Chapter 6

Question 1

Define pooling

Answer 1

an arrangement that facilitates the grouping of loss exposures and the resources to pay for any losses that may occur. loss exposure should be independent of one another for the polling arrangements to function best

Question 2

Define independent loss exposures.

Answer 2

Loss at one loss exposure has no effect on the probability of a loss at another loss exposure

Question 3

Why are correlated loss exposures?

Answer 3

Not independent. Ex. Fire at single location.

Question 4

How is the standard deviation calculated for a pool?

Answer 4

Square root of the number of members in the pool times the variance (single member)

Question 5

What are the benefits of insurance?

Answer 5

1. Paying for losses (indemnifies)
2. Managing cash flow uncertainty
3. Complying with legal requirements
4. Promoting insureds’ loss control activities (offering discounts for alarms/sprinklers)
5. enabling insureds to use resources efficiently (frees up money which can be used elsewhere)
6. Providing support for insureds’ credit (facilitates loans, guarantees lessor)
7. Providing insurers with a source of investment funds (funds can be used for new construction, research, and technology advancements)
8. Reducing Social Burdens (compensates people so they don’t have to rely on govt benefits)

Question 6

What are the characteristics of an ideally insurable loss exposure?

Answer 6

1. Pure Risk
2. Fortuitous losses
3. Definite (as to time cause & location) & Measurable (oil tank rupture not definite)
4. Large number of similar exposure units
5. Independent and not catastrophic
6. Affordable (if premium too high, no demand)

Question 7

Define fortuitous loss.

Answer 7

A loss that is accidental and unexpected

Question 8

What are the necessary conditions for the law of large numbers to apply?

Answer 8

One of a large number of similar exposure units

1. The events have occurred in the past under substantially identical conditions and have resulted from unchanging, basic causal forces
2. The events can be expected to occur in the future under the same unchanging conditions
3. The events have been, and will continue to be, independent and sufficiently

Question 9

Define private insurer.

Answer 9

Insurance organizations that are not owned or operated by federal or state governments

Question 10

Define arbitrage.

Answer 10

the ability to gain without any risk of loss

Question 11

Define cross sectional loss transfer.

Answer 11

The spreading of risk across a large number of similar exposure units within the same period. Achieved through pooling, which takes advantage of the law of large numbers

Question 12

Define intertemporal loss transfer.

Answer 12

risk transfer function insurance can provide is the spreasing of risk through time. does not require a large number of similar exposure units; therefore insurers are willing to insure unique loss exposures where there is little or no pooling of similar exposure units…

Question 13

Define premises and operations liability.

Answer 13

The possibility that an organization will be held liable because of injury or damage from either of two causes:

1. An accident occurring on premises owned or rented by the organization.
2. An accident occurring away from such premises, but only if it arises out of the organization’s ongoing operations

Question 14

Define products liability loss exposure

Answer 14

Arise out of injury or damage that results from defective or inherently dangerous products

Question 15

Define Personnel Loss Exposure

Answer 15

Is a condition that presents the possibility of loss caused by a key person’s death, disability, retirement, or resignation that deprives an organization of that person’s special skill or knowledge that cannot be readily replaced

Question 16

Define Exclusive Insurer

Answer 16

Only possible insurer because of law or because no private insurer offers a competing plan

Question 17

When does the government partner with private insurers?

Answer 17

When private insurers are no longer able to adequately provide coverages they had typically offered previously.

Question 18

What is the National Flood Insurance Program?

Answer 18

meets previously unmet needs for flood insurance. serves the social purpose of amending and enforcing building codes and reducing new construction in flood zones

Question 19

describe the traits of an independent or uncorrelated loss exposure

Answer 19

Independent- uncorrelated with any others, when a loss at one loss exposure has not effect of the probability of a loss at another loss exposure

Question 20

describe the likelihood of extreme outcome when using a pooling arrangement

Answer 20

as the number of participants in the pool grows, extreme outcomes become less likely at the pool level

Question 21

describe the effect of pooling on the frequency of loss, severity of loss, and the probability distribution of losses

Answer 21

pooling does not change the frequency or severity of an individual loss exposure, but it does change the probability distribution of the loss because the sources of the loss exposures and the resources to pay for losses have been combined. the results is that the uncertainty around the expected value has decreases

Question 22

ist the ways insurance benefits individuals, organizations, and society

Answer 22

1. indemnifies individuals and organizations for covered losses
2. enables individuals and organizations to manage cash flow uncertainty
3. enables individuals and org to meet legal requirements
4. promotes risk control
5. frees up insured’s financial resources for other expenditures or investments
6. supports insured’s credit
7. provides source of investment funds for insurers and insureds
8. helps reduce social burden

Question 23

explain how an organization risk financing goals goals through the use of insurance

Answer 23

indemnifies for covered losses- insurance indemnifies the insured, subject to applicable deductibles and policy limits for losses to covered loss exposures resulting from covered causes of loss

manages cash flows- insurance helps reduce the financial effect on the insured’s cash flow to any deductible payments and any loss amounts that exceed the policy limit

meet legal requirements- insurance is often used or required to satisfy statutory requirements and contractual requirements that arise from business relationship

Question 24

list risk sharing mechanisms an insurer may use to promote risk control

Answer 24

1. deductibles
2. premium credit incentives
3. contractual requirements

Question 25

identify the 6 characteristics of an ideally insurable loss exposure

Answer 25

1. pure risk 2. fortuitous losses 3. definite and measurable 4. large number of similar exposure units 5. independent and not catastrophic 6. affordable

Question 26

explain why insurance is designed to cover pure, not speculative risk

Answer 26

because the purpose of insurance is to indemnify the insured for a loss, not to enable the insured to profit from the loss. if the loss exposure has a possibility of gain, the insurance premium the insurer would have to charge would offset the potential gain

Question 27

identify the factors an insurer must be able to determine for a loss exposure to be define in time, cause, and location

Answer 27

1. event that led up to the loss 2. when the event or series of events occurred 3. where the event occurred

Question 28

describe they types of losses an insurer might consider uninsurable because the premium charged would not be economically feasible

Answer 28

those involving only low severity losses and those involving a high frequency of loss

Question 29

explain whether the building that houses an organization's main operations would meet the six ideally insurable characteristics for FIRE

Answer 29

for most property loss exposures the main UW criteria focus on the threat of loss by fire. commercial property loss exposures associated with fire generally meet all 6 characteristics. an exception would be arson for profit

Question 30

explain whether the building that houses an organization's main operations would meet the six ideally insurable characteristics for WINDSTORM

Answer 30

windstorm damage to commercial property loss exposures is a pure risk subject to fortuitous losses that are define and measurable however it may not meet the last 3 ideally insurable characteristics: large number of similar exposure units( depends of property, location, property type, and use), independent and not catastrophic, premiums economically feasible

Question 31

explain whether the building that houses an organization's main operations would meet the six ideally insurable characteristics for FLOOD

Answer 31

flood involves pure risk and losses that are fortuitous, define, and measurable. the main issue is that the flood cause of loss is geographically concentrated, so loss exposures tend not to be independent, and losses could be catastrophic from the insurer's perspective. as a result, flood loss premiums are high and flood can be economically unfeasible to insure for some organizations

Question 32

describe 2 common sources of liability risk faced by many commercial organizations

Answer 32

premises and operations liability- liability bc of bodily injury or property damage caused by an accident on owned or rented premises or away from the premises if it arises out of the org's ongoing operations products liability- liability bc of bodily injury or property damage resulting from defective or inherently dangerous products

Question 33

compare the insurability of personnel losses caused by an employee's death and those caused by an employee's retirement

Answer 33

personal losses caused by an employee's death- exhibit the 6 characteristics of an ideally insurable loss exposure. such a loss exposure involves pure risk that is fortuitous, independent and not cat, and that is usually economically feasible to insure personnel losses caused by an employee's retirement- do not meet the 6 ch of an ideally insurable loss exposure. such a loss exposure involves pure risk that is fortuitous, independent, and not catastrophic, and that is usually economically feasible to insure

Question 34

identify common sources of liability risk faced by individuals

Answer 34

1. real property ownership ) premises) liability loss exposure 2. auto liability loss exposures

Question 35

for purposes of life insurance, identify individual circumstances that may prevent insurers from offering an economically feasible premium

Answer 35

individual circumstances such as health conditions or hazardous occupations

Question 36

explain why retirement does not usually exhibit the fortuitous characteristics of ideally insurable loss exposures

Answer 36

The individual has control over savings and choice of retirement dates

Question 37

identify reasons for government involvement in insurance

Answer 37

1. to fulfill insurance needs unmet by private insurers 2. to compel people to buy a particular type of insurance 3. to obtain greater efficiency and or provide convenience to insurance buyers 4. to achieve collateral social purpose

Question 38

explain how the government provides incentives for the purpose of insuranc

Answer 38

through a combinations of regulation and provision of insurance at a reasonable price

Question 39

identify 3 levels of government insurance programs

Answer 39

1. exclusive insurer 2. partner with private insurers 3. competitor to private insurers

Question 40

explain how state or federal governmental involvement in insurance programs is determined

Answer 40

if the rationale for gov involvement extends beyond state boundaries or would affect interstate commerce, the federal gov should be running the insurance program