Basic Insurance Concepts And Principles

Question 1

Insurance

Answer 1

The legal agreement, or contract, whereby two parties involved agree to the limits of the indemnification, the circumstances under which it will occur and what things of value (consideration) will be exchanged by the parties to the contract.

Question 2

Person

Answer 2

A legal entity which acts on behalf of itself, accepting legal and civil responsibility for the actions it performs and making contracts in its own name. Can include individual human beings, associations, organizations, corporations, partnerships, and trusts.

Question 3

Agency Contract

Answer 3

A contract that is held between an insurer and an agent/producer, containing the expressed authority given to the agent/producer, and the duties and responsibilities to the principal. An agent who is in violation of the agency contract may be held personally liable to the insurer.

Question 4

Agent/Producer

Answer 4

A person who acts for another person or entity with regard to contractual arrangements with third parties; a legal representative of an insurance company. The classification of PRODUCER usually includes agents and brokers; AGENTS are the agents of the insurer. Insurer is the PRINCIPAL.

Question 5

Applicant or Proposed Insured

Answer 5

A person who requests or seeks insurance from an insurer.

Question 6

Beneficiary

Answer 6

The person who receives the benefits from the policy of insurance.

Question 7

Death Benefit

Answer 7

The amount paid when a claim is issued against a policy of insurance.

Question 8

Insurance Policy

Answer 8

A contract between a policyowner (and/or insured) and an insurance company which agrees to pay the insured or the beneficiary for loss caused by specific events.

Question 9

Insured

Answer 9

The person covered by the policy of insurance who may or may not be the applicant or policyowner.

Question 10

Insurer (principal)

Answer 10

The company who issued a policy of insurance.

Question 11

Life Insurance

Answer 11

A coverage upon a person’s life, and granting, purchasing or disposing of annuities. Insures against the financial loss caused by the premature death of the insured.

Question 12

Policyowner

Answer 12

The person who is entitled to exercise the rights and privileges in the policy and who may or may not be the insured.

Question 13

Premium

Answer 13

The money paid to the insurance company for the policy of insurance.

Question 14

Risk

Answer 14

The uncertainty or chance of a loss occurring. There is pure and speculative risk, and only pure risk is insurable.

Question 15

Pure Risk

Answer 15

Situations that can only result in a loss or no change. There is no opportunity for financial gain. Pure risk is the only type of risk that insurance companies are willing to accept.

Question 16

Speculative Risk

Answer 16

Situations that involve the opportunity for either loss or gain, i.e. gambling. These types of risks are not insurable.

Question 17

Perils

Answer 17

The causes of loss insured against in an insurance policy.

Question 18

Health Insurance

Answer 18

Insures against the medical expenses and/or loss of income caused by the insured’s sickness or accidental injury.

Question 19

Property Insurance

Answer 19

Insures against the loss of physical property or the loss of its income-producing abilities.

Question 20

Casualty Insurance

Answer 20

Insures against the loss and/or damage of property and resulting liabilities.

Question 21

Hazards

Answer 21

Conditions or situations that increase the probability of an insured loss occurring. Hazards are classified as physical, moral, and morale hazards. Conditions such as lifestyle and existing health, or activities such as scuba diving, are hazards and may increase the chance of a loss occurring.

Question 22

Physical Hazards

Answer 22

Individual characteristics that increase the chances of the cause of loss. Physical hazards exist because of a physical condition, past medical history, or a condition at birth, such as blindness.

Question 23

Moral Hazards

Answer 23

Tendencies towards increased risk. Moral hazards involve evaluating the character and reputation of the proposed insured. Moral hazards refer to applicants who may lie on an application for insurance, or, in the past, have submitted fraudulent claims against an insurer.

Question 24

Morale Hazards

Answer 24

Similar to moral hazards, except that they arise from a state of mind that causes indifference to loss, such as carelessness. Actions taken without forethought may cause physical injuries.

Question 25

Legal Hazard

Answer 25

A set of legal or regulatory conditions that affect an insurer's ability to collect premiums that are commensurate with (equal to in value) the exposure to loss that the insurer must bear.

Question 26

Law of Large Numbers

Answer 26

The larger the number of people with a similar exposure to loss, the more predictable actual losses will be. This law forms the basis for statistical prediction of loss upon which insurance rates are calculated.

Question 27

Exposure

Answer 27

A unit of measure used to determine rates charged for insurance coverage.

Question 28

Homogeneous Group

Answer 28

A large number of units having the same or similar exposure to loss. The basis of insurance is sharing risk among the members of a large homogeneous group with similar exposure to loss.

Question 29

Distribution of Exposures

Answer 29

"Spread of risk." Is profitable when poor risks are balanced with preferred risks, with "average" or "standard" risks in the middle.

Question 30

Adverse Selection

Answer 30

The insuring of risks that are more prone to losses (i.e., seeking more insurance and filing more often) than the average risk.

Question 31

How do insurance companies protect themselves from adverse risk?

Answer 31

Refusing or restricting coverage for bad risks, or charging them higher rates for insurance coverage.

Question 32

"Critical" risks

Answer 32

All exposures in which possible losses would result in financial ruin for insured, the insured's family, and/or their business.

Question 33

"Important" risks

Answer 33

Exposures in which losses would lead to major changes in person's lifestyle/profession.

Question 34

"Unimportant" risks

Answer 34

Exposures in which possible losses could be met by current assets/income without undue financial strain/lifestyle change.

Question 35

What common sense principles should you apply to an insurance program?

Answer 35

1) Consider the odds 2) Don't risk more than you can afford to lose 3) Don't risk a lot for a little.

Question 36

RMT: Sharing

Answer 36

A group of inividuals/businesses with same/similar loss exposure share the losses that occur in the group.

Question 37

RMT: Transfer

Answer 37

Most effective way to handle risk. Transfer loss to another party. I.e., an insurance policy transfers risk from individual to insurance company.

Question 38

RMT: Avoidance

Answer 38

Eliminates loss exposure. I.e., avoiding riding a plane to avoid plane crash loss.

Question 39

RMT: Retention

Answer 39

Planned assumption of insured's risk through deductibles, co-pays, and self-insurance. Purpose is: 1) Reduce expenses/improve cash flow 2) Increase control of claim reserving/settlements 3) Fund losses that cannot be insured.

Question 40

RMT: Reduction

Answer 40

Lessens possibility of loss. I.e., installing smoke detectors or having an annual physical.

Question 41

Pure Risks

Answer 41

Risks that involve only the chance of loss with no chance of gain. Not all are insurable!

Question 42

What characteristics must be present before a pure risk can be insured?

Answer 42

1) Loss must be due to chance (accidental). 2) Loss must be definite and measurable. 3) Loss must be statistically predictable. 4) Loss cannot be catastrophic (i.e., wars, nuclear events) 5) Loss exposure to insured must involve large homogenous exposure units (law of large numbers). 6) Insurance must not be mandatory.

Question 43

Insurable Events

Answer 43

If a possible event could result in loss to a person, it may be insurable. The more predictable a loss becomes, the more insurable it becomes. The more unpredictable, the less insurable it becomes. Level of loss to be insured is not legally specified.