event of loss, an insured or a beneficiary is permitted to collect only to the extent 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. LIFE AND HEALTH EXAMPLE: Brenda has a health insurance policy for $20,000. After she was hospitalized, her medical expenses added up to $15,0000. The insurance policy will reimburse Brenda only for $15,000 (the amount of the loss), and not for $20,0000 (the total amount of insurance)

Exposure

is a unit of measure used to dermine rates charged for insurance coverage. In life insurance, all of the following factors are considered in determining rates: -the aged of the insured -medical history -occupation -sex

Retention (Risk management techniques) "S-T-A-R-R"

is the planned assumption of risk by an insured through the use of deductibles, co-payments, or self-insurance. It is also known as self-insurance when the insured accepts the responsibility for the loss before the insurance company pays. The purpose of retention is 1. to reduce expenses and improve cash flow 2. to increase control of claim reserving and claims settlements 3. to fund for losses that cannot be insured

Avoidance (Risk management techniques) "S-T-A-R-R"

one of the methods of dealing with risk is AVOIDANCE, which means eliminating exposure to a losss. Example: 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. Risk avoidance is effective but seldsom practical

Reduction (Risk management techniques) "S-T-A-R-R"

since we usually cannot avoid risk entirely, we often attempt to lessen the possibility or severit of a 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 lifestyle

Law of Large Numbers

states 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 caluclated Example:When an insurance company issues a policy on a 35-year-old male, the company really has no way of knowing or accurately prediciting when he will die. However, the LAW OF LARGE NUMBERS, look at a large group of similar risk - 35 yrs old males of similar lifestyles and health conditions- and make 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. KNOW THIS!!! AS THE NUMBER OF PEOPLE IN A RISK POOL INCREASES, FUTURE LOSSES BECOME MORE PREDICTABLE.

Transfer (Risk management techniques) "S-T-A-R-R"

the most effective way to hand risk is to TRANSFER it so that the loss is borne by another party. Insurance is the most common method of transferring risk from an individual or a group to an insurance company. Though the purchasing of insurancr will not eliminate the risk of death or illness, it relieves the insured of the financial losses these risk bring

The loss exposure to be insured must involve large homogenous exposure units (ideally insurable risk)

there must be a sufficiently large pool to be insured and those in the pool must be grouped into classes with similar risks so the insurer is able to predict loses based upon the LAW OF LARGE NUMBERS. This enables insurers to properly predict the average frequency and severity of future losses and to set appropriate premium rates. ( in life insurance, the use of mortality tables allows the insurer to project losses based on statistics.)

The lost must be statically predictable (ideally insurable risk)

this enables insurers to estimate the average frequency and severity of future losses and to set appropriate premium rates ( in life and health insurance, the use of mortaility tables and morbidity tables allows the insurer to project losses based on statistics)