Sec 1: General Insurance Concepts

Can individuals purchase any kind of insurance they desire?

No. They first must be insurable.

In Property Insurance, what is the difference between a Peril Policy and an All-Risk Policy?

Some property insurance policies are named peril, covering only those perils that are listed in the policy, while others are all risk, covering all perils, except for those excluded.

Non-Profit Status

A Non-Profit status exists when profits are returned to subscribers in the form of reduced premium or expanded benefits.

How is a Risk Retained?

A Risk is Retained, when a person decides to assume financial responsibility for certain events. The deductible amount on an auto insurance policy may be seen as a way the insured retains some portion of the risk. In addition, his premium is reduced because of this assumption of risk.

Hazard

A hazard is defined as something that increases the risk, or chance of loss.

In Property Insurance, how do you define a loss?

A loss in Property Insurance is defined as a reduction in the value of the insured property caused by an insured peril, such as fire.

Examples of Insurable Interest

A person is presumed to have an insurable interest in: 1. his or her own life. 2. the life of a close relative or a spouse. 3. on financial loss that will take place if an insured individual dies. Ex: 2 partners in a business, each of whom brings substantial expertise to that business. If one partner should die, the business could fail, resulting in a loss to the other partner.

How is a Risk Reduced?

A risk is Reduced, when a person practices living a healthier lifestyle, thereby reducing the chance of major illness.

What are the Ways to Manage Risk?

A risk may be Retained, Avoided, Reduced, or Transferred. (R-A-R-T)

Stock Insurers

A stock insurance company, like other stock companies, consists of stockholders who own shares in the company. the individual stockholder provides capital for the insurer. In return, they share in any profits and any losses. management control rests with the Board of Directors, selected by the stockholders. The Board of Directors elect the officers who conduct the daily operations of the business.

Domestic, Foreign and Alien Insurers

An insurer is defined not only by its corporate status, but also by its locality, or domicile of incorporation. If an insurer is incorporated under the laws of the state in which it conducts business, that insurer is considered a domestic insurer. If an insurer is incorporated in a country other than the US, it is considered an alien insurer. Therefore, an insurer in Ohio and conducting business in Ohio is considered a domestic insurer. This same Ohio-based insurer conducting business in Utah is considered a foreign insurer. An insurer incorporated in Canada and conducting business anywhere in the United States or its territories is an alien insurer.

Mutual Insurers

In a mutual company, there are no stockholders. In a mutual company, ownership rests with the policyholders. They vote for a Board of Directors, which in turn elects or appoints the officers to operate the company. Funds not paid out after paying claims and not used in paying for other costs of operation may be returned to the policyholders in the form of policy dividends. Dividends from a mutual may never be guaranteed and are not taxable.

Independent Financial Rating Services

In today's market, no matter what the type of insurance company, agents and clients are very concerned about financial stability. To determine the financial strength of a prospective carrer, agents and clients often turn to independent rating services such as Best's Guide, Standard & Poor's and Moodys. these private publications may be purchased direct from the publishers or are available at most larger libraries. They rate insurance companies according to the amount of financial reserves the company has available to pay future claims and other liabilities.

Why do Insurance companies collect premium?

Insurance companies collect premiums to cover expenses, profits, and the cost of expected losses.

How do Insurance companies market their products?

Insurance companies market their products generally by using AGENTS to sell their products or by selling directly through MASS MARKETING. The majority of policies are sold through agents. Companies that sell through agents vary by whether their agents are their employees or independent businesspersons, and by who owns the policy expirations.

Insurance

Insurance is a social device for spreading the chance of financial loss among a large number of people. By purchasing insurance, a person shares risk with a group of others, reducing the individual potential for disastrous consequences.

Insured

Insured is the person who is covered by the insurance

What is the purpose of Insurance?

It is the purpose of insurance to restore the insured to his or her original position before the loss happened. The purpose of insurance is not to provide a person with the opportunity of making a profit on an accident or sickness.

6. ADVERSE Selection

Many exclusions are also designed to prevent adverse selection, such as the exclusion of damage due to flood on most property insurance policies. From the insurer's point of view, offering coverage for flood damage would constitute adverse selection, since only those clients living in potential flood zones would buy it. As a result, the insurer would very likely lose money writing this coverage. To solve this problem, flood insurance is available in designated flood areas through the federal government's National Flood Insurance Program (NFIP).

How is reinsurance written?

Reinsurance may be written: (E-Q-F) 1. On an "excess of loss" basis, which means the re-insurer will pay only the portion of loss that exceeds a threshold. 2. On a "quota-share" basis, which means that the insurers will share loss on a pro-rata or fixed-percentage basis. 3. On a "facultative" where the insurer elects to reinsure certain risks, but not others.

How do Risk Managers evaluate Risks?

Risk Managers evaluate Risks for: 1. Loss Frequency (Probability of Loss) 2. Severity 3. Potential Dollar Losses over Time Once the loss exposures are identified and analyzed, the best techniques for dealing with them must be examined.

What are the characteristics for determining which group of individuals share a common risk?

Risk is determined by common characteristics such as age, gender, and occupation.

Risk

Risk is the possibility (uncertainty) that a loss might occur and is the reason that people buy insurance. If a certain event happens (accident, sickness, or death), loss occurs. Insurance is designed to provide for such losses.

3. Loss Must Be UNCERTAIN

Since the purpose of insurance is to reduce or eliminate uncertainty, it is obviously not in the public interest to permit the writing of insurance for intentional acts, such as a person committing suicide 2 days after purchasing an insurance policy.

Speculative Risk

Speculative Risk (such as gambling), creates a risk situation and offers the opportunity for gain as well as the possibility of loss.

Insurer

The Insurance company or "insurer" receives relatively small amounts of money, referred to as "premium", from each of the large number of people buying insurance. The insurer promises to pay the insured according to the terms of the policy if a loss occurs. A large, uncertain loss is traded in this way for a small, certain loss (the premium).

What is the basic principle of the Law of Large Numbers?

The basic principle of this law is that the larger the number of separate risks of a like nature combined into one group... The more predictable the number of future losses of that group within a given time period.

Where does Insurance companies base their expected losses?

The expected losses are based upon the past experience of the average risk. The fact that some people never experience an automobile accident or that some live will beyond their lief expectancy is immaterial, for they are balanced by other people who are involved in accidents or die prematurely. Those insureds who suffer loss are compensated, while many other insureds do not experience sizable losses.

Government Insurers

The federal government provides life and health insurance through various sources. The federal government has offered a variety of military life insurance plans including United States Government Life Insurance, national Service Life Insurance, and Serviceman's Group Life Insurance. Because private insurance policies exclude catastrophic risks, the federal government has stepped in to provide them. At the state level, government are involved in providing unemployment insurance, workers compensation programs and secondary-injury funds, and state-run medical-expense insurance plans. Federal, state and local governments provide social insurance to a segment of the population who would otherwise be without disability income, retirement income, or medical care, such as Medicaid.

What is the intent of a life-insurance policy?

The intent of a life-insurance policy is to allow the family to continue financially as if the principal breadwinner were still alive.

4. Economic HARDSHIP

The nature of the loss must be such that an economic hardship would occur should the loss occur. The nature of the loss must be such that it is worthwhile to incur the premium cost to cover potential loss with the cost of premium is a major consideration to the insurance buyer.

Principle of Indemnity

The principle of indemnity restores the insured person, in whole or in part, to the condition he or she enjoyed prior to the loss.

4.a. Example of a Non-Qualifying Economic HARDSHIP

There would be little point in obtaining insurance to cover occurrences so minor that a loss would not produce economic hardship. For example, if a person loses one day's pay because of an injury, a loss occurs, but it is not significant enough to be covered by insurance.

How is a Risk Avoided?

To Avoid a Risk, a person might stay home rather than drive somewhere.

How can one be Insurable?

To be insurable: 1. a risk must involve the possibility of loss only, and not gain. 2. the applicant must have Insurable Interest.

Claim

To be paid for a loss, the insured must notify the insurer by making a claim

3.a. UNCERTAINTY in Insurance

Uncertainty arises out of NOT knowing what is going to happen, or being unable to predict what is going to happen to the individual exposure unit.

5. Exclusion of CATASTROPHIC Perils

While the ability to predict future losses with a reasonable degree of accuracy is critical to the insuring function, certain types of perils do not lend themselves to prediction. Such perils, when they cause losses, do not establish a pattern of predictability that can be relied upon for future predictions of anticipated loss. These perils are usually excluded from coverage.

How does the Principle of Indemnity show in a Life or Health Insurance?

With respect to life insurance, the "value" is assigned not to the person's life, but to the person's potential earning power.

Forms of Restoration

(PRR) Payment, Repair or Replacement

What does insurance companies do to make sure they have Insurable Risks?

1. An insurance company must be able to predict future losses accurately. 2. The company must deal only with Insurable Risks

Examples of Non-Commercial Insurers (Non-Profit)

1. Blue Cross 2. Blue Shield

What are the 2 ways by which Risk is Transferred?

1. If someone's negligence causes an injury, the person injured could sue the negligent party, transferring the burden of the risk to the negligent party. 2. The 2nd method for transferring risk is accomplished through the use of insurance. The risk of loss is transferred to the insurance company. However, unlike the first instance of risk transfer, the entire burden is not merely transferred to one party, it is shared among a number of insureds who share the same chance and uncertainty of an event occurring.

When should Insurable Interest exist in varous Insurance types?

1. Life Insurance - insurable interest must exist at the time of the application for insurance, but it need not exist at the time of the insured's death. 2. Property and Casualty Insurance - insurable interest must exist at the time of application and at the time of loss.

Authorized vs Unauthorized Insurers

Before an insurance company can conduct business it must, by law, receive a Certificate of Authority to do so. Insurance statutes require a company to secure a license from the Department of Insurance to sell insurance in a particular state. Once the insurer receives the license, it is considered "admitted" into the state as a legal insurer, and is "authorized" to transact the business of insruance. This licensing power is used to regulate company activities. Licenses may be issued to domestic companies, foreign companies, or alien companies. Surplus Lines carriers are exempt from licensing.

How does insurance companies predict the potential losses of a large group?

By studying the past experiences of the group using the mathematical principles of probability and statistics

3 Major Sources of Insurance

C-N-G 1. Private COMMERCIAL Insurers (profit-making) 2. Private Non-Commercial Insurers (NON-PROFIT service organizations) 3. the US GOVERNMENT

Captive Insurers

Captive Insurers are formed to serve the insurance needs of their stockholders while avoiding the uncertainties related to commercial insurance availability and costs. A captive insurer's stock is controlled by one interest or a group of related interests who have direct involvement and influence over the company's operations. For example, an association of self insured corporations may purchase reinsurance from a captive insurer that they control Most captive insurers are non-admitted alien corporations.

Why and when do companies use reinsurance?

Companies often use reinsurance to reduce the risk of a catastrophic loss. Insurance against loss by earthquakes and aviation accidents might not be available if a single carrier had to assume all of the risk. Reinsurance makes it possible for a carrier to issue a policy and then share the risk with a larger insurer or a group of insurers.

Morale Hazard

Ex: A careless client or one with no pride of ownership in their property.

Physical Hazard

Ex: A dead tree next to your house that could blow over during the next windstorm causing damage to your roof

Moral Hazard

Ex: A dishonext client who intentionally damages their own property

What is the requirement for the Law of Large Numbers to operate?

For the law of large numbers to operate, it is essential that a large number of exposure units be combined.

1. Large Number of HOMOGENEOUS UNITS

The expected loss experience of a group of exposure units cannot be predicted with any certainty unless there is a large number of exposure units in that group. Risks are not considered insurable unless the insurance company has a large enough number of similar risks and knows enough about its previous loss experience to be able to predict the future reliably.

Independent insurance agents

sell the insurance products of several companies and work for themselves or for other agents. They sell

Examples of "Exposure Units" in various Insurance Industries

1. Life and Health Insurance - the economic value of the individual person's life. 2. Property and Casualty Insurance - the car, home or other item to be insured.

3 Types of Hazard

1. Physical Hazard 2. Moral Hazard 3. Morale Hazard

Examples of Commercial Insurers

1. Private Life Insurers 2. Health Insurers 3. Stock and Mutual Insurers

4 Types of Private Insurers

1. Reciprocals 2. Fraternal Insurers 3. Lloyd's Associations 4. Re-Insurers

5.a. Examples of CATASTROPHIC Perils

1. War 2. Nuclear Risk 3. Earthquakes

Peril

A Peril is defined as a cause of loss, such as fire, lightning, wind, etc.

Fraternal Insurers

Fraternal benefit societies are primarily life insurance carriers that exist as social organizations and usually engage in charitable and benevolent activities. Fraternal insurers are distinguished by the fact that their membership is usually drawn from those who are also members of a lodge or fraternal organization. One characteristic of fraternal life insurance is the open contract, which allows fraternal insurers to assess their policyholders in times of financial difficulty.

6 Examples of Insurable Risks

H-CUH-CA 1. Large Number of HOMOGENEOUS UNITS 2. Loss Must Be CALCULABLE 3. Loss Must Be UNCERTAIN 4. Economic HARDSHIP 5. Exclusion of CATASTROPHIC Perils 6. ADVERSE Selection

3.b. Examples of Certain Losses

If insurance is provided for other than uncertain losses, the element of chance is not a factor. Nor is there any element of uncertainty in losses occasioned by natural wear and tear or deterioration, depreciation, or defects in property covered under insurance. Losses are expected in these situations, therefore such losses would not be uncertain.

What happens if a large enough number of exposure units are combined?

If large enough numbers of exposure units are combined, the degree of error in predicting future losses decreases as the number of individual exposure units in a group increases. The larger the group, the more closely the predicted experience will approach the actual loss experience.

2.b. How is loss calculated in Health Insurance?

In HEALTH insurance, it is especially difficult to determine economic loss. For this reason, economic loss is measured by lost wages or by actual medical expenses incurred.

2.a. How is loss calculated in Life insurance?

In LIFE insurance, monetary value is placed on the insured's income-earning capacity.

Insurable Interest

Insurable Interest is a quality of an applicant by which he/she must have a legitimate interest in the preservation of the life or property insured.

What is another term for the "Insurance Company"?

Insurance Company = Insurer

Pooling Concept

Looking at groups of individuals, rather than the individuals themselves, to make predictions is called the pooling concept and is an accurate way of predicting potential losses.

Loss

Loss is defined as the reduction in the value of an asset.

Will Insurance cover Speculative Risk like Gambling?

No

Can insurance companies predict the number of losses per individual?

No. Insurance companies can only predict the number of losses expected for a group, not for each individual.

Insurable Risks

Not all risks are insurable, and it is important to outline those risks to which insurance concepts can be properly applied.

Surplus Lines

Occasionally , it may be difficlut to place a risk in the normal marketplace. If the risk is very large or unusual in nature, typical carriers may be unwilling to assume it. For some special risks, the only market may be with specialty carriers. Such business must be placed through a licensed excess or surplus lines broker, who will attempt to place it with an unauthrized carrier located in another state or out of the country (such as Lloyd's of London)

Policy

Policy or "Contract of Insurance" is a legal document established when there is an agreement between the insurer and the insured.

Premium

Premium is the total amount of money that the insurance company or insurer receives from the person buying the insurance

Pure Risk

Pure Risk is the type of risk that insurers accept. With pure risk, there is a the possibility that a certain event will occur, for example, accident or sickness.

Reciprocal Insurers

Reciprocal insurers are un-incorporated groups of people providing insurance for one another through individual indemnity agreements. Each individual who is a member of the reciprocal is known as a subscriber. Administration, underwriting, sales promotion, and claims handling for the reciprocal insurance is handled by an attorney-in-fact.

Reinsurance

Reinsurance is a form of insurance between insurers. it occurs when an insurer (the re-insurer) agrees to accept all or a portion of a risk covered by another insurer.

Lloyd's Association

Similar, but not connected to Lloyd's of London, a Lloyd's Association is an unincorporated group of individuals who band together to assume risks in the area of Surplus Lines. Each person is individually responsible only for the share of the risk they agree to assume.

2. Loss Must Be CALCULABLE.

Since the purpose of insurance is to reduce or eliminate the uncertainty of economic loss, the insurer must be able to place a monetary value on the loss. The potential loss must be measurable so that both parties can agree on the precise amount payable in the event the loss occurs.

What is the Law of Large Numbers?

The law of large numbers allow an insurance company to predict the expected losses of a group.