Nature of Insurance

Risk Pool

Also known as loss sharing, spreads risk by sharing the possibility of loss over a large number of people. It transfers risk from an individual to a group.

Speculative risk

Is a type of risk that involves the chance of both loss and gain; it is not insurable.

Law of large numbers

Is 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 giver period.

Hazard

Is any factor that gives rise to a peril.

Risk Retention

Is 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, the part that you are responsible for. One way to handle a retained risk is through self- insurance.

Morale Hazard

Is hazard arising from indifference to loss because of the existence of insurance.

Adverse Selection

Is selecting "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.

Reinsurance

Is 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

Is 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.

Moral Hazard

Is 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.

Peril

Is the immediate specific event causing loss and giving rise to risk.

Risk

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

Pure Risk

Is type of risk that involves the chance of loss only; there is no opportunity for gain; insurable.

Risk Avoidance

Occurs when individuals evade risk entirely. It is the act of not doing something that could possible 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.

Risk Reduction

Take 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.