Chapter 1 - Insurance Overview

Premiums for life insurance are not tax-deductible and death benefits, received in a lump sum, are not taxable. Which of the following is taxable?

***Interest on life proceeds paid in installments Dividends Accelerated benefits Policy loans

Other Classifications of risk

- Financial - deal strictly with the potential for monetary loss. Insurance deals with financial risks. - Nonfinancial - non-monetary situations that have a potential for loss. ex: a blind date. - Static - Static risks are independent of changes to the economy and are more consistent over time. A static loss may be an unintended change in ownership due to theft, destruction of an asset or a result of human error. - Dynamic - Dynamic risks are caused by a changing economy, and include changes in product price, purchasing trends and technology. Dynamic risks typically result in gain and societal advancement. - Fundamental - Fundamental risks involve an entire population or group of people, and include risks that everyone may be susceptible to, such as natural disasters, war or unemployment. Because fundamental risks are not the fault of individuals, society is held to deal with them. Most often, the government provides insurance for fundamental risks, such as national flood insurance. - Particular - specific to individuals and are often managed through insurance.

Two types of risk

Speculative and Pure

Insurance Coverage basic terms

indemnity, limit of liability, premium, deductible, coinsurance, claim

Insurance Contract

legal agreement made between an insurance company and an individual

The type of insurance that covers a debt

Credit

Types of Hazards

- Physical - (poorly constructed roofs) - Moral - predisposition, character, habits and values of a person that increase the chance of a loss occurring (addiction to drugs or alcohol) - Morale - careless attitude, indifference or lack of responsibility, which increase the chance of a loss occurring. (It doesn't matter if I get sick because I have health insurance) - Legal - application of laws, regulations, and legal court rulings that increase the chance or amount of loss. A person who files a lawsuit without any real evidence of infliction or damage suffered from another party is engaging in a legal hazard

ABC Insurer transfers risk to DEF Insurer. ABC Insurer decides to transfer some other risks to LMO Insurer. When ABC Insurer needs to submit a claim on risks that were reinsured to DEF Insurer, which insurer(s) pays the claims?

ABC and DEF insurers

The law of large numbers and spreading the uncertainty of loss over a large number of people is:

Insurance

Transferring uncertainty of loss to the insurance company is the definition of:

Insurance

Another term which means the same as insurance policy is:

Insurance contract

Which of the following correctly describes the law of large numbers?

It states that as a group's size increases, it is easier to predict the number of future losses over a specific time period.

The total amount an insurer will pay for an insured risk is the definition of:

Limit of Liability

Real world examples of insurance interest

Martha is married and has 4 children under the age of 6. She is taking a life insurance policy out on her husband so that if anything happens to him, she and the children would be taken care of. Martha has an insurable interest in her husband. Mike and Matthew are business partners. They have taken out policies on each other to cope with the loss if one of them would die. They also have insurance on their top salesman - protecting the revenue that he brings in. George borrowed money from a finance company. The company has a credit life insurance policy that would cover George's debt if anything happened to him.

Molly hates her job. Her 70-hour weeks at the law firm have just gotten to be too much, especially since she really does want to take that trip to the Virgin Islands that she's been putting off for years because of work demands. She remembers that she has a disability policy that will pay her 70% of her paycheck while she is disabled and cannot work. She starts thinking, if she deliberately hurts herself, causing a self-inflicted disability, she will get everything she wants: time off from work, a paycheck, albeit somewhat smaller, she can take a trip to the Virgin Islands, and even start the search for a new job. What type of hazard is demonstrated here?

Moral

What type of hazard is an insured's careless attitude?

Morale

Classifications of Pure Risk

Personal, Property, Liability, and Risks due to failures of others

Adverse selection

Tendency for poorer than average risks to seek insurance. insurers seek to minimize this. (smokers seeking insurance)

Limit of Liability

The maximum amount for which an insurer is liable.

Risk

The possibility of uncertainty of loss occurring

Insurance is which method of handling risk?

Tranfer

Which of the following elements of insurable risks specifically discourages adverse selection?

Which of the following elements of insurable risks specifically discourages adverse selection? Select one: a. Loss exposures must be chosen randomly.**** b. Loss must be predictable. c. There must be a large number of homogenous units. d. Loss must not be catastrophic.

Variable Insurance

comprised of variable life and variable annuities. Variable insurance products invest premium dollars in securities, which carry more risk due to price fluctuations

Risk pooling is characterized by:

Similar and independent risks grouped together, and spreading risk over a large number of people

Which of the following definitions best describes hazard?

Something that increases the chance of loss due to a peril

The law of large numbers:

States that as a group increases in size, the easier it is to predict the number of future losses over a certain period of time

Insurable Interest examples

- Purchaser is also the person insured under the policy - Marriage or blood relationship - Business Partners - Creditor-debtor relationship

Elements of Insurance Risk

- occur by chance or accident - definite and measurable (must have economic value. must be obvious that a loss has taken place) - be predictable (insurer can establish what premium is required to adequately cover the risk) - large number of similar (homogenous) exposure units for each type of insurable risk - Loss exposures must be chosen randomly (must not be concentrated to a particular group or population) - Loss must not be catastrophic

Law of Large Numbers

A principle stating that the larger the number of similar exposure units considered, the more closely the losses reported will equal the underlying probability of loss.

Premium

A specific sum of money paid by the insured to the insurance company in exchange for financial protection against loss.

Insurance is:

A transfer of the uncertainty of loss from the insured to the insurance company

Mathematicians who analyze statistical risk information for insurance companies are called:

Actuaries

Premium

Amount to be charged for a certain amount of insurance coverage.

This product protects against the risk of living too long:

Annuities

In all of the following scenarios, the statements regarding loss are false EXCEPT:

Betty submits a claim for $300 to her insurance company. The amount of Betty's loss is $300.

The term describing the insured's notification to the insurer requesting payment for a covered loss is:

Claim

What term means the insured's demand for payment of benefits?

Claim

Which of the following is best described as the cost-sharing between the insurer and the insured?

Coinsurance

Risk pooling is best described by which of the following?

Combining similar losses from many people so the average loss over the entire group remains relatively constant

Judith is injured in a car accident. She incurs a covered loss of $50,000. She is required to pay $3,000 before the insurer will cover 80% of the covered loss. Which of the following terms best describes the $3,000 Judith must pay?

Deductible

Which of the following best describes spreading uncertainty of loss over a group of many individuals, and the law of large numbers?

Insurance

Claim

Insured demanding payments of the benefits provided by the policy

Which of the following is another term for insurance company?

Insurer

JKL Insurer transfers risk to PQR Insurer. JKL Insurer transfers some other risks to GHI Insurer. When JKL Insurer has a loss on risks transferred to both PQR and GHI Insurers, which insurer(s) pays the claims?

JKL, PQR, and GHI Insurers

Types of insurance

Life,Health,Annuities(protect against the risk of living longer than expected),Property, Casualty, Credit, Variable (variable life and variable annuities)

Which of the following accurately characterizes an insurable risk?

Loss is definite

All of the following correctly describe risk pooling, EXCEPT:

Loss sharing spreads risk by sharing the possibility of loss over a small number of people. (b. Risk pooling transfers risk from an individual to a group. c. Risk pooling allows a large number of people to be insured for a small amount of money. d. Each member of the group shares in the losses of the group and is promised a future benefit.)

The consideration Walter pays for his insurance coverage is called the:

Premium

Pure Risk

Present potential for loss only. The only type of risk that is insurable. Ex: accident, illness, or death.

Flu shots and annual physical exams are examples of what method of handling risk?

Reduction

Samantha is concerned about driving to work on major highways. She does not purchase insurance, nor avoid the major highways. What method of handling risk is Samantha using?

Retention (when a person chooses not to take proactive steps to transfer, avoid or reduce the risk.)

Which of the following terms means risk is spread by sharing the possibility of loss over a large number of people?

Risk pooling

Methods of Handling Risk

STARR: Sharing- when an insured and an insurance company share the cost of risk - deductible is a form of risk sharing Transfer- Risk is transferred from one party to another. The Insurer charges a small premium in exchange for providing benefits to the party relieved of the risk (the insured) in the event of a covered loss. Avoidance - completely avoiding doing things to avoid risk Retention - when a person chooses not to take proactive steps to transfer, avoid or reduce risk. the person deals with the risk when it happens. One type of risk retention is self-insurance: when a person is aware of the risk and chooses to be financially responsible for any losses that may occur. Reduction- actively finding ways to minimize loss exposure to a risk. ex: annual wellness exams, employer-paid fitness memberships. (both loss control and prevention would be flu shots and smoke free premises)

Beth is required to pay a $400 deductible on her health insurance claim. Which method of handling risk is demonstrated here?

Sharing

Mortality

The rate at which a specific population dies

In life and health insurance, a person's greatest asset is:

Their earning power

All of the following are not elements of insurable risks EXCEPT:

a. Loss must be indefinite and immeasurable. b. Loss must not be predictable. c. Loss exposures must be chosen deliberately. d. Loss must not be catastrophic.****

Adverse selection occurs when:

a poorer than average person risk seeks insurance

Which of the following is a method of handling risk?

a. Exposure b. Increase risk c. Sharing*** d. Losses

Physical hazards that increase the potential for loss include:

a. Lack of exercise b. High blood pressure c. Driving while intoxicated d. None of the above***

The Insurance Department passed a law mandating that every group health insurance policy cover maternity on the same basis as other sickness. What type of hazard is described here?

a. Legal*** b. Morale c. Moral d. Physical

Some losses are guaranteed to happen. For example, people who live in a flood plain are highly likely to undergo a flood. Socially-funded insurance , the National Flood Insurance Program, steps in to provide flood insurance coverage to residents living in the flood plain. Which of the following elements of insurable risks is not met by this example?

a. Loss exposures must be chosen randomly.*** b. Loss must be unpredictable. c. Loss must occur by chance or accident. d. None of the above

All of the following correctly describe risk pooling, EXCEPT:

a. Loss sharing spreads risk by sharing the possibility of loss over a small number of people. *** b. Risk pooling transfers risk from an individual to a group. c. Risk pooling allows a large number of people to be insured for a small amount of money. d. Each member of the group shares in the losses of the group and is promised a future benefit.

Which of the following is not a type of hazard?

a. Physical hazard b. Morale hazard c. Moral hazard d. Perilous hazard***

Which of the following correctly identifies the most important principle(s) of insurance?

a. Risk pooling b. Insurable interest c. The law of large numbers

All of the following are methods of handling risk except:

a. Transfer b. Avoidance c. Reduction d. Reinsurance***

What method of handling risk is used when an insurance policy requires the insured to pay a deductible before the insurance begins to pay benefits?

a. Transfer b. Reduction c. Sharing*** d. Retention

Hazard

anything that increases the chance of a loss occurring from a particular peril. Hazards are conditions such as icy roads, improperly stored toxic waste, and driving while intoxicated

Risks Due to the Failure of Others

are the potential for financial loss caused by individuals who agree to perform a service or follow through on an agreement and fail to complete the task

Peril

cause of loss and the event insured against. In life and health insurance, the perils are premature death, dependency during old age, accident, and sickness

Risk

chance of loss occuring

Exposure

condition of being prone to loss due to a hazard or uncertain event

Liability Risks

financial loss caused by injury to other people and damage or destruction to others' property. Casualty Insurance and Errors and Omissions (E&O) coverage are two examples of insurance that protect against liability risks.

For accurate morality or morbidity rates..

groups must consist of large number of similar individuals

Indemnity

insurance that compensates the beneficiaries of the policies for their actual economic losses, up to the limiting amount of the insurance policy Indemnity means "to make whole"

the dollar amount of policy benefits paid to or on the part of an insured...

is a direct reflection of the loss valuation.

Personal Risks

jeopardize an individual's greatest asset, their earning power. divided into four categories based on the peril, or cause of the potential loss: Premature death, Sickness or accident, Unemployment, and Dependent old age.

Insurance is designed to...

offset the financial damage caused by loss

Property Risks

potential for loss caused by destruction or theft of property

Speculative Risk

present potential for loss or gain and are not covered by insurance policies. ex: stock market, gambling

Morbitity

rate at which people get sick

Reinsurance

spreading risk from one insurer to one or more other insurers

Insurable Interest

states that an individual must have a valid concern for the continuation of the life or well-being of the person insured. it must be shown when an individual applies for a life and health insurance policy.

exposure unit

the economic value of the life and well being of the insured individual precisely the dollar value of the life insurance policy

Which of the following best describes loss?

the unintentional decrease in the value of an asset.

Which method of handling risk is insurance?

transfer (Insurance is a transfer of risk from the insured to the insurer.)

Loss

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