Insurance: Chapter 1

Question 1

What is Risk?

Answer 1

A condition with a possibility of loss or a situation with an exposure to loss

Question 2

What is Peril?

Answer 2

The cause of a loss.
- Fire
- Windstorm
- Liability
- Collision
- Theft
- Sickness/Injury

Question 3

What is a Hazard?

Answer 3

A condition that may create or increase the chance of loss arising from a given peril. May also increase the frequency or severity of the loss
-Building on on earthquake fault
-Poor maintenance of a car’s brakes

Question 4

Law of large numbers states that?

Answer 4

As number of independent events increases, the likelihood grows of that actual results will be close to the expected results

Question 5

There should be the same portion of good and bad risks in the insured group as there were from in the one from which the statistics were taken is the definition of?

Answer 5

Adverse Selection

Question 6

The incidence and severity of sickness and accidents in a well-defined class/es of persons?

Answer 6

Morbidity

Question 7

What is shown on a mortality table?

Answer 7

The probable rate of death at each age, usually shown as how many per thousand

Question 8

What are the characteristics that risk must have in order for an insurance company to assume the risk?

Answer 8

1. Must be sufficiently large number of homogeneous exposure units to make losses reasonably predictable
2. Loss produced by the risk must be definite and measurable
3. Loss must be fortuitous or accidental
4. Loss must not be catastrophic to the insurance company

Question 9

What is self-insurance?

Answer 9

A formal program of risk retention for a business. It performs most of functions of an insurance company for its own risks. It is primarily used by large companies.

Question 10

What are the advantages of self-insurance?

Answer 10

1. Avoiding costs associated with commercial insurance
2. Reserves can be invested in short term money markets and earnings can be used to offset the costs of the program

Question 11

What are the disadvantages of self-insurance?

Answer 11

1. Exposure to catastrophic loss
2. Company may have to pay taxes on reserves held for future claims at year-end
3. Company must duplicate services provided by insurance company

Question 12

What are the 3 areas of Risk Control?

Answer 12

1. Risk Avoidance (renting property instead of purchasing or not buying house with a pool)
2. Risk Diversification (store assets in different locations)
3. Risk Reduction (install sprinklers, smoke detectors, burglar alarms or create safety program for businesses

Question 13

What are the two ways of risk financing?

Answer 13

1. Risk Retention (deductibles in insurance policies, coinsurance in insurance policies or self-insurance)
2. Risk Transfer (Insurance, incorporation of your business, hedging contracts or hold harmless agreements)

*these are called risk sharing, they are not insurance transfers

Question 14

What are the 3 basic rules of risk management?

Answer 14

1. Coverage for potential catastrophes should be purchased first
2. Severity is more important than probability
3. High probability will mean high premiums or a decline of coverage by the carrier

Question 15

What is probably the most suitable technique for risks that involve high loss severity and low loss frequency?

Answer 15

Risk Transfer

Question 16

What is probably the most suitable technique for risks that involve high loss severity and high loss frequency?

Answer 16

Risk Avoidance, because insurance premiums would be prohibitive

Question 17

What is probably the most suitable techniques for risks that involve low loss severity and high loss frequency?

Answer 17

Either risk retention or risk reduction. The high frequency implies that the transfer will be costly

Question 18

What is probably the most suitable technique for risks that involve low loss severity and low loss frequency?

Answer 18

Risk retention. These risks seldom occur and their financial impact is inconsequential when they do.

Question 19

What is the principle of indemnity?

Answer 19

Principle underlying insurance contracts under which the insurer seeks to reimburse the insured for ~ the amount lost, no more and no less.
Four principles supporting indemnity
1. Insurable interest
2. The concept of actual value
3. Other insurance
4. Subrogation

Question 20

What is insurable interest?

Answer 20

A right or relationship which is insured so that the insured will not suffer a financial loss from a loss. It must operate at the issuance of an insurance policy and at the time of loss in property and casualty insurance.

(Note life insurance insurable interest must operate at time of issuance but not at time of death.)

Question 21

What are the four requirements for a contract to be legally enforceable?

Answer 21

1. There must be an agreement preceded by an offer and an acceptance to whom the offer is made
2. There must be consideration
3. The principal must have legal capacity to execute contract. Minors must have adult sign. Incompetent or intoxicated adults have limited or no capacity to execute contracts
4. Contract must be for lawful purposes

Question 22

What is a unilateral contract characteristic?

Answer 22

Only one of the parties of an insurance contract makes a binding promise that if broken breaches the contract.

Question 23

What is contract adhesion?

Answer 23

Contract is accepted as is or not at all. Not a regulated contract. Because

Question 24

Who can alter an insurance contract via waiver provision?

Answer 24

President, VP, secretary etc.

Agents cannot change the contract terms.

Question 25

Why are insurance contracts called aleatory contracts?

Answer 25

Because the amount of dollars spent by the contract parties is typically unequal. The insured may pay large premiums and receive no proceeds from the policy. Conversely they may pay only a small premium and receive a large benefit.

Question 26

What is rescission of an insurance contract?

Answer 26

When a contract is deemed null from its beginning due to fraud, misrepresentation, concealment or mutual mistakes as to a material fact.

The carrier will refund the premium paid and rescind the contract.

Question 27

What is reformation?

Answer 27

The amendment to a contract between the parties when the contract fails to express the original intent of the parties.

Question 28

What is the collateral source rule?

Answer 28

In tort liability (someone is held accountable for wrong actions), the plaintiff’s measure of damage should not be mitigated by payments received from sources other than the negligent party.

Question 29

What is subrogation?

Answer 29

When an insurer pays a claim, it takes over the rights its insured had against a negligent third party.

(Insurer pays collision coverage to their insured driver, then takes over right to sue negligent driver)

Question 30

What are the 5 parts of an insurance contract?

Answer 30

1. Declarations: Factual statements that identify specific person, property or activity being insured and the parties to the transaction. Not pre-printed
2. Definitions: Explains the key policy terms
3. Insuring Agreements: Spells out the basic promises of the insurance company
4. Conditions: Spells out in detail the duties and rights of both parties
5. Exclusions: Spells out the circumstances when the insurer will not pay

Question 31

What may the insured owner do with policy ownership?

Answer 31

Since life insurance is a financial asset, it may have cash value and typically has a death benefit, the owner can transfer the policy to someone else, receive the cash values or dividends, borrow against the cash value or change the beneficiary.

Question 32

What is beneficiary designation?

Answer 32

The person named in the contract to receive all or a portion of the proceeds of the policy. There can be primary and contingent beneficiaries