F475 VERSION 1

Insurance

The transfer of financial uncertainty from an individual or organization to an insurer.

Insurance premium

The amount paid to an insurer in exchange for insurance coverage.

Risk pooling

Combining premiums and loss exposures from many similar insured individuals.

Pure risk

A risk involving only the possibility of a loss or no loss.

Speculative risk

A risk involving the possibility of profit, loss, or no change.

Subjective risk

Risk based on an individual's personal perception or uncertainty.

Objective risk

The measurable variation between actual losses and expected losses.

Fundamental risk

A risk that affects a large number of people at the same time.

Particular risk

A risk that primarily affects a specific individual or small group.

Financial risk

A risk involving the possible loss of financial value.

Nonfinancial risk

A risk involving a nonmonetary loss.

Probability of loss

The chance that a loss will occur.

Loss frequency

The expected number of losses occurring during a given period.

Loss severity

The potential financial size or damage of a loss.

Law of large numbers

As the number of similar exposures increases, actual losses are more likely to approach expected losses.

How does the law of large numbers help insurers?

It improves loss predictions and reduces objective risk.

Risk management

The process of identifying, evaluating, and managing risks and potential losses.

First step in the risk management process

Determine the objectives of the risk management program.

Second step in the risk management process

Identify the risks to which the individual is exposed.

Third step in the risk management process

Evaluate the probability and severity of each potential loss.

Fourth step in the risk management process

Determine the available risk management alternatives.

Fifth step in the risk management process

Select the appropriate alternative for each risk.

Sixth step in the risk management process

Implement the risk management plan.

Seventh step in the risk management process

Periodically evaluate and review the risk management program.

Risk management objectives

Provide cost effective protection and continuing income following a loss.

Tools for identifying risks

Checklists, survey forms, financial statement analysis, and life cycle analysis.

Why must a risk management plan be reviewed periodically?

Risk exposures change and the original risk management choices may contain errors.

Risk avoidance

Eliminating an activity or exposure so that the related loss cannot occur.

Risk reduction

Taking actions that reduce the frequency or severity of a possible loss.

Risk retention

Personally accepting and paying for a potential loss.

Risk transfer

Shifting the financial consequences of a loss to another party, usually an insurer.

Risk sharing

Distributing a risk among multiple parties.

High severity and low frequency risk

Transfer or share the risk using insurance.

High severity and high frequency risk

Avoid the risk.

Low severity and low frequency risk

Retain the risk.

Low severity and high frequency risk

Retain or reduce the risk.

Peril

The direct cause of a loss, such as fire, wind, theft, or collision.

Hazard

A condition that increases the probability or severity of a loss.

Moral hazard

Dishonest behavior that increases the chance of loss, such as filing a false claim.

Morale hazard

Carelessness or indifference to loss caused by having insurance.

Physical hazard

A physical condition that increases the chance of loss, such as icy roads or defective equipment.

Difference between a peril and a hazard

A peril causes the loss, while a hazard increases the likelihood or severity of the loss.

Requisites of an insurable risk

Numerous similar exposures, accidental losses, measurable losses, no catastrophic threat to the insurer, and affordable premiums.

Homogeneous exposure units

A large number of exposure units with similar characteristics.

Accidental loss requirement

The insured loss must occur by chance rather than intentionally.

Measurable and determinable loss

A loss whose cause, time, location, and financial amount can be established.

Catastrophic risk requirement

A loss should not affect so many insured units that it threatens the insurer's financial stability.

Affordable premium requirement

The premium must be reasonable compared with the protection provided.

Adverse selection

The tendency of individuals with higher than average risk to purchase or renew insurance.

Underwriting

Classifying applicants into risk groups, selecting insureds, and assigning premiums.