Rmin Chapter 2

Front 1

What are basic characteristics of insurance

Back 1

1) Pooling of losses
2) Payment of fortuitous losses
3) Risk Transfer
4) Indemnification

Front 2

Define pooling of losses

Back 2

Pooling is the spreading of losses incurred by the few over the entire group, so that in the process, average loss is substituted for actual loss.

Pooling involves the grouping of a large number of exposure units so that the law of large numbers can operate to provide a substantially accurate prediction of future losses.

Front 3

Define payment of fortuitous losses

Back 3

A loss that is unforeseen and unexpected and occurs as a result of chance.

Payment must be accidental.

EX: Person slipping on a icy side walk and breaking their leg.

Insurance policies do not cover intentional losses.

Front 4

Define risk transfer

Back 4

A pure risk is transferred from the insured to the insurer, who tyypically is in a stronger financial position to pay the loss than the insured.

EX: Premature death, poor health, disability, destruction, and theft of property, and personal liability lawsuits.

Front 5

define indemnification

Back 5

The insured is restored to his or her approximate financial position prior to the occurrence of the loss.

EX: House burns up. Homeowners insurance will indemnify you or restore you to your previous position.

If you are sued because of the negligent operation of an automobile, your auto liability insurance will pay those sums that you are legally obligated to pay.

If you are seriously disabled, disability income insurance policy will restore at least part of the lost wages.

Front 6

What are the 6 requirements of an insurable risk?

Back 6

1) Large number of exposure units
2) Accidental and unintentional loss
3) Determinable and measurable loss
4) No catastrophic loss
5) Calculable chance of loss
6) Economically feasible premium

Front 7

Define the first requirement of insurable risk 'large number of exposure units'

Back 7

The purpose of the first requirement is to enable the insurer to predict loss based on the law of large numbers.

Front 8

Define the second requirement of insurable risk: 'accidental and unintentional loss'

Back 8

Second requirement - loss should be accidental and unintentional; ideally, the loss should be fortuitous and outside the insured's control.

Required because it controls moral hazard and assures randomness in the law of large numbers.

Thus, if an individual deliberately causes a loss, he or she should not be indemnified for the loss.

Front 9

Define the third requirement of insurable risk: 'determinable and measurable loss'

Back 9

Third requirement - loss should be determinable and measurable .

Must be definite as to cause, time, place, and amount.

Losses may be hard to measure.

Front 10

Define the fourth requirement of insurable risk: 'no catastrophic loss'

Back 10

The loss should not be catastrophic. THis means that a large proportion of exposure units should not incur losses at the same time.

Front 11

Define the fifth requirement of an insurable risk

Back 11

Calculable chance of loss - to establish an adequate premium

Front 12

Define the sixth requirement of an insurable risk

Back 12

Economically feasible premium
So people can afford to buy

Front 13

True or False; Most personal, property and liability risks can be insured

Back 13

True;

Front 14

True or False; Speculative Risks (Market, financial, production and political risks) are difficult to insure

Back 14

True

Front 15

List all six requirements of an insurable risk

Back 15

1) Large number of exposure units
2) Loss must be accidental and unintentional
3) Loss must be determinable and measurable
4) Loss should not be catastrophic
5) Chance of loss must be calculable
6) Premium must be economically feasible.

Front 16

Define Adverse Selection

Back 16

Adverse selection those who suffer more loss want to obtain regular insurance

The tendency of persons with a higher-than-average chance of loss to seek insurance at standard (average) rates, which if not controlled by underwriting, results in higher-than-expected loss levels.

High risk drivers who seek auto insurance at standard rates.

Front 17

True or False; If not controlled, adverse selection results in higher-than-expected loss levels

Back 17

true

Front 18

How can adverse selection be controlled?

Back 18

Underwriting and policy provisions.

Underwriting - process of selecting and classifying applicants for insurance. Applicants who meet the underwriting standards are insured at standard or preferred rates. If underwriting is not met, insurance isdenied or an extra premium must be paid.

Policy provisions - suicide clause in life insurance and preexisting conditions clause in health insurance.

Front 19

Name two important differences between insurance and gambling

NC of SR

SUP

Back 19

1) Creation of new speculative risk - Gambling creates a new speculative risk, while insurance is a technique for handling an already pure risk. No new risk is created by insurance.

2) Social Unproductivity; Gambling is socially unproductive. Winner's gain comes at the expense of the loser. In contrast, insurance is always socially productive, because neither the insurer nor the insured is placed in a position where the gain of the winner comes at the expense of the loser. Both insurer and insured have a common interest in the prevention of a loss. Both parties win if the loss does not occur. Gambling transactions do not restore the losers to their former financial position, and insurance contracts restore the insureds financially in whole or in part if a loss occurs.

Front 20

Differences between Insurance and Hedging

Back 20

1) Insurance involves transfer of insurable risks, because the requirements of an insurable risk generally can be met. Hedging, however, is a technique for handling risks that are typically uninsurable, such as protection against a decline in the price of agricultural products and raw materials

2) Risk Transfer vs. Reduction - Insurance can reduce the objective risk of an insurer by application of the law of large numbers and hedging involves only risk transfer not risk reduction.

Front 21

What are the two types of insurance?

Back 21

Private insurance and Government insurance

Front 22

What does private insurance include?

Back 22

1) Life and heath insurance
2) Property and Liability

Front 23

What does government insurance include?

Back 23

1) Social Insurance
2) Other government insurance

Front 24

What is life and heath insurance, and property and liability insurance (private insurance)

Back 24

1) Life and health - life pays death benefits to designated beneficiaries when they die. Benefits pay for funeral expenses, uninsured medical bills, estate taxes, and other expenses.

Life insurance also sells group and individual retirement plans that sell retirement benefits.

Also sell individual and group health insurance plans that cover medical expenses.

Both life and health sell disability.

Life, retirement, heath, and disability

Front 25

What is property and liability insurance

Back 25

Property insurance indemnifies property owners against the loss or damage of real or personal property caused by various perils, such as fire, lightning, windstorm, or tornado.

Liability insurance - covers the insured's legal liability arising out of property damage or bodily injury to others; legal defense costs are also paid.

Casualty - broad field of insurance that covers whatever is not covered by fire, marine, and life insurance; casualty lines include auto, liability, burglary, and theft, workers compensation and health insurance.

Front 26

Name the two major categories private insurance can be grouped into?

Back 26

Personal and Commercial

Front 27

What is personal line of private insurance?

Back 27

Coverages the insure the real estate and personal property of individuals and families or provide protection against legal liability.

Front 28

What is commercial line of private insurance/

Back 28

Refer to property and casualty coverages for business firms, nonprofit organizations, and government agencies

Front 29

What are the two insurance programs that government insurance can be divided into?

Back 29

Social insurance programs and other government insurance programs.

Front 30

Define social insurance programs

Back 30

Government insurance programs with certain characteristics that distinguish them from other government insurance plans.

Programs are financed entirely or in large part by mandatory contributions from employers, employees, or both, and not primarily by the general revenues of government.

The right to receive benefits is ordinarily derived from or linked to the recipient's past contributions or coverage under the program; the benefits and contributions generally vary among the beneficiaries according to their prior earnings, but the benefits are heavily weighted in favor of low-income groups.

Most programs are compulsory - covered workers and employees are required by law to pay contributions and participate in the programs.

Front 31

Name the five benefits of insurance to society

Back 31

1) Indemnification for loss
2) Reduction of worry and fear
3) Source of investment funds
4) Loss prevention
5) Enhancement of Credit

Front 32

Define the benefit of indemnficiation for loss

Back 32

Indemnification permits individuals and families to be restored to their former financial position after a loss occurs.

As a result, they can maintain their financial security.

Because insureds are restored either in part or in whole after a loss occurs, they are less likely to apply for public assistance or welfare benefits, or to seek financial assistance from relatives and friends.

Allows firms to remain in business and employees to keep their jobs

Front 33

True or false; indemnification function contributes greatly to family and business stability and therefore is one of the most important social and economic benefits of insurance

Back 33

true

Front 34

Define the benefit - reduction of worry and fear

Back 34

Second benefit is that worry and fear are reduced.

True for before and after a loss.

If a family has life insurance, it is less likely to worry about the financial security of their dependents in the event of premature death

Worry and fear are also reduced after a loss occurs, because the insureds know that they have insurance that will pay for the loss.

Front 35

Define the benefit - source of investment funds

Back 35

the insurance industry is an important source of funds for capital investment and accumulation.

Premiums are collected in advance of the loss, and funds not needed to pay immediate losses and expenses can be loaned to business firms.

Funds are typically invested in shopping centers, hospitals, factories, housing developments and new machinery and equipment.

Front 36

Define the benefit loss prevention

Back 36

insurance companies are actively involved in numerous loss-prevention programs and also employ a wide variety of loss-prevention personnel, including safety engineers and specialists in fire prevention, occupational safety and health, and products liability.

Loss prevention activities reduce both direct and indirect, or consequential losses. Society benefits, because both types of losses are reduced.

Front 37

Define the benefit - enhancement of credit

Back 37

insurance makes a borrower a better credit risk because it guarantees the value of the borrower's collateral or gives greater assurance that the loan will be repaid.

Lending institutions require property insurance on the house before the mortgage loan is granted. Property insurance protects the lender's financial interest if the property is damaged or destroyed.

EX: Physical damage insurance on the car may be required before the loan is made. Thus, insurance can enhance a person's credit.

Front 38

List the costs of insurance to society

Back 38

1) Cost of Doing business
2) Fraudulent claims
3) Inflated claims

Front 39

Define the cost of doing business

Back 39

Insurers consume scarce economic resources - land, labor, capital, and business enterprise - in providing insurance to society.

An expense loading must be added to the pure premium to cover the expenses incurred by insurance companies in their daily operations.

An expense loading is the amount needed to pay all expenes, including commissions, general administrative expenses, state premium taxes, acquisition expenses, and an allowance for contingencies and profit.

Front 40

How is the cost of insurance justified?

Back 40

1) From the insured's viewpoint, uncertainty concerning the payment of a covered loss is reduced because of insurance. Second, the costs of doing business are not necessarily wasteful, because insurers engage in a wide variety of loss prevention activities.

The insurance industry provides jobs to millions of workers in the United States.

However, because economic resources are used up in providing insurance to society, a real economic cost is incurred.

Front 41

Define fraudulent claims

Back 41

Faked or staged accidents to collect benefits.

The payment in fraudulent claims result in higher premiums to all insureds.

The existence of insurance also prompts some insureds to deliberately cause a loss so as to profit from insurance. These social costs fall directly on society.

Front 42

Define inflated claims

Back 42

"inflated or padded claims" - although the loss is not intentionally caused by the insured, the dollar amount of the claim may exceed the actual financial loss.

EX: attorneys for plaintiffs sue for high-liability judgments that exceed the true economic loss of the victim.

Insureds inflate the amount of damage in auto collision claims so that the insurance payments will cover the collision deductible.

Disabled persons often malinger to collect disability income benefits for a longer duration.

Insureds exaggerate the amount and value of property stolen from a home or business.

Premiums must be increased to pay the additional loses.