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24 Cards in this Set
- Front
- Back
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2 main elements to definition of insurance |
- financial: premium payment - legal: contractual relationship |
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Financial Definition of Insurance |
- premium payment - b/c insurance allows group's losses to be predicted with reasonable accuracy, also allows cost of losses to be financed and redistributed in advance |
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Legal Definition of Insurance |
- contractual relationship - contract in which one party agrees to compensate another party for losses covered by the contract
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Types of losses
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- direct and indirect
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Chance of loss |
- probability of loss= number expected/total exposed - creates demand for insurance |
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Why is chance of loss important ?
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- if no possibility for loss, or if they certain to occur, insurance would not exist b/c there would be no need for it - no element of uncertainty for loss and rather should be treated as expense, which should not be handled by insurance
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Peril |
- the cause of loss or contingency that causes loss
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Named peril or specified peril contracts
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- only those perils specifically named
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Open peril |
- all except those perils specifically excluded - burden of proof is different
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Proximate Cause of Loss or Doctrine of Proximate Cause |
- first insured peril in unbroken chain of events leading to loss- all is paid - loss would have not occurred without this step - Generally, if proximate cause of loss is insured peril, insurer will pay claim and related damages associated with unbroken chain of events started by occurrence of peril - if proximate cause of loss is excluded, insurer will not pay claim |
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Hazard
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- something that increases probability or severity loss when loss occurs (or both) - doesn't cause loss but makes loss more frequent and severe - two types: moral and physical
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Physical Hazard |
- related to physical environment - ex.: storing gasoline, poor lighting in crime prone area
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Moral Hazard |
- engaging in behavior that increases losses that insurers must pay - behavioral activities such as insurance fraud: exaggerating loss to collect insurance proceeds
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Risk |
- describe there is possibility of loss - identify probability of loss - identify cause of loss-peril - identify conditions that increase frequency and severity of loss (hazard) - identify property or person exposed - identify potential $ amount of loss - describe variation in potential losses- ability to predict
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Social Insurance
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- government body sponsored, defined by statue
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Private Insurance |
- non-government sponsored, defined by insurance contracts - financed by insurers, rely on premiums and interest earned by investing premiums
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Examples of Private Insurance |
- non-life: Property & Casualty- fire, marine, casualty, bonding - life: life health, annuities - other: weather, municipal bond, boiler and machine, motion picture completion |
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Building Blocks of Insurance Premium |
- Earned Premium [EP] - Insured Loss Claim [ILC] - Loading Expenses [LE] - Investment Income [II] (serves to reduce premium paid b/c they cover portion of LE and ILC) - Fair Rate of Return [FRoR] - EP = ILC + LE - II + FRoR
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Loss Ratio |
- portion of insurer's premium that pays for insured claims divided by earned premium
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Expense Ratio |
- measure loading expenses (administrative and overhead expenses) divided by written premium |
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Combined Ratio |
- sum of insurer's loss ratio and expense ratio in a given product line - value of less than 100% reflects profitable insurance operations - investment income needs to cover short fall, if any
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Cashflow Underwriting |
- insurance losses are more than offset by investment income insurance company earns on its premiums - insurer prices insurance well below its actuarial value and anticipates investment income to cover losses and make profits - dangerous practice since investment income may not materialize if investment rates decline or losses occur |
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Costs of operating insurance mechanism |
- commissions - overhead of company - exaggerated claims - intentional losses (moral) - genera indifference about way we treat our property (morale) - does not include losses that would have occurred anyway |
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Insurance Benefits to Society
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- stability of families - aids planning ability to businesses - facilitates credit transactions - anti-monopoly device - reduce credit costs - increases capital efficiency |
