Insurance and Takaful – Tutorials 1-8 Review

Flashcards covering fundamental concepts from Insurance & Takaful Tutorials 1-8, including risk definitions, risk management techniques, insurance principles, claims, reinsurance, takaful models, and related terminology.

What is a loss exposure?

Any situation or circumstance in which a loss is possible, regardless of whether a loss occurs.

How does objective risk differ from subjective risk?

Objective risk is the measurable variation of actual loss from expected loss and declines with more exposure units, whereas subjective risk is personal uncertainty based on an individual’s state of mind and is not easily measured.

State the historical definition of risk.

Uncertainty concerning the occurrence of a loss.

Differentiate objective probability from subjective probability.

Objective probability is the long-run relative frequency of an event based on infinite observations with unchanged conditions, while subjective probability is an individual’s personal estimate of the chance of loss.

Define chance of loss.

The probability that a particular event resulting in loss will occur.

Define physical hazard.

A physical condition that increases the chance of loss.

Define moral hazard.

Dishonesty or character defects in an individual that increase the chance of loss.

Define attitudinal (morale) hazard.

Carelessness or indifference to loss that increases its frequency or severity.

Define legal hazard.

Characteristics of the legal or regulatory environment that increase the frequency or severity of losses.

Distinguish peril from hazard.

Peril is the cause of loss; hazard is a condition that creates or increases the chance of loss.

Explain the difference between pure risk and speculative risk.

Pure risk involves only the possibility of loss or no loss, whereas speculative risk involves the possibility of loss, no loss, or profit.

How does diversifiable risk differ from non-diversifiable risk?

Diversifiable risk affects individuals or small groups and can be reduced through diversification; non-diversifiable risk affects the entire economy or large groups and cannot be eliminated by diversification.

What is financial risk?

Uncertainty of loss due to adverse changes in commodity prices, interest rates, foreign exchange rates, or the value of money.

Define enterprise risk.

All major risks faced by a business—pure, speculative, strategic, operational, and financial—viewed collectively.

What is enterprise risk management (ERM)?

A unified program that manages all major risks faced by a firm within a single framework.

State one key difference between ERM and traditional risk management.

Traditional risk management focused mainly on pure risks, whereas ERM addresses pure, speculative, strategic, operational, and financial risks together.

Describe avoidance as a risk-control technique.

Eliminating a risk exposure entirely by never acquiring it or abandoning it.

Describe loss prevention.

Measures aimed at reducing the frequency of a specific loss.

Describe loss reduction.

Measures aimed at reducing the severity of a loss after it occurs.

What is retention in risk financing?

A firm or individual keeps (retains) part or all of a loss from a given exposure; can be active or passive.

Give two examples of non-insurance transfers.

Contracts, leases, or hold-harmless agreements that shift risk to another party.

When is insurance an appropriate risk-financing technique?

When loss probability is low but potential severity is high.

Explain pooling of losses in insurance.

Losses incurred by the few are spread over the entire group, substituting average loss for actual loss.

What is a fortuitous loss?

A loss that is unforeseen, unexpected, and occurs by chance.

Define risk transfer in private insurance.

The insured shifts a pure risk to an insurer better able to pay the loss.

What does indemnification mean?

Restoring the victim of a loss, wholly or partially, by payment, repair, or replacement.

State the law of large numbers.

As the number of exposure units increases, actual results more closely approach expected results, reducing objective risk.

List the six characteristics of an ideally insurable pure risk.

(1) Large number of exposure units, (2) Accidental and unintentional loss, (3) Determinable and measurable loss, (4) Non-catastrophic loss, (5) Calculable chance of loss, (6) Economically feasible premium.

What is adverse selection?

The tendency of persons with higher-than-average chance of loss to seek insurance at standard rates, raising loss levels if not controlled.

Name two methods insurers use to control adverse selection.

Careful underwriting and charging higher premiums to substandard applicants; policy provisions are also used.

Give two major differences between insurance and gambling.

Insurance handles existing pure risk and is socially productive; gambling creates new speculative risk and is socially unproductive.

Define risk management.

A systematic process for identifying, evaluating, and selecting techniques to manage pure loss exposures.

List the four steps in the risk-management process.

Identify exposures, measure/analyze them, select techniques, implement and monitor the program.

Name three pre-loss objectives of risk management.

Economy, reduction in anxiety, meeting legal obligations.

Name three post-loss objectives of risk management.

Survival of the firm, continued operations, stability of earnings (also continued growth and social responsibility).

Why might a firm form a captive insurer?

To insure its own loss exposures through an insurer it owns, gaining cost control and coverage stability.

Which risk technique suits low-frequency, low-severity losses?

Retention.

Which risk technique suits low-frequency, high-severity losses?

Transfer, typically through insurance.

Which risk technique suits high-frequency, low-severity losses?

Loss prevention combined with retention; excess insurance may be purchased.

Which risk technique suits high-frequency, high-severity losses?

Avoidance.

How does actual cash value support the principle of indemnity?

It restores the insured to the pre-loss position (replacement cost minus depreciation), preventing profit from insurance.

Give two exceptions to the principle of indemnity.

Valued policy, replacement-cost insurance (others: valued-policy laws, life insurance).

How does insurable interest reduce moral hazard?

A party must stand to lose financially, so there is no gain from deliberately causing a loss.

Differentiate concealment from misrepresentation.

Concealment is intentional nondisclosure of material fact; misrepresentation is a false, material statement relied on by the insurer. Both make the contract voidable.

Define an aleatory contract.

A contract where the values exchanged are unequal; the insured may receive much more than premiums paid if a loss occurs.

Why is an insurance contract unilateral?

Only the insurer makes a legally enforceable promise; the insured is not obliged to pay future premiums.

What does contract of adhesion mean in insurance?

The policy is drafted by the insurer and accepted on a ‘take-it-or-leave-it’ basis; ambiguities are construed against the insurer.

Define the doctrine of waiver.

Voluntary relinquishment of a known legal right—e.g., issuing a policy despite an incomplete application waives the right to later deny claims on that basis.

What is the main role of actuaries?

Use mathematics, statistics, and financial theory to quantify and manage risk, set premiums, and ensure financial soundness.

List two reasons actuarial pricing is harder than pricing most products.

Need for long-term predictions amid uncertainty and compliance with strict regulatory solvency standards (other reasons: complexity of risk, volatility, ethics, ongoing professional development).

State the primary responsibility of underwriters.

Assess risks in insurance applications, decide acceptance, terms, and pricing to maintain a profitable, balanced portfolio.

Name three sources underwriters use for information.

Insurance applications, supporting documents (e.g., medical or inspection reports), and loss-history data (also external databases, actuarial analysis, etc.).

In insurance, what does “production” mean?

The volume of new business (written premium, policy count) generated by an agent or broker in a given period.

Give three basic objectives of insurers in settling claims.

Fulfill policy obligations fairly, settle promptly and efficiently, and control costs/fraud while maintaining customer satisfaction.

Outline four steps in the claims-settlement process.

Claim notification, investigation/documentation, evaluation/coverage determination, settlement offer (then negotiation, payment, closure).

Define reinsurance.

Insurance for insurers; the ceding insurer transfers part of its risk to a reinsurer to reduce exposure to large losses.

Give two reasons insurers buy reinsurance.

Risk transfer and diversification; enhances financial stability, capacity, fulfills regulatory capital needs.

What is facultative reinsurance?

Reinsurance negotiated separately for each individual risk or policy; reinsurer chooses whether to accept on a case-by-case basis.

What is treaty reinsurance?

A standing agreement in which a reinsurer automatically accepts a specified share of a defined portfolio of policies of the ceding insurer.

Under an excess-of-loss treaty with a $2 million retention, how are $1.4 million of annual losses shared?

Ceding insurer: $1.4 million; reinsurer: $0 (losses did not exceed retention).

Under the same treaty, how are $3.6 million of annual losses shared?

Ceding insurer: $2 million (retention); reinsurer: $1.6 million (excess over retention).

Why are investments important to insurance companies?

They generate income to pay claims, support long-term liabilities, maintain solvency, diversify risk, meet regulatory requirements, and allow competitive pricing.

Translate the literal meaning of the word "takaful."

From Arabic ‘kafala’—to guarantee or take care of one another.

Define takaful as an alternative to insurance.

An Islamic cooperative risk-sharing system where participants donate into a common fund to mutually indemnify losses, adhering to Shariah principles.

List three objectives of takaful.

Mutual cooperation, risk sharing/solidarity, compliance with Shariah (also fairness, social welfare, financial security).

Name four key principles of takaful.

Tabarru’ (donation), shared responsibility, mutual cooperation, prohibition of riba and gharar (plus Shariah compliance).

Identify three elements in conventional insurance prohibited in takaful.

Riba (interest), gharar (excessive uncertainty), and qimar/maysir (gambling/speculation).

Explain riba in the context of takaful.

Any receipt or payment of interest; takaful investments and operations must avoid interest-bearing activities.

Explain gharar in the context of takaful.

Excessive uncertainty or ambiguity in contract terms; takaful seeks clear, transparent agreements.

Explain qimar/maysir in the context of takaful.

Gambling or speculative risk taking; takaful excludes contracts dependent on chance gains.

Describe the Tabarru’ operational model.

Participants donate premiums to a communal fund that pays claims; surplus is held for charity or participant benefit according to rules.

Describe the Al-Mudharabah model.

Profit-sharing model where participants supply capital, operator invests funds; profits shared by agreed ratio, losses borne by participants.

Describe the Wakalah model.

Operator acts as agent for participants, charges a fixed wakalah fee; surplus after claims is returned to participants or used for charity.

Contrast takaful and conventional insurance in governance.

Takaful is overseen by a Shariah board ensuring Islamic compliance; conventional insurance is governed by secular regulation focused on shareholder value.

Contrast takaful and conventional insurance in guarantees.

Takaful offers no fixed investment guarantees; payouts depend on fund performance, while conventional insurance guarantees contractual benefits subject to policy terms.

Contrast the policyholder-shareholder relationship in takaful versus conventional insurance.

Takaful involves mutual risk sharing among participants with surplus distribution; conventional insurance separates policyholders (customers) from shareholders (owners seeking profit).

How are profits and losses shared under the Al-Mudharabah model?

Profits from investments are shared between participants and operator by pre-set ratio; participants bear losses up to their contributions, operator’s loss limited to lost effort.

How are profits and losses treated under the Wakalah model?

Operator earns a fixed fee; any surplus after claims is returned to participants or used charitably—operator does not share in investment profit/loss.

Give one common misconception: takaful equals conventional insurance.

False—takaful follows Shariah principles and eliminates riba, gharar, and qimar, operating on donation and mutual sharing rather than risk transfer for profit.

Give one common misconception: takaful is only for Muslims.

False—takaful products are open to all who prefer ethical, Shariah-compliant risk-sharing solutions.

Give one common misconception: takaful offers lower benefits than conventional insurance.

False—takaful aims to provide competitive coverage and benefits comparable to conventional products while adhering to Islamic ethics.

List the four techniques for risk control.

Avoidance, loss prevention, loss reduction, duplication (spare units), and separation (split assets).

Differentiate strategic risk from operational risk.

Strategic risk arises from business decisions that affect goals; operational risk stems from internal processes, systems, or people failures.

Define duplication as a risk-control method.

Creating backups or spares (e.g., duplicate records) to reduce severity of loss.

Define separation as a risk-control method.

Dividing assets or activities (e.g., multiple warehouses) so a single loss does not affect the entire operation.

What is passive retention?

Failure to identify or act on a loss exposure, resulting in unplanned self-insurance of losses.

Explain ‘economically feasible premium’ in insurability.

The premium must be affordable relative to the coverage; otherwise people will not buy insurance and adverse selection worsens.

Why must insurable losses be accidental and unintentional?

To satisfy random, fortuitous nature of risks and reduce moral hazard—deliberate losses would undermine pooling.

What is an umbrella liability policy?

Insurance providing excess liability coverage above primary policies and broadening protection in certain areas.

Define coinsurance in property insurance.

A clause requiring the insured to carry insurance equal to a specified percentage of property value to receive full loss payment.

Define subrogation.

The insurer’s right to recover from a negligent third party after indemnifying the insured.

How does subrogation support indemnity?

Prevents the insured from collecting twice (from insurer and wrongdoer) and holds the negligent party responsible.

What is the principle of utmost good faith?

Parties to an insurance contract must disclose all material facts honestly (related doctrines: representations, concealment, warranty).

Define a warranty in insurance contracts.

A statement or promise that must be true; breach may void the contract regardless of materiality.

Explain estoppel in insurance context.

Legal doctrine that prevents a party from denying a fact if its conduct led another to reasonably believe that fact to be true and act on it.

What is the purpose of coinsurance in health insurance?

Sharing medical costs between insurer and insured to reduce overutilization of services.

Define ‘aggregate deductible’.

Deductible that applies to all losses in a policy period; once satisfied, further losses are paid in full up to policy limits.

What is a disappearing deductible?

A deductible that decreases as the loss amount increases, disappearing at a specified loss value.

List two advantages of retention.

Saves on premium loadings and encourages loss prevention; also increases cash-flow benefits.

List two disadvantages of retention.

Potentially large losses may threaten solvency, and retained losses may be uncertain and variable.