Nature of Insurance and Risk Management

A set of practice flashcards covering the fundamental concepts of insurance, including risk types, hazards, the law of large numbers, and methods of handling risk based on the introductory lecture notes.

What is the insurance definition of risk?

The uncertainty regarding the possibility of loss.

What are the four fundamental requirements for exposure units in risk pooling?

The units must be large in number, homogeneous (similar), face accidental or unintentional losses, and be independent of each other.

What is the definition of adverse selection?

The tendency of higher-risk individuals to seek insurance coverage more frequently than lower-risk individuals.

What are three methods used by insurers to control adverse selection?

Medical underwriting, waiting periods, and preexisting condition limitations.

How does the law of large numbers enable insurance companies to predict losses?

It states that the larger the number of similar risks insured, the more accurately future losses can be predicted.

What is the purpose of the principle of indemnity?

To restore the insured to the same financial position they were in before the loss and prevent them from making a profit from insurance.

Which type of insurance is considered an exception to the principle of indemnity?

Life insurance, because it is a valued contract.

What is the difference between a peril and a hazard?

A peril is the specific event or cause that results in a loss (e.g., fire), while a hazard is a condition that increases the likelihood of a loss occurring.

What are the three types of hazards identified in insurance?

Physical (tangible/observable conditions), Moral (dishonest character or intentional acts), and Morale (carelessness or indifference due to having insurance).

What is a pure risk and how does it differ from a speculative risk?

A pure risk involves only the possibility of loss with no chance of gain and is insurable; a speculative risk involves the possibility of both loss and gain and is not insurable.

What does the acronym STARR stand for in the context of handling risk?

Sharing, Transfer, Avoidance, Reduction, and Retention.

How is a direct loss distinguished from an indirect loss?

A direct loss is immediate damage from a peril, while an indirect loss is a consequential loss resulting from that damage.

How does self-insurance differ from having no insurance?

Self-insurance is a planned method of risk retention, whereas having no insurance is unplanned.

What is the relationship between an accident and an occurrence?

Every accident is an occurrence, but not every occurrence is an accident, as occurrences can be gradual.