Chapter 3 - ratemaking, underwriting, rating

Question 1

Define rate.

Answer 1

• the price of insurance for a period of one year

Question 2

Define premium.

Answer 2

• is arrived at by multiplying the rate times the amount of insurance purchased.
• it is the total cost of an insurance policy or a portion of that policy.

Question 3

What is ratemaking?

Answer 3

• the process of establishing rate for each class of insurance
• is carried out by actuaries who are highly trained professionsals
• they may be employed insurers or an organization that specializes in determining advisory rates

Question 4

What principles are required to determine premiums?

Answer 4

• law of averages (law of large numbers)

- theory of probability.

Question 5

Define law of large numbers.

Answer 5

• the principle that the reliance to be placed upon a given probability is increased when the number of trials or cases is increased

Question 6

Define theory of probability.

Answer 6

• relates to the likelihood of an occurrence, expressed by the ratio of the number of actual occurrences to that of possible occurrences
• # of actual occurrences/# of possible occurrences = probability or chance of event happening
• usually spoken of as the chance that the event will happen

Question 7

What factors is the reliability of predictions dependant on?

Answer 7

1) size of sample
- more reliable with larger size
2) time period over which sample was taken
- more reliable results with longer time periods
3) conditions in the past relative to future conditions
- predictions of events in the future based on past events tend to be reliable

Question 8

What are the steps in rate determination?

Answer 8

1) classifcation of risks established on:
a) types of objects insured
b) hazards of exposure

2) Gather statistics on past losses
- validity depends on loss data covering a number of losses over a period of time
- used to predict future

3) Determine pure premium (premium required to meet the losses that occur)

4) Determine total premium
- pure premium + loadings, repair costs, inflation, overhead, profit, expenses (such as cost of production)

5) Determine rate

Question 9

What do loadings (for trends in accidents) include?

Answer 9

• increases in unexplained fires
• more auto theft
• increases in severe weather disturbances

Question 10

What does cost of production include?

Answer 10

• brokers
• commissions
• promotion
• advertising

Question 11

What does overhead include?

Answer 11

• providing for business premises
• equipment
• office supplies
• staff salaries
• taxes

Question 12

Define chance.

Answer 12

• the probability of an event occurring
• may be represented as a fraction
• numerator is the # of times event happens
• denominator is the # of times event may possibly happen
• stats on losses suffered by a large # of people, the # of losses suffered by a similar group can be predicted with reasonable accuracy.

Question 13

What are policies referred as when they name the perils they insure?

Answer 13

• named-peril policy

Question 14

What are policies referred as when they are a combination of fire and casualty?

Answer 14

• multi-peril

Question 15

What does an all risks policy entail?

Answer 15

• may sound all inclusive but include exclusions for certain events or perils

Question 16

What are crime coverages made up of?

Answer 16

• burglary, robbery, theft, hold-up, dishonesty, embezzlement, and forgery are perils clearly defined in fidelity and burglary insurance which makes up the crime coverages

Question 17

What does boiler and machinery insurance cover?

Answer 17

• breakdown and explosions

Question 18

What does auto insurance cover?

Answer 18

• all perils
• collisions
• upset
• fire
• theft

Question 19

Define negligence.

Answer 19

• is the doing of something a reasonable person would not do or not doing something a reasonable person would do

Question 20

What is physical hazard?

Answer 20

• refers to the subject matter of insurance aka the physical features of a risk
  ex) construction of property, location in relation to water supplies for firefighting, existence of fire and burglar alarms, age, make and model of a vehicle

Question 21

What is a moral hazard?

Answer 21

• relates to the conditions attributable to the human element
• grows out of attitudes
• depends on the character of insured
• includes dishonesty and fraud

Question 22

What are examples of preventative measures used to remove or reduce a physical hazard?

Answer 22

• non-skid wax
• fasten down loose flooring
• clean and maintain heating systems
• correct overfusing
• sprinklers, fire extinguishers, smoke alarms installation
• burglar alarm, safe, vault, guard, procedures on how to handle money

Question 23

What is the subject of an insurance contract?

Answer 23

• risk

- may be accepted or rejected based on level

Question 24

What is an application?

Answer 24

• request for insurance

Question 25

What does an underwriter do?

Answer 25

- looks at both the risk and the applicant decides whether to: - accept risk - reject risk - accept risk subject to certain conditions

Question 26

What will underwriters base their decision on?

Answer 26

1) personal info about applicant 2) details of physical hazard and exposures to risk under consideration 3) special factors pertaining to the class of risk or type of insurance

Question 27

Define exposure.

Answer 27

- is the danger of loss arising from what happens to another risk close by - is also the sum total of values insured under a policy, aka, the total amount the insurer could become liable for under a policy

Question 28

What are the reasons for rejecting a risk?

Answer 28

1) insurer may not insure that class of insurance 2) the risk may be too hazardous and has an almost certain potential for loss 3) risk may be substandard - the potential for improving it exists, but the applicant is not prepared to carry out suggested improvements

Question 29

Define retention.

Answer 29

- is the amount an insurer retains for its own account not including reinsurance

Question 30

Define reinsurance.

Answer 30

- is the process whereby an insurer may share its risk with another insurer by paying to that insurer a portion of the premium it receives for the risk. - its a mean of spreading the risk further

Question 31

What depends on the amount an insurer will cover?

Answer 31

1) concentration of values - of this AND other nearby risks - if the risk involves coverage against loss by fire or is sibject to catastrophic loss possibility 2) reinsurance facilities - available to reduce the risk to average proportions and to keep amount of retention within the maximum limit laid down in overall company policy by the directors

Question 32

Define loading.

Answer 32

- is an additional charge included in an insurance rate to reflect a hazard not contemplated in the basic rate of the class

Question 33

What are factors for risk selection?

Answer 33

- subject - application - exposure - info from technical services

Question 34

Define casualty insurance.

Answer 34

- is loosely used to describe an area of insurance not particularly or directly concerned with life insurance, fire insurance, or auto insurance. - most frequently it refers to liability, crime, and plate glass insurance but may include surety as well

Question 35

Define inland marine insurance.

Answer 35

- refers to coverages for almost anuthing that is not insured under a property or casualty policy. - includes such diverse items as movable property such as contractors equipment, tools, accounts receivable policies, property in transit (except sea voyages) - but also includes bridges, wharves, tunnels, power transmission lines and pipelines because they are instruments of transportation (and are also referred to as real property)

Question 36

Define rating.

Answer 36

- is applying the established rates to the specific items that are to be insured.