FINA4354 Exam 1 Review Vocabulary

chance of loss

the probability that an event that causes a loss will occur

objective probability

the long-run relative frequency of an event based on the assumptions of an infinite number of observations and of no change in the underlying conditions

subjective probability

the individual's personal estimate of the chance of loss

peril

the cause of loss (ex. property damage because of fire, windstorm, lightning, or damage to your car because of a collision with another vehicle)

hazard

a condition that creates or increases the frequency or severity of a loss

physical hazard

a physical condition that increases the frequency or severity of loss

moral hazard

dishonesty or character defects in an individual that increase the frequency or severity of loss

attitudinal hazard

carelessness or indifference to a loss, which increases the frequency or severity of a loss

legal hazard

characteristics of the legal system or regulatory environment that increase the frequency or severity of a loss

risk control

techniques that reduce the frequency or severity of losses

avoidance

a technique for managing risk by avoiding the risk entirely

loss prevention

a technique that reduces the probability of loss so that the frequency of losses is reduced

loss reduction

a technique that reduces the severity of loss

duplication

having back-ups or copies of important documents or property available in case a loss occurs

separation

the assets exposed to loss are separated or divided to minimize the financial loss from a single event

diversification

a technique that reduces the chance of loss by spreading loss exposure across different parties

risk financing

techniques that provide for the funding of losses

retention

an individual or business firm retains part or all of the losses that can result from a given risk

active retention

an individual is aware of the risk and deliberately plans to retain all or part of it

passive retention

risks may be unknowingly retained because of ignorance, indifference, or laziness

self-insurance

a special form of planned retention by which part or all of a given loss exposure is retained by the firm

noninsurance transfers

transfers risk to another party other than an insurance company

transfer of risk by contracts

undesirable risks transferred by contracts

hedging

a technique for transferring the risk of unfavorable price fluctuations to a spectacular by purchasing or selling futures contracts on an organized exchange

incorporation

a business firm transfers to the creditors the risk of having insufficient assets

insurance

the pooling of fortuitous losses by transfer of such risks to insurers, who agree to indemnify insureds for such losses, to provide other pecuniary benefits on their occurrence, or to render services connected with the risk

pooling of losses

basic characteristic of insurance, the spreading of losses incurred by the few over the entire group, so in that process, average loss is substituted for actual loss

fortuitous loss

basic characteristic of insurance, a loss that is unforeseen, unexpected, and occurs as a result of chance

risk transfer

basic characteristic of insurance, a pure risk is transferred from the insured to the insurer, who typically is in a stronger financial position

indemnification

basic characteristic of insurance, the insured is restored to his or her approximate financial position prior to the occurrence of the loss

characteristics of an ideally insurable risk

large number of exposure units, accidental and unintentional loss, determinable and measurable loss, no catastrophic loss, calculable chance of loss

adverse selection

the tendency of persons with a higher-than-average chance of loss to seek insurance at standard (average) rates, which, if not controlled by underwriting and policy provisions, results in higher-than-expected loss levels and unprofitable business

underwriting

the process of selecting and classifying applicants for insurance

stock insurer

a corporation owned by stockholders

mutual insurer

a corporation owned entirely by the policyholders

reciprocal exchanges

an unincorporated organization in which insurance is exchanged among the members (called subscribers)

lloyd's corporation

not an insurer but is the world's leading insurance market that provides service and physical facilities for its members to write specialized lines of insurance

blue cross and blue shield plans

generally organized as nonprofit, community-oriented plans

managed care plans

finances healthcare, involved in making healthcare decisions that previously were made only by the patient and the healthcare practitioner, focuses on controlling costs, facilitates case management (healthcare practitioners communicate and work toward a unified course of treatment)

captive insurers

an insurer owned by a parent firm for the purposes of insuring the parent firm's loss exposures

marketing systems

the various methods for selling and marketing insurance products

personal selling systems

systems in which commissioned agents solicit and sell life insurance products to prospective insureds

financial distribution systems

using commercial banks and other financial institutions as a distribution system to market life insurance and annuity products

direct response system

a marketing system by which life and health insurance products are sold directly to consumers without a face-to-face meeting with an agent

other distribution systems

a variety of additional distribution systems to sell their products including worksite marketing, stock brokers, financial planners, and group insurance

independent agency system

a business firm that usually represents several unrelated insurers, the agency owns the expirations or renewal rights to the business, and the independent agent is compensated by commissions that vary by line of insurance

exclusive agency system

the agent represents only one insurer or a group of insurers under common ownership

direct writer

an insurer whose sales representatives are employees (such as salaried representatives), and not independent contractors, insurers that use the exclusive agency system for selling insurance products

direct response system

selling insurance where a direct response insurer sells directly to the public by television, telephone, mail, newspapers, and other media

multiple distribution system

the use of several distribution systems by an insurer

important principles of underwriting

attain an underwriting profit, select prospective insureds according to the company's underwriting standards, provide equity among the policyholders

first step in settling a claim

the insured provides prompt notice of loss

second step in settling a claim

the insurer investigates the claim with the cooperation of the insured

third step in settling a claim

the insured provides proof of loss if required

fourth step in settling a claim

the insurer makes a decision about paying the claim

reinsurance

an arrangement by which the primary insurer that initially writes the insurance transfers to another insurer (called the reinsurer) part or all of the potential losses associated with such insurance

ceding company

the primary insurer that initially writes the insurance

reinsurer

the insurer that accepts part or all of the insurance from the ceding company

retention limit/net retention

the amount of insurance retained by the ceding company for its own account

cession

the amount of insurance ceded to the reinsurer

purposes of reinsurance

increase underwriting capacity, stabilize profits, reduce the unearned premium reserve, provide protection against a catastrophic loss, enable an insurer to retire from a territory or class of business, obtain underwriting advice from the reinsurer

treaty reinsurance

an agreement under which the primary insurer must automatically cede to the reinsurer all business written in a certain category, and the reinsurer must accept the business

quota-share treaty

the ceding company and reinsurer agree to share premiums and losses based on some proportion

ceding commission

a commission paid to the primary insurer to help compensate for the expenses incurred in writing the business under a quota-share treaty

surplus-share treaty

the reinsurer agrees to accept insurance in excess of the ceding insurer's retention limit, up to some maximum amount

excess-of-loss reinsurance

a reinsurance agreement in which the reinsurer pays for part or all of the loss that exceeds the ceding company's retention limit up to some maximum level

reinsurance pool

an organization of insurers that underwrites insurance on a joint basis

policyholders' surplus

the difference between an insurance company's assets and liabilities

loss reserve

the estimated cost of settling claims for losses that have already occurred but that have not been paid as of the valuation date

case reserves

loss reserves that are established for each individual claim when it is reported

incurred-but-not-reported reserve

a reserve that must be established for claims that have already occurred but have not yet been reported to the insurer

unearned premium reserve

a liability item that represents the unearned portion of gross premiums on all outstanding policies at the time of valuation

loss ratio

the ratio of incurred losses and loss adjustment expenses to premiums earned, incurred losses + loss adjustment expenses / premiums earned

expense ratio

equal to the company's underwriting expenses divided by the written premiums, underwriting expenses / premiums written

combined ratio

the sum of the loss ratio and the expense ratio

investment income ratio

compares net investment income to earned premiums, net investment income / earned premiums

overall operating ratio

equal to the combined ratio minus the investment income ratio

rate

the price per unit of insurance

exposure unit

the unit of measurement used in insurance pricing

pure premium

the portion of the rate needed to pay losses and loss-adjustment expenses

loading

the amount that must be added to the pure premium for other expenses

gross rate

the pure premium and a loading element

gross premium

paid by the insured consists of the gross rate multiplied by the number of exposure units

judgment rating

each exposure is individually evaluated, and the rate is determined largely by the judgment of the underwriter

class rating

exposures with similar characteristics are placed in the same underwriting class, and each is charged the same rate

pure premium method

the portion of the gross rate needed to pay losses and loss-adjustment expenses, incurred losses and loss-adjustment expenses / number of exposure units

loss ratio method

the actual loss ratio is compared with the expected loss ratio and the rate is adjusted accordingly, actual - expected / actual

merit rating

a rating plan by which class rates (manual rates) are adjusted upward or downward based on individual loss experience

schedule rating

each exposure is individually rated, a basis rate is determined for each exposure, which is then modified by debits or credits for undesirable or desirable physical features

experience rating

the class or manual rate is adjusted upward or downward based on past loss experience, the insured's past loss experience is used to determine the premium for the next policy period

retrospective rating

the insured's loss experience during the current policy period determines the actual premium paid for that period

reasons for regulating insurers

maintain insurer solvency, compensate for inadequate consumer knowledge, ensure reasonable rates, make insurance available

methods for regulating insurers

legislation, courts, and state insurance departments

types of solvency regulation

minimum capital and surplus requirements, risk-based capital standards, reserve requirements, restrictions on investments, review of annual financial statements, field examinations, early warning system, fast system analysis

prior-approval laws

insurance rates must be filed and approved by the state insurance department before they can be used

modified prior-approval laws

if the rate change is based solely on loss experience, the insurer must file the rates with the state insurance department, and the rates may be used immediately

file-and-use law

insurers are required only to file the rates with the state insurance department, and the rates can be used immediately

use-and-file law

insurers can put into effect immediately any rate changes, but the rates must be filed with the regulatory authorities within a certain period after first being used

flex-rating law

prior approval of rates is required only if the rate increase or decrease exceeds a specified range

state-made rates

the state determines the rates, forms, and classifications that insurers must follow