Property and Casualty Insurance License

risk

Risk is a condition where there is a chance, likelihood, or probability of a potential loss. Specifically, risk is the uncertainty concerning a loss. Insurance is a way of managing or handling risk.

pure risk

risk that will result in either a loss or no change in status—there is no possibility for gain. This type of risk can be insured

speculative risk

risk that may result in a loss, a gain, or no change in status, so are not insurable

loss

a reduction, decrease, or disappearance in value that affects someone’s property or financial position. A loss is the basis for a claim under an insurance contract.

exposure (loss exposure)

the condition of being at risk for a loss, whether or not an actual loss occurs. People and property are at risk of loss purely by existing.

peril

the cause of a loss, examples: Fire, lightning, wind, death, and disability

hazard

A condition that increases the probability or likelihood that a loss will occur from a peril.

physical hazard

A physical condition that increases the probability of loss, including the use, condition, or occupancy of property. May often be seen, heard, felt, tasted, or smelled.

Examples: Flammable material stored near a furnace, or an icy sidewalk.

moral hazard

Dishonest tendencies that increase the probability of a loss, including certain characteristics and behaviors of people.

Examples: An insured burns down their own house or fakes an injury to collect the insurance payout.

morale hazard

An attitude of indifference toward the risk of loss that increases the probability of a loss occurring.

Example: The driver of a car stops at a convenience store to pick up a few items and leaves the car unlocked with the key in the ignition. This action increases the probability that the car may be stolen.

methods of managing risk

STARR-

Sharing: A large number of persons pooling resources to share in a loss

Transfer: An insured purchasing insurance transfers the risk

Avoidance: Some exposure can be eliminated entirely (never driving a car)

Reduction: Prevention of potential loss (installing sprinklers)

Retention: Taking the responsibility of a loss (a deductible on an insurance policy)

Elements of insurable risks

• There must be a large number of homogeneous (like) units with comparable exposures to help accurately predict future losses

• The chance of loss must be statistically calculable, and the premium must be affordable for the consumer

• The loss must be uncertain, accidental, and due to chance

• The loss must be measurable, meaning it is definite and verifiable in terms of amount, cause, place, and time

• The loss must cause a financial hardship

• Catastrophic perils need to be excluded. War, calamity, and nuclear hazard are considered uninsurable because of the potential enormity of the loss and an insurer’s inability to pay losses. Illegal activity would also be excluded.

adverse selection

the principle that people will seek insurance more frequently for risks that are hard to insure. To balance against adverse selection, insurers will charge a higher premium for less favorable risks or, in some cases, decline coverage altogether.

Example: People living in earthquake zones are more likely to purchase earthquake coverage. If an insurer issues earthquake coverage to all applicants in that area in the same way it issues basic coverage against other perils, the insurer may be at great financial risk if an earthquake strikes. To protect against this adverse selection, earthquake coverage is excluded from many property policies, and those seeking coverage must pay an additional premium to add coverage either by endorsement or by purchasing a separate policy.

reinsurance

insurance for insurers. It is a device used by insurers to spread their risk and limit the loss they will face in the event of a large claim or catastrophic loss, which helps stabilize profits, increase the insurer’s ability to underwrite risks, and build confidence with consumers and investors.

Example: A wildfire causes significant property damage to residential buildings. An insurer selling Homeowners insurance in the area will likely see a substantial increase in claims, and paying all legitimate covered claims may bankrupt the insurer. By spreading the risk to other insurers, loss payments are more affordable for each involved insurer.