Comprehensive Insurance and Risk Management Concepts for Students

Risk

is defined as uncertainty concerning the occurrence of a loss.

Objective Risk

Defined as relative variation of actual loss from expected loss

Subjective risk

defined as uncertainty based on a person's mental condition or state of mind- or an educated guess

Objective Probabilities

can be determined by deductive reasoning

Subjective Probabilities

is the individual's personal estimate of the chance of loss.

Peril

is the cause of loss i.e., fire, windstorm, hail, tornado, earthquake.

Hazard

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

Example of Physical hazard

Ice on the road

Example of Moral Hazard

Faking an accident, or employee theft.

Attitudinal hazard

Carelessness or indifference to a loss.

Legal hazard example

Being subject to a large jury award

Enterprise risk

risks that are faced by a business firm

Pure risk

when there is only loss or no loss

Diversifiable risk

risk affects only individuals or small groups (non-systemic)

Non-diversifiable

risk affects everyone- the entire economy (systemic)

Personal risks

affect an individual or family such as premature death, retirement risks, poor health, or unemployment.

Direct Loss

results from physical damage, destruction, or theft (example is fire destroys a home)

Indirect Loss

is a financial loss because of the direct loss (fire destroys home so you must rent another home, apartment, hotel and eat at restaurants).

Loss Control

techniques that reduce the frequency or severity of losses.

Loss control includes

Avoidance, Loss Prevention, and Loss Reduction

Loss reduction includes

Duplication, Separation, and Diversification

Risk Financing

techniques that pay for losses after they occur.

Risk Financing techniques include:

Retention, Noninsurance transfers, and Insurance.

Retention

the deductible on your auto insurance policy is

Loss control techniques

Sprinkling systems in a building are ______ because they will reduce the severity of a fire.

Non insurance transfer example:

Hold-harmless agreement

Basic characteristics of insurance

pooling of losses, payment of fortuitous losses, risk transfer, indemnification

Pooling

sharing of losses by an entire group

Law of large numbers

actual results will more closes approach probable results. this is also true if the number of units (insured) are increased.

Fortuitous loss

occurs because of chance

Characteristics of an ideally insurable risk include:

Large number of exposure units

Loss must be accidental and unintentional.

Loss must be determinable and measurable.

Loss cannot be catastrophic.

Chance of loss must be calculable.

Premium must be economically feasible.

Accidental and Unintentional losses

will result in a decrease in moral hazard and be more accurate prediction of future losses.

reinsurance

one way to avoid catastrophic losses

property risk

best meet the requirement for being insurable.

examples of uninsurable risks

Financial, market, and production risks

Adverse Selection

when a person most likely to have losses is also most likely to seek insurance at standard rates.

Example of Adverse Selection

Unhealthy people that seek insurance at standard rates

Speculative risk

insurance can handle existing pure risks, while gambling creates this

Life insurers

sell life insurance, annuities, and disability income insurance.

Inland marine insurance

is for goods being shipped on land.

Workers compensation insurance

is classified as casualty insurance.

General liability

is a form of casualty insurance

Insurance benefits society

because of less worry and fear, indemnification for losses, and loss prevention

Social costs associated with insurance include

operation expenses, fraudulent claims, and inflated claims.

Expense loading

is the amount needed to pay all expenses, including underwriting and loss-adjusted expensed, commissions, general administrative expenses, state premium taxes, acquisition expenses, and an allowance for contingencies and profit.

Risk management

is concerned with the identification and treatment of loss exposures.

Loss exposure

A situation in which a loss is possible, regardless of whether a loss occurs

Post-loss risk management objective

continuing operations

Pre-loss objectives:

Preparing for potential losses in the most economical way and reduction of anxiety

Risk management is concerned with

both identifying potential losses and selecting the appropriate techniques for treating loss exposures.

Loss Severity

defined as the probable size of the losses which may occur during some period.

Loss Frequency

defined as the probable number of losses that may occur during some period.

Maximum possible loss

The worst loss that could ever happen to a firm

probable maximum loss.

The worst loss that is likely to happen

Characteristics of avoidance

certain loss exposures are never acquired, may be abandoned, and chance of loss is reduced to zero

Retention is appropriate

if the worst possible loss is not serious.

captive insurer

is an insurer owned by a parent firm for the purpose of insuring the parent firm's loss exposures.

A captive may be used to

insure loss exposures that the parent firm finds difficult to insure with private insurers.

Self-insurance

a form of planned retention

advantages of retention

include lower expenses, increased cash flow, and encouragement of loss prevention.

Hold harmless agreement

an example of a noninsurance transfer

deductible

represents risk retention by an insurance purchaser.

excess insurance plan

is when the insurer does not participate in the loss until the actual loss exceeds the amount a firm has decided to retain.

manuscript policy

one that is specifically written for the insured

Insurance is appropriate for

low-frequency, high-severity loss exposures.

Avoidance is appropriate for

low-frequency, high-severity loss exposures.

Retention is appropriate for

low-frequency, low-severity loss exposures.

Hard Market

when profitability is declining, industry has underwriting losses, underwriting standards tighten, premiums increase, insurance becomes expensive and more difficult to obtain

Soft Market

profitability is improving, underwriting standards loosen, premiums decline, and insurance is easier to obtain.

Enterprise Management

defined as a strategic business discipline that supports the achievement of an organization's business objectives by addressing the full spectrum of its risks and managing the combined impact of the risks as an integrated risk portfolio.

ERM is concerned with

ALL risk of a business enterprise

Hazard Risk

associated with an organizations' property, liability, and personnel-related loss exposures.

Process Risk

Operational risks from the organizations' regular practices and procedures.

Underwriting Cycle

Property and liability insurance is characterized by a repetitive patten of loose underwriting standards with low premiums, followed by tight underwriting standards with high premiums.

Industry capacity

the relative level of surplus in the insurance industry

Soft market

Investment returns can lengthen the duration of a _______ by offsetting underwriting losses.

risk register chart

a chart that shows risk categories, maximum possible and maximum probable loss, risk severity, risk scores