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8 Cards in this Set

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Basic Characteristics of Insurnace

1. Pooling of losses - spreading of losses to entire group, law of large number




2.Payment of fortuitous losses - accidental, random occurrence




3. Risk transfer - pure risk is transferred from insured to insurer, stronger financial position




4. Indemnification - restored financial position prior to loss occurrence

General requirements of insurable risk

1. Large number of exposure units - large group subject to same peril




2. Accidental and unintentional loss - fortuitous, not to increase the premium by moral hazard; not to violate law of large number, inaccurate prediction




3. Determinable and measurable loss - definite to cause, time, place and amount -> determine how much to pay




4. No catastrophic loss - may break down pooling technique




5. Calculable chance of loss - avg. frequency and severity of future loss estimated with certain accuracy -> charge proper premium




6. Economically feasible premium - insured able to pay the premium

What is adverse selection and how to tackle this problem?

Definition: Tendency of persons with higher-than average chance of loss to seek insurance at standard premium rates




Tackled by: Underwriting, policy provisions/conditions

Insurance vs Gambling

1. Gambling creates new speculative risk


Insurance handles existing pure risk




2. Gambling is socially unproductive


Insurnace is socially productive - common interest on prevention of a loss



Insurance vs hedging

Similarity


1. Risk is transferred


2. No risk is created




Difference


1. Insurance transfer pure risk


Hedging transfer speculative risk




2. Insurance reduce objective risk (by law of large number)


Hedging does not involve risk reduction

Types of insurnace

Private insurance


- Life and health insurance


- Property(real or personal property loss or damage) and Liability Insurance(Legal defense cost, legal liability)




Government Insurance


1. Social insurance (e.g. MPF) (Entire part by mandatory contribution)


2. Other Government Insurance program

Benefits of insurance to society

1. Indemnification for loss - restored financial position, permit firms in business after loss




2. Reduction of worry and fear - as insurance pay for losses




3. Source of investment funds - premium paid in advance -> loans to firms




4. Promotion of loss control - involve in loss-prevention programs, reduce direct and indirect loss




5. Enhancement of credit - guarantees the value of borrower's collateral

Cost of Insurance

1. Cost of doing business - social resources(land, labor, environment), expense operating loading(commission, administration, tax, contingency, profit)




2. Fraudulent claims - deliberately cause a loss -> higher premium




3. Inflated claims - exceed the actual financial loss -> higher premium