Insurance Fundamentals and Risk Management

Vocabulary terms and definitions related to basic insurance concepts, risk management strategies, types of insurance entities, and the laws of agency.

Risk

The possibility that a loss will occur.

Speculative Risk

A type of risk where there is the ability to gain something, such as in gambling.

Pure Risk

A type of risk where there is only the potential to lose; insurance only covers this type of risk (e.g., a car accident).

Insurance

A contract that transfers the risk of loss from an individual to an insurance company.

Exposure

Risks for which an insurance company is liable; the potential for accidents to occur used to decide premium rates and whether to insure.

Peril

The cause of a loss (e.g., if a house burns, the peril is fire).

Loss

Unintended unforeseen damage to property, injury, or amount paid.

Direct Loss

Physical loss to property with no intervening cause (e.g., lightning strikes a house).

Indirect Loss

The consequence of a loss taking place (e.g., loss of income).

Hazard

Anything that increases the chance of a loss incurring.

Physical Hazard

Something tangible that increases the chance of loss (e.g., tires with no tread).

Moral Hazard

A hazard arising from an individual's character (e.g., dishonesty or lying on an application).

Morale Hazard

A hazard arising from a state of mind or attitude (e.g., leaving doors unlocked).

STARR

Acronym for methods of handling risk: Sharing, Transfer, Avoidance, Retention, and Reduce.

Sharing (Risk Management)

Method where two or more individuals or businesses pay a portion of a loss (e.g., stockholders in a corporation).

Transfer (Risk Management)

Method where an insurance company agrees to pay if the customer has a loss.

Avoidance (Risk Management)

Method of managing risk by eliminating it or stopping the activity that causes it.

Retention (Risk Management)

Method where an individual or business pays for a loss via a deductible.

Reduce (Risk Management)

Method to lessen the chance a loss will occur (e.g., installing a sprinkler system).

1st Party

The insured or the customer in an insurance contract.

2nd Party

The insurance company in an insurance contract.

Contract

A legally enforceable deal between the 1st and 2nd party that defines limits of coverage and conditions.

CANHAM

Acronym for elements of Insurable Risk (Pure Risk): Calculable, Affordable, Non-catastrophic, Homogenous, Accidental, and Measurable.

Adverse Selection

Occurs when a market is filled with high-risk individuals and few low-risk individuals remain due to high premium costs, leading to more payable claims.

Reinsurance

Insurance for insurers.

Ceding Insurer

The insurance company that is reducing its risk by transferring it to another company.

Reinsurer

The company that assumes the risk from the ceding insurer.

Facultative Reinsurance

Type of reinsurance where the reinsurer considers each risk individually before allowing the transfer.

Treaty Reinsurance

Type of reinsurance where the reinsurer accepts all risk of a certain type from the ceding company.

Stock Insurer

Owned by stockholders, issues non-participating policies, and pays guaranteed taxable dividends to stockholders.

Mutual Insurer

Owned by policyholders, issues participating policies, and pays non-guaranteed dividends to policyholders (considered a tax-free return of premium).

Fraternal Benefit Societies

Exists for the benefit of members (often common religion or ethnic groups) providing insurance benefits called certificates.

Reciprocal Insurers

Unincorporated groups of people known as subscribers who agree to insure each other's losses, managed by an attorney-in-fact.

Lloyds Association

A marketplace or hub where member underwriters individually insure unusual or large risks (e.g., celebrity body parts).

Risk Retention Groups

A liability insurance company for policyholders who must all be in the same type of business (e.g., car dealers).

Risk Purchasing Groups

Groups that obtain coverage for members but are not insurers themselves.

Self Insurers

Entities that retain risk, set aside reserve funds to cover losses in advance, and pay their own claims.

Domestic Insurer

An insurer operating in its home state where it was originally formed.

Foreign Insurer

An insurer formed in one state that works in others.

Alien Insurer

An insurance company formed in another country.

Certificate of Authority

The license required by a state for an insurance company to sell insurance.

Admitted (Authorized) Insurer

A licensed insurance company.

Surplus Lines

Non-admitted carriers that write customizable policies for large or specialized risks (e.g., casinos, skyscrapers) that cannot be purchased just for a lower price.

Independent Insurance Agents

Independent contractors who sell policies for several companies and own the renewals they sell.

Captive (Exclusive) Agents

Independent contractors representing only one company, which owns the renewals of the policies sold.

General Agents (Managing General Agents)

ndividuals who hire, train, and supervise other agents within a geographical area.

Direct-Writing Companies

Companies whose products are sold by employees rather than independent contractors.

Commingling

The illegal act of mixing personal funds with insureds' or insurers' funds.

Agency

A relationship where the insurance agent works on behalf of the principal (the insurance company).

Law of Agency

Legal principle stating that contracts made by the agent are considered contracts of the principal, and the principal is liable for agent actions.

Express Authority

Authority that is specifically written in the agent's contract.

Implied Authority

Authority not written in the contract but implied by the nature of the deal.

Apparent Authority

Authority based on tasks an agent performs that a reasonable person assumes they have the power to do.

Law of Large Numbers

Statistical principle stating that the larger the group, the more accurately future losses can be predicted.