Insurance Exam Chapter 2

Hazard

Any factor that gives rise to a peril

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

Peril

Peril

The immediate specific event causing loss and giving rise to risk.

Elements of Insurable Risk:

1) Loss must be due to chance (accident) - outside the person's control. 2) Loss must be definite and measurable - time, place, amount, and when payable. 3) Loss must be predictable - estimate the average frequency and severity. 4) Loss cannot be catastrophic - must be reasonable aka not like a 1 billion dollar policy. 5) Loss exposure to be insured must be large - insurance company must be able to predict loss. 6) Loss must be randomly selected - adverse selection.

Risk Retention:

Being aware of the risks involved and taking precautions for financial protection. You decide that public transportation cannot get you everywhere you want to go when you want to go there, now you must decide what limits to put on your financial responsibility by choosing your deductible. The auto policy's deductible is an illustration of risk retention, through the deductible the insured retains part of the risk which is the part that you are responsible for. One way to handle a retained risk is through self-insurance.

Morale Hazards

Hazard arising from indifference to loss because of the existence of insurance. Careless attitude like reckless driving and cliff jumping.

Physical Hazards

Poor health, overweight, blind.

Which of these statements is not a characteristic of the Law of Large Numbers?

Rates can be calculated to compensate for losses

ABC company is attempting to minimize the severity of potential losses within the company. The company is engaged in risk:

Reduction

An insurer has a contractual agreement which transfers the portion of its risk exposure to another insurer. What type of contractual agreement is this?

Reinsurance contract

How can an insurance company minimize exposure to loss?

Reinsuring risk

Which of the following can be defined as the potential for loss?

Risk

Purchasing insurance is an example of:

Risk Transference

Which term describes the elimination of a hazard?

Risk avoidance

Adverse Selection

Selection "against the company". Tendency of less favorable insurance risks to seek or continue insurance to a greater extent than others. Also, tendency of policy owners to take advantage of favorable options in insurance contracts. Aka poor people who take a lot of medication looking for insurance but the insurance company not wanting to give it to them because they know this information so that poor person has a high risk.

Moral Hazards

The effect of personal reputation, character, associates, personal living habits, financial responsibility, and environment, as distinguished from physical health, upon an individual's general insurability. Dishonesty, drugs, alcohol abuse.

Risk

The uncertainty regarding loss; the probability of loss occurring for an insured or prospect.

Loss

The unintentional decrease in value of an asset due to peril

Law of Large Numbers

A basic principle of insurance that the larger the number of individual risks combined into a group, the more certainty there is in predicting the degree or amount of loss that will be incurred in any given period.

Human Life Value

A method of determining the financial value of a person's life based on computing the current value of a person's future earnings for a certain period of time.

Risk Pooling

Loss sharing which spreads risk by sharing the possibility of loss over a large number of people. It transfers risk from an individual to a group.

Risk ____ is the process of analyzing exposures that create risk and designing programs to handle them.

Management

Risk Avoidance:

Occurs when individuals evade risk entirely. It is the act of not doing something that could possibly cause a loss or the inactivity of participation in an event that may potentially cause a loss situation. An example would be driving an automobile, if you never leave the house you completely avoid the possibility of getting into an auto accident.

Speculative Risk Vs. Pure Risk

Speculative Risk: the type of risk that involves the chance of both loss and gain; it is not insurable. Pure Risk: the type of risk that involves the chance of loss only; there is no opportunity for gain; it is insurable.

Risk Reduction:

Takes place when the chances of loss are lessened. Changing one's lifestyle to minimize a known risk is an example of risk reduction. You decide you cannot stay in the house all day, every day, so avoiding the risk of an auto accident is not possible. You decide to reduce the risk by only using public transportation.

Reinsurance

The acceptance by one or more insurers, called reinsurers, of a portion of the risk underwritten by another insurer who has contracted for the entire coverage.

Risk Transfer:

The act of shifting the responsibility of risk to another in the form of an insurance contract. Through the insurance contract, the burden of carrying the risk and indemnifying the financial loss is transferred from the individual to the insurance company. Purchasing insurance does not eliminate the risk entirely; however, it is one of the most effective ways of transferring risk.

An insurable risk requires:

The chance of loss must be calculable