Unit 1 Part A

Question 1

risk

Answer 1

possibility that loss will occur

Question 2

insurance

Answer 2

transfers the risk of financial loss from one entity (the insured) to the insurer

Question 3

speculative vs pure risk

Answer 3

speculative – chance of loss or gain; cannot be insured (gambling)
pure – chance of loss only

Question 4

exposure

Answer 4

risks for which the insurance company are liable
higher risk = higher premium

Question 5

peril

Answer 5

cause of loss (ex. house burns down, peril = fire)

Question 6

a loss

Answer 6

(1) unintended, unforeseen damage to a property
(2) injury
(3) amount paid

Question 7

direct loss

Answer 7

physical loss to property with no intervening cause (ex. lightning striking a house)

Question 8

indirect loss

Answer 8

consequential loss as the result from a direct loss (ex. loss of rental income due to a house fire)

Question 9

hazard

Answer 9

anything that increases the chance of a loss occurring

Question 10

physical vs moral vs morale hazard

Answer 10

physical – physically identifiable, like tires slick with no tread

moral – arise from an individual’s character, such as dishonesty with your insurance company

morale – state of mind/careless attitude, like an insured leaving their home unlocked when not at home

Question 11

STARR

Answer 11

methods of handling risk:
Sharing
Transfer
Avoidance
Retention
Reduction

Question 12

Sharing (STARR)

Answer 12

in risk sharing, 2+ people agree to pay a portion of any loss incurred

Question 13

Transfer (STARR)

Answer 13

insurance facilitates the risk transfer – the premium is small with certainty whereas a loss may be large and unexpected

Question 14

Avoidance (STARR)

Answer 14

risk avoidances means eliminating risk by not participating in a certain activity (ex. an individual who does not drive as much)

Question 15

Retention (STARR)

Answer 15

risk retention means the insured will pay for the loss if it occurs – if you don’t have car insurance you must pay out of pocket for damage you may cause to someone else’s car in an accident

Question 16

Reduction (STARR)

Answer 16

risk reduction refers to lessening the chance a loss will occur, or the extent of the loss (ex. automatic sprinkler system)

Question 17

insurance companies use the risk management method of __________ to spread a risk of loss among thousands of insureds

Answer 17

transferring

Question 18

1st party =
2nd party =

Answer 18

= insured/customer
= insurer/company

Question 19

law of large numbers

Answer 19

the larger the group, the more accurately losses can be predicted and therefore increase accuracy in charging the correct premium (how many $ in claims pooled together)

Question 20

CANHAM

Answer 20

characteristics of pure risks:
Calculable
Affordable
Non-catastrophic
Homogenous
Accidental
Measurable

Question 21

Calculable (CANHAM)

Answer 21

premiums are calculated based upon prior loss statistics

Question 22

Affordable (CANHAM)

Answer 22

premium for transferring risk should be affordable for average customer

Question 23

Non-catastrophic (CANHAM)

Answer 23

risk should be non-catastrophic; national/area disasters (floods, earthquakes) often have coverage limits; peril of war is often excluded

Question 24

Homogenous (CANHAM)

Answer 24

risk must be similar in nature so the same factors affect the chance of loss

Question 25

Accidental (CANHAM)

Answer 25

loss must have been accidental

Question 26

Measurable (CANHAM)

Answer 26

definite (time and place) and measurable loss = proof of loss est. with dollar amounts

Question 27

adverse selection

Answer 27

occurs when people who are more likely to need to file a claim (higher-risk individuals) are more likely to purchase insurance than those who are less likely to file a claim (lower-risk individuals), why underwriting process exists

Question 28

reinsurance

Answer 28

insurance for insurers

Question 29

the company reducing its risk is called ______ the insurer; the company assuming the risk is the _________

Answer 29

ceding reinsurer

Question 30

two ways to go about reinsurance

Answer 30

1. facultative reinsurance -- reinsurer considers each risk before allowing the transfer 2. treaty reinsurance -- reinsurer accepts all risks of a certain type