Unit 1

Question 1

What is a risk?

Answer 1

Risk is the possibility that a loss will occur.

Question 2

What is insurance?

Answer 2

Insurance is a contract that transfers the risk of financial loss from an individual or business to an insurance company.

Question 3

What is insurance designed for?

Answer 3

Insurance is designed to cover only losses that involve risk.

Question 4

What are the two types of risks? Define them.

Answer 4

Speculative riskshave a possibility of a loss and also the possibility of a gain. Gambling and investing are examples of speculative risks; you could win money or you could lose money. Insurance companies will not insure you to go to Las Vegas to gamble in case you lose money.

Pure risks only involve the possibility of experiencing a loss, not a gain. ‘The chance of being in a car accident is a pure risk. Pure risks can be covered by insurance.

Question 5

What is an exposure?

Answer 5

The potential for accidents and other losses.

Risks for which the insurance company would be liable.

Ex. a person who drives his car to and from sales calls all day will have a higher exposure to risk than someone who works remote and makes sales calls over the telephone. The higher the exposure to risk, the higher the premium.

Question 6

What is a peril?

Answer 6

The cause of a loss. Insurance policies will cover various perils.

Ex.if a house burns down, the peril (cause of loss) is the fire. If electronics in a home are destroyed because of lightning, the cause of loss (peril) is lightning. If you drive your car through a hailstorm and the car body is damaged, the peril is hail. A peril is simply what caused the loss.

Question 7

Define a loss.

Answer 7

A loss is defined as: (1) the unintended, unforeseen damage to property, (2) injury, or (3) amount paid.

Question 8

What are the two types of loss?

Answer 8

Direct loss is physical loss to property with no intervening cause. Examples of direct loss include lightning striking a house and an automobile hitting a tree.

Indirect loss is a consequential loss as the result from a direct loss. Examples of indirect loss include loss of rental income due to house fire, which cause a loss of profits for the landlord. The indirect loss is always consequential of the direct loss.

Question 9

What is a hazard? Describe the three types of hazards.

Answer 9

Hazard-increases the chance of loss

• Physical hazard–the hazard can be seen
• Moral hazard-dishonesty
• Morale hazard–carelessness

Question 10

What is a method of handling risks?

Answer 10

STARR-Method of handling risk
• Sharing
• Transfer
• Avoidance
• Retention
• Reduction

Question 11

Explain STARR.

Answer 11

Sharing In risk sharing, two or more individuals or businesses agree to pay a portion of any loss incurred by any member of the group. Stockholders in a corporation share the risk.

Transfer-Risk transfer is what happens with insurance. The insurer (insurance company) agrees to pay if an insured (customer) has a loss–the insured no longer bears that risk. The individual has a cost in the form of a premium payment. But, in contrast to the loss which is large and uncertain, the premium is a much smaller certainty.

Avoidance-Risk avoidance means eliminating a particular risk by not engaging in a certain activity.
For example, an individual who does not drive avoids the risk of injuring someone in an automobile collision and being held liable for those damages.

Retention- Risk retention means the individual or business will pay for the loss if it occurs, or a portion of the loss via a deductible. If you don’t have car insurance to pay for the damages you cause to another person in an accident, you have retained that risk.

Reduction- Risk reduction refers to lessening the chance that a loss will occur, or lessening the extent of a loss if it occurs. If a business installs a sprinkler system in its building, this will help reduce or eliminate the damage caused by a fire.

Question 12

What is a contract (policy)?

Answer 12

Contract (Policy)

• An agreement between the insured and the insurer

• Ist party-insured (customer)
•2nd party–insurer (insurance company)

Question 13

What is the Law of Numbers? Explain.

Answer 13

The law of large numbers is the principle that makes insurance possible.

Law of large numbers–the larger the group, the more accurately losses can be predicted

While insurance companies cannot specifically name which individuals will have a can predict fairly accurately how many dollars in claims they will have to pay out ea the actual losses they experienced in the past. This prediction allows them to charge premium that, pooled together, will cover all claims and operating costs.

Question 14

Are all risks insurable?

Answer 14

Not all risks are insurable. Pure risks have certain characteristics and can be remembered using the acronym CANHAM

Question 15

What is CANHAM? Explain.

Answer 15

Calculable- Premiums must be calculable based upon prior loss statistics for that particular risk in order to predict future losses.

Affordable- The premium for transferring the risk should be affordable for the average consumer.

Non-catastrophic–The risk must be non-catastrophic for the insurance company. National or area disasters, such as floods, riots, wars, and earthquakes, will often have coverage limitations in insurance policies. These events cause widespread simultaneous losses to many insured properties. ‘The peril of war is excluded from most policies. If the insurer were to cover these types of risk, the risk could be detrimental (or catastrophic) to the insurer.

Homogeneous The risk must be similar in nature so the same factors affect the chance of loss. For example, if an actuary was going to predict the likelihood that a wood frame house would suffer a fire in California, the actuary would not include brick houses in the sample.

Accidental-‘The loss must have been caused due to chance (accident). Intentional losses caused by the insured are not covered by insurance.

Measurable A definite (time and place) and measurable loss means that proof of loss must be established with numbers and dollar amounts, not just casual references.

Question 16

What is Adverse Selection and it’s characteristics?

Answer 16

Adverse selection–risks that have a greater-than-average chance of loss.

•Not wanted by insurers

• Tendency for high-risk individuals to get and keep insurance

• Why insurers go through the underwriting process

• High risk = higher rate or refusal to insure

Question 17

Define Reinsurance.

Answer 17

Reinsurance–an insurance company (the ceding company) paying another insurance company (reinsurer) to take some of the company’s risk.

It transfers risk from one insurer to another insurer.

• Reinsurers help spread the insurer’s risk

• Facultative-the reinsurer evaluates each risk before allowing the transfer

• Treaty–the reinsurer accepts the transfer according to an agreement called a treaty

Question 18

What is a stock insurer?

Answer 18

A stock insurer is a business formed as a corporation and owned by its stockholders (also known as shareholders). The corporation is run by a board of directors elected by the stockholders. Profits from the insurance operation may be distributed to the stockholders as dividends. These dividends are taxable to the stockholder/shareholder. Dividends are never guaranteed because profits can never be guaranteed. The policies issued by stock insurers are called non-participating (or non-par)policies since dividends never go to policyholders in this arrangement.

Question 19

What is a mutual insurer?

Answer 19

Mutual Insurer

• Owned by the policyholders (customers)

•Dividend is not guaranteed

• Dividend is paid to policyholder

• Dividend is not taxable; considered refund of premium

• Issues participating policies

Mutual policies are referred to as participating (par) policies because the policyowners participate in the operating results of the company. Mutual companies are referred to as participating (par) companies because they sell par policies.

Question 20

What is a fraternal benefit society?

Answer 20

Fraternal Insurer

• Provides insurance and other benefits

• Must be a member of the society to get the benefits, organizations are typically based on a common religion or ethnic group.

Fraternal benefit societies exist for the benefit of their members and offer insurance as one of the benefits of membership. Fraternals also provide social activities and usually engage in charitable and benevolent causes. Fraternals are organized under a lodge system and receive some income tax advantages.

Question 21

What are reciprocal insurers?

Answer 21

Reciprocal Insurer

Reciprocal insurers are unincorporated groups of people that agree to insure each other’s losses under a contract. The members of the reciprocal groups are known as subscribers. Each subscriber has an account through which premiums are paid and earned interest is tracked. If any subscriber suffers a loss covered by the reciprocal insurance agreement, each subscriber account is assessed an equal amount to pay the claim. Administration, underwriting, sales promotion, and claims handling for the reciprocal insurance are handled by an attorney-in-fact. The attorney-in-fact is often controlled and overseen by an advisory committee of subscribers.

Reciprocal Insurers

•Subscribers

• Unincorporated

• Members are assessed if a loss occurs to any member of the group

• Managed by an attorney-in-fact

Question 22

Who are Lloyd’s Associations?

Answer 22

Lloyd’s associations, named in reference to the famous underwriting group Lloyd’s of London, are not insurance companies. Rather, they provide a hub for the exchange of information among member underwriters who actually transact the business of insurance. Members are individually liable and responsible for the contracts of insurance into which they enter.

Lloyd’s Association

• Insurance provided by individual underwriters, not companies
• Insure unusual risks
• Hole-in-one contest
• Athlete’s arm
•Celebrity’s hair

Question 23

What are risk retention groups (RRG)?

Answer 23

A risk retention group is an insurer formed for the sole purpose of providing liability insurance for its policyholders. ‘The policyholders must all be members of the same type of business. Risk retention groups are regulated by the state where they are headquartered and can operate in other states as well.

Risk Retention Group

• Liability insurance company created for policyholders from the same industry.

• Example–a car dealers’ risk retention group in which only car dealers can be policyholders

Question 24

Describe a risk purchasing group.

Answer 24

Similar to risk retention groups, risk purchasing groups are formed for the sole purpose of obtaining liability insurance for its members. However, unlike risk retention groups, risk purchasing groups are not insurers themselves and are not regulated as such; they only purchase insurance on behalf of their members. Risk purchasing groups were authorized by the same federal law that allowed the formation of risk retention groups.

Risk Purchasing Group

• A group of businesses from the same industry that join together to buy liability insurance from an insurance company

Question 25

What are self -insurers?

Answer 25

Self-insurance is a means of retaining, rather than transferring, risk. Businesses may develop a formal program for self-insuring all or a portion of certain risks. The business sets aside reserve funds to cover losses in advance and may even have a claims system like an insurance company. A company that has a savings account to pay claims if an employee gets hurt is self-insured.

Self-Insurance
• A business that pays its own claims
•Reserves funds to cover losses
• Retains risk rather than transfers

Question 26

Describe Private vs Government Insurers.

Answer 26

Insurance companies may be privately owned, operated by the state, or operated by the federal government.
The government can step in to provide insurance that is not ordinarily available from private insurers.

The federal government provides:
• war risk insurance;
• nuclear energy liability insurance;
• flood insurance; and
• federal crop insurance.

At the state level, the government is involved in providing unemployment insurance and may provide workers’ compensation benefits through state funds.

The federal government provides
insurance.
• War risk insurance
• Nuclear energy insurance
• Flood insurance
• Federal crop insurance
• Unemployment insurance (at state level)
• Workers’ compensation (at state level)

Question 27

Describe Domestic, Foreign and Alien insurers

Answer 27

Insurance Company Location

• Domestic–the state where a company is incorporated

• Foreign–company is incorporated in another state or U.S. territory

• Alien-company is incorporated in another country

Question 28

What’s the difference between Authorized and Unauthorized insurers?

Answer 28

States usually require companies to have a license to sell insurance in the state. The license is called a certificate of authority. When a company is licensed, it is called admitted or authorized.

Some states allow companies to sell insurance to certain types of risks (called surplus lines) without having to have a license. These companies are then called nonadmitted, unauthorized, or nonapproved.

•Certificate of authority-state license for an insurance company
• Authorized
•surence compas
• Admitted
Certificate of authority
Sell, place, and service most
insurance contracts
• Unauthorized
• Insurance company
Nonadmitted
No certificate of authority
Sell surplus lines insurance products

Question 29

Describe surplus lines

Answer 29

Sometimes an individual or a business will have an exceptionally large or specialized risk that no authorized insurer can or will cover. In such cases, insurance may be obtained from an unauthorized/ nonadmitted insurer on a surplus lines basis. Surplus lines insurance is placed with a nonadmitted carrier by a surplus lines agent or broker.
Surplus lines insurance can only be transacted according to certain rules governing that type of business. For example, states keep lists of acceptable surplus lines insurers and the particular risks that are covered. There are also rules that do not allow surplus lines insurance to be purchased only to get a cheaper rate when the insurance is available from an authorized insurer.
Surplus lines insurance is also called excess and surplus lines because, in some cases, a limited amount of coverage is available from an authorized insurer, and only the excess is obtained through the surplus lines insurer.
Gaming, casinos and entertainment, mining, and skyscrapers are all examples of exposures that might require surplus lines insurance.

Surplus Lines
• Insurance sold by unauthorized/ nonadmitted insurers- if on the state’s approved list of surplus
insurers
• Can only be sold to certain high-risk insureds
• Cannot be sold solely for a cheaper rate than licensed/admitted

Question 30

Describe financial ratings of insurers

Answer 30

Insurers may also be classified according to their financial strength. There are several independent rating agencies that evaluate various factors such as an insurer’s loss experience, reserves, investment performance, management, and operating expenses. They then assign an insurer a rating based on that analysis.

The organizations that rate insurers include AM Best, Inc., Standard & Poor’s Insurance Rating Services, Moody’s Investors Service, Duff & Phelps Credit Rating Company, and Weiss Ratings. These firms do not all rate every company, and each firm has different criteria on which companies are evaluated. Each firm also uses a different rating scale.

Financial Strength Rating
• A report card of the company

Question 31

Describe agency systems and the types of agents.

Answer 31

Most insurers sell their product through insurance producers, or agents. Agents represent the insurer, not insured. Brokers or consultants represent the insured. There are four different types of agents.
Independent insurance agents are individuals that sell the insurance products of several companies and are independent contractors, not employees of the insurers).

Independent agents own the renewals of the policies they sell.

Captive (exclusive) agents are individuals that represent only one company. Captive agents are independent contractors, not employees of the insurer. ‘The insurance company owns the renewals of the policies sold on their behalf.

General agents (GAs) or managing general agents (MGAs) are individuals that hire, train, and supervise other agents within a specific geographical area. GAs and MGAs earn overriding commissions (overrides) on the business produced by the agents they manage.

Direct-writing companies are companies whose products are sold by employees, not independent contractors. This type of producer may be compensated by a salary, commission, or both. ‘The insurance company owns the renewals of the policies sold on their behalf

Methods of Marketing
• Independent
• Exclusive or captive
• General agents or managing
general agents
• Direct-writing companies

Question 32

What is direct response marketing?

Answer 32

In direct response marketing, there is no producer or agent. Policies are sold directly to the public by
the insurer. Direct response marketing is conducted through the mail, by advertisements in newspapers and magazines, on television and radio, or through the internet.

Direct Response
• No agent/producer involved
• Direct mail, magazines, television, internet, and radio advertisements

Question 33

Describe law of agency and an agency.

Answer 33

Under the law of agency, contracts made by the agent are considered to be contracts of the principal.
When the insurer (principal) provides specific directions and exerts more control over an agent’s job duties, then an agency relationship may exist. Payments made to an agent within the scope of the agent’s authority are considered to be received by the principal. The knowledge of the agent is assumed to be the knowledge of the principal.Therefore, the principal is liable for the statements and actions of her agents.

Agency
•The insurance agent acts on behalf of the principal (insurance company).

Question 34

What are the three types of authority in an agency?

Answer 34

Under the law of agency, there are three types of authority: express, implied, and apparent.

Express authority is the authority made explicit in a producer’s written agency agreement with the insurer. Express authority is the wording in the contract that specifically tells the producer what they can and cannot do. For example, if the producer is given express authority to write a $500,000 life
insurance policy. he cannot write a $1.000.000 policy.

**Implied authority ** is not written in the agency contract, but it is assumed to be granted to an agent in accordance with general business practices. For example, an agent’s contract may not say in writing that the agent has the right to print business cards with the insurer’s logo on them, but this authority is implied by allowing the agent to act on the insurer’s behalf. Implied authority is power that the agent believes he or she has because the power is necessary for the agent to conduct the business of the insurer.

Apparent authority is authority that others believe the agent has. If the insurer’s name is on the sign at the agent’s place of business and the agent takes applications for the insurer’s policies, then the agent has apparent authority from the insurer to conduct business, as far as the public is concerned.
Sometimes, agents may act with apparent authority that the insurer did not intend for the agent to have.
The insurer may still be bound by those actions if the agent’s apparent authority creates a presumption of agency in the mind of the insured. For example, if an agent sends an insured an email stating that the insured’s policy covers flooding but, in reality, the policy excludes flooding from coverage, the company may be required to pay the claim because of the actions of the agent.

Question 35

What are 3 types of authority?

Answer 35

Agent Authority

Express- -authorities written in
agent contract

•Implied -authorities not written
in agent contract but tasks agent must perform; implied that agent has this authority

Apparent–tasks the agent does
that a reasonable person would
assume as authority, based on the
agents actions and statements

Question 36

What is a fiduciary?

Answer 36

A fiduciary is a person in a position of financial trust. The following are examples of an agent’s fiduciary
responsibility .

**Fiduciary= Trust **
• Promptly sends premiums to insurer
• Has knowledge of products
• Complies with laws and regulations
• Does not commingle funds

Question 37

What is commingling?

Answer 37

Commingling is the illegal act of mixing personal funds with the insureds or insurers funds.

Any agent who takes funds held in trust for personal use is guilty of theft and will be punished as provided by law.

Question 38

Describe suitability considerations

Answer 38

An agent must use suitability considerations to make purchase recommendations that are
appropriate, or suitable, in light of a clients particular needs, objectives, and circumstances.