Insurance Chapter 1 Examples

You are unsure whether your apartment will be burglarized.

Risk — uncertainty about whether a loss will occur.

An insurer expected 100 accidents but recorded 110. The difference between expected and actual losses represents this concept.

Objective risk — measurable variation between actual and expected losses.

Olivia feels nervous that her car will be stolen, even though theft is uncommon in the area.

Subjective risk — uncertainty based on personal feelings.

Owning a car creates the possibility of damage, theft, or liability claims.

Loss exposure — a situation where a loss could occur.

Historical data show that 2 out of every 100 insured cars are stolen annually.

Chance of loss — the probability that a loss will occur.

Past data show that 2% of insured homes experience a fire each year.

Objective probability — probability supported by facts or data.

A driver believes there is a 50% chance of crashing because the roads feel dangerous.

Subjective probability — a personal estimate of the chance of an event.

An insurer can predict losses more accurately with 100,000 similar policyholders than with 10.

Law of large numbers — more exposure units make losses easier to predict.

A kitchen fire destroys an apartment. The fire is the cause of the damage.

Peril — the direct cause of a loss.

Broken stairs increase the possibility that someone will fall.

Hazard — a condition that increases the chance or severity of loss.

An icy sidewalk increases the chance that someone will fall.

Physical hazard — a physical condition that increases the chance of loss.

A business owner intentionally starts a fire to collect insurance money.

Moral hazard — dishonesty increases the chance of loss.

A driver stops locking her car because she knows it is insured.

Attitudinal hazard — carelessness caused by indifference toward loss.

A court system frequently awards extremely large damages in lawsuits.

Legal hazard — characteristics of the legal system increase possible losses.

A house may burn down or remain unharmed, but its owner cannot profit from the fire.

Pure risk — only loss or no loss is possible.

A person buys stock that could increase in value, decrease in value, or remain unchanged.

Speculative risk — profit, loss, or no change is possible.

A fire damages one family’s home but does not affect the entire economy.

Diversifiable risk — a risk affecting an individual or small group.

A severe recession causes unemployment and business losses across the country.

Nondiversifiable risk — a risk affecting the economy or a large group.

One major bank fails and causes failures throughout the financial system.

Systemic risk — one failure spreads throughout an interconnected system.

A company faces property damage, lawsuits, employee injuries, and financial losses.

Enterprise risk — all major risks faced by a business.

A company coordinates its insurance, safety, financial, and strategic risks under one company-wide program.

Enterprise risk management — managing major business risks together.

A company enters a new market, but customers do not want its product.

Strategic risk — uncertainty involving business goals or decisions.

A computer failure shuts down a company’s payment system.

Operational risk — loss resulting from failed systems, processes, or people.

Rising interest rates increase a company’s borrowing costs.

Financial risk — uncertainty caused by financial conditions.

A person faces unemployment, disability, poor health, or premature death.

Personal risks — risks that directly affect individuals or families.

A parent who financially supports two children dies unexpectedly at age 40.

Premature death — an income earner dies before meeting financial responsibilities.

A parent would have earned $2 million for the family during the remainder of her career.

Human life value — the present value of future earnings contributed to the family.

A person’s car could be stolen or damaged in a collision.

Property risks — risks involving loss or damage to property.

A fire causes $50,000 of physical damage to a restaurant.

Direct loss — damage caused immediately by a peril.

A restaurant loses income while it remains closed after a fire.

Indirect loss — an additional financial loss resulting from a direct loss.

A hotel loses rental income after storm damage forces it to close.

Consequential loss — another name for an indirect loss.

A customer slips in a store and sues the owner for medical expenses.

Liability risk — possible legal responsibility for injury or damage.

A business installs alarms and sprinklers to control potential fire losses.

Risk control — techniques that reduce the frequency or severity of loss.

A person sells a motorcycle and stops riding so a motorcycle accident cannot occur.

Avoidance — eliminating an activity so its risk cannot occur.

A store trains employees to clean spills immediately to prevent customers from falling.

Loss prevention — reducing how often losses occur.

A business saves money and purchases insurance so it can pay future losses.

Risk financing — arranging funds to pay for losses.

A driver chooses a $1,000 deductible and pays that portion of a claim personally.

Retention — keeping part or all of a risk.

A large company creates a formal fund to pay its employees’ predictable health claims.

Self-insurance — a planned form of retention.

A renter’s lease requires the renter to pay for damage caused to the property.

Noninsurance transfer — risk transferred through a contract rather than insurance.

A contractor agrees to protect a property owner from liability arising from the contractor’s work.

Hold-harmless clause — one party contractually assumes another party’s liability.

A farmer locks in a future selling price for corn to protect against falling prices.

Hedging — using a financial transaction to reduce price risk.

A business owner forms a corporation so business creditors generally cannot take the owner’s personal assets.

Incorporation — using the corporate structure to limit an owner’s personal liability.

A business stores duplicate computer records on a backup server.

Duplication — maintaining backups or copies.

A company places factories in California and Texas so one disaster will not stop all production.

Separation — placing assets or operations in different locations.

An investor owns stocks from several industries instead of investing everything in one company.

Diversification — spreading risk among different investments or activities.

A restaurant installs automatic sprinklers so a fire causes less damage.

Loss reduction — reducing the severity of a loss.

A driver pays a premium to an insurer that agrees to cover specified accident losses.

Insurance — transferring risk to an insurer in exchange for a premium.