Nature of Insurance, Risk, Perils, and Hazards

Reduction

minimizing the severity of a potential loss; smoke alarms or stop smoking prevents fires

Law of large numbers

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.

Homogeneous exposure units

Similar objects of insurance that are exposed to the same group of perils.

Loss exposure

any situation that presents the possibility of a loss

Hazard

any factor that gives rise to a peril

Transfer

buying insurance is the best way to transfer risk; incorporation and hold-harmless clauses are examples

Sharing

each party assumes a portion of the risk receiving benefits under the system

Morale hazard

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

Speculative risk

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

Risk pooling

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

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

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

Avoidance

one treatment of risk where you don't do anything; the elimination of a hazard is an example of 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.

Retention

self insure; used when loss are highly predictable and the worst possible loss is not serious

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 risk entirely; however, it is one of the most effective ways of transferring risk.

Moral hazard

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

the immediate specific event causing loss and giving rise to risk

Principle of Indemnity

the principle of indemnity involves making an insured whole by restoring them to the same condition as before a loss

Risk Management

the process of analyzing exposures that create risk and designing programs to handle them

Risk

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

Loss

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

Pure risk

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