Exam 1 (Ch 1, 2, 3, 6) Risk mgmt

Explain the historical definition of risk

uncertainty concerning the occurrence of a loss

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 relative variation of actual loss from expected loss. As the number of exposure units under observation increases, objective risk declines.

Subjective risk is uncertainty based on one’s mental condition or state of mind. Accordingly, objective risk is measurable and statistical; subjective risk is personal and not easily measured

Define chance of loss

the probability that an event will occur.

What is the difference between objective probability and subjective probability?

Objective probability refers to the long-run relative frequency of an event based on the assumption of an infinite number of observations and no change in the underlying conditions.

Subjective probability is the individual’s personal estimate of the chance of loss.

What is the difference between peril and hazard?

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

Define physical hazard, moral hazard, attitudinal hazard, and legal hazard

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

Moral hazard is dishonesty or character defects in an individual that increase the chance of loss.

Attitudinal hazard (morale hazard) is carelessness or indifference to a loss. Legal hazard refers to characteristics of the legal system or regulatory environment that increase the frequency or severity of losses

Explain the difference between pure risk and speculative risk

Pure risk is defined as a situation in which there are only the possibilities of loss or no loss.

Speculative risk is defined as a situation where either profit or loss is possible.

How does diversifiable risk differ from nondiversifiable risk?

Diversifiable risk is a risk that affects only individuals or small groups and not the entire economy. It is a risk that can be reduced or eliminated by diversification.

In contrast, nondiversifiable risk is a risk that affects the entire economy or large numbers of persons or groups within the economy. It is a risk that cannot be reduced or eliminated by diversification.

Explain the meaning of enterprise risk.

that encompasses all major risks faced by a business firm, which include pure risk, speculative risk, strategic risk, operational risk, and financial risk

What is financial risk?

the uncertainty of loss because of adverse changes in commodity prices, interest rates, foreign exchange rates, and the value of money

What is systemic risk?

the risk of collapse of an entire system or entire market due to the failure of a single entity or group of entities that can result in the breakdown of the entire financial system

How does enterprise risk management differ from traditional risk management?

(a) Enterprise risk management combines into a single unified treatment program all major risksfaced by the firm. These risks include pure risk, speculative risk, strategic risk, operational risk, and financial risk.

(b) Traditional risk management considered only major and minor pure risks faced by a corporation. These risks were limited to property, liability, and personnel-related loss exposures. Enterprise risk management considers all risks faced by a corporation as described in (a) above

Identify the major types of personal risks that are associated with economic insecurity

the risks of premature death, insufficient income during retirement, old age, poor health, unemployment, and alcohol and drug addiction. In addition, persons owning property are exposed to the risk of having their property damaged or lost from numerous perils. Finally, liability risks are also associated with great financial and economic insecurity

Describe the major social and economic burdens of risk on society.

(a) The size of an emergency fund must be increased.

(b) Society may be deprived of needed goods and services.

(c) Worry and fear are present.

Explain the difference between a direct loss and an indirect or consequential loss

A direct loss is a financial loss that results from the physical damage, destruction, or theft of property.

Indirect loss results from or is the consequence of a direct loss.

For example, if a student’s car is stolen (direct loss), he or she will lose the use of the car until it is replaced or recovered (indirect loss)

Identify the major risks faced by business firms

property risks, liability risks, loss of business income, cyber security and identity theft, crime exposures, human resources exposures, foreign loss exposures, intangible property exposures, and government exposures

Risk control

1. avoidance

2. loss prevention

3. loss reduction

4. duplication

5. separation

6. diversification

Avoidance

This means a certain loss exposure is never acquired, or an existing loss exposure is abandoned. For example, a drug manufacturer can avoid lawsuits associated with a dangerous drug by not producing the drug

Loss prevention

Certain activities are undertaken that reduce the frequency of a particular loss.

One example is periodic inspection of steam boilers to prevent an explosion

Loss reduction

This refers to measures that reduce the severity of a loss after it occurs.

One example of loss reduction is an automatic sprinkler system in a department store that can reduce the severity of a fire loss.

Risk-financing techniques for managing risk

1. retention

2. noninsurance transfer

3. insurance

Assume that the chance of loss is 3% for two different fleets of trucks. Explain how it is possible that objective risk for both fleets can be different even though the chance of loss is identical.

Although the chance of loss may be identical for two different groups, the relative variation of actual from expected loss may be quite different.

For example, if a company has a fleet of 1,000 trucks, the expected number of collision losses each year may be 30.

However, actual losses may vary each year from 25 to 35. In contrast, another fleet of 1,000 trucks may have the same number of expected losses (30), but the annual variation may be considerably higher, such as 20 to 40. Thus, objective risk is greater for the second fleet.

Identify the type of risk

The Department of Homeland alerts the nation of a possible attack by terrorists

This is a nondiversifiable risk because the entire nation can be affected by a terrorist attack

Identify the type of risk

A house may be severely damaged in a fire

This is a pure risk. The insured rarely profits if his or her house is damaged in a fire.

Identify the type of risk

A family head may be totally disabled in a plant explosion

This is pure risk because of the loss of earned income. You usually do not profit if you are totally disabled.

Identify the type of risk

An investor purchases 100 shares of Microsoft stocks

This is a speculative risk. Profit or loss is possible

Identify the type of risk

A river that periodically overflows may cause substantial property damage to thousands of homes in the floodplain

This is a nondiversifiable risk because large numbers of people can lose their homes in a major flood

Identify the type of risk

Home buyers may be faced with higher mortgage payments if the Federal Reserve raises interest rates at its next meeting

This is a nondiversifiable risk because large numbers of home buyers will be adversely affected by higher interest rates and higher monthly mortgage payments. From the viewpoint of home builders and realtors, a rise in interest rates is also a financial risk that can slow down the sale of new and used homes.

Identify the type of risk

A worker on vacation plays the slot machines in a casino

This is a speculative risk because both profit and loss are possible

Identify an appropriate technique/s that would be appropriate for dealing with the risk

A family head may die prematurely because of a heart attack

Risk control such as exercise, losing weight, and following a healthy diet can reduce the chance of dying prematurely from a heart attack. Life insurance can also be used, which reduces or eliminates the financial consequences to surviving family members if a family head dies prematurely

Identify an appropriate technique/s that would be appropriate for dealing with the risk

An individual’s home may be totally destroyed in a hurricane

Property insurance is an appropriate technique for dealing with the risk of a hurricane. Retention can also be used by purchasing the policy with a deductible

Identify an appropriate technique/s that would be appropriate for dealing with the risk

A new car may be severely damaged in an auto accident

A catastrophic loss exposure is present. Auto liability insurance should be purchased to deal with the exposure.

Identify an appropriate technique/s that would be appropriate for dealing with the risk

A surgeon may be sued for medical malpractice

Professional liability insurance should be purchased to deal with malpractice suits. The surgeon could also use risk control to reduce the possibility of injuring a patient

Andrew owns a gun shop in a high-crime area. The store does not have a camera surveillance system. The high cost of burglary and theft insurance has substantially reduced his profits. A risk management consultant points out that several methods other than insurance can be used to handle the burglary and theft exposure. Identify and explain two noninsurance methods that could be used to deal with the burglary and theft exposure.

(a) Avoidance. Andrew can avoid the risk of burglary or robbery by going into a different line of

business. However, this is not a practical solution and may not be feasible.

(b) Risk control. Risk control efforts can be undertaken to reduce both the frequency and severity of losses. A burglar alarm system can be installed. The gun shop can be relocated to another part of the city where crime rates are lower. Losses also can be prevented by hiring a guard or patrol service to protect the property.

(c) Retention. Andrew may decide to retain all losses, thereby eliminating the need for burglary insurance. However, since a large loss could result in financial ruin, he may decide to retain losses only up to a certain amount, such as $1,000. Excess insurance can be purchased for losses exceeding the retention limit.

For each of the following, what method for handling risk is used?

The decision not to carry earthquake insurance on a firm’s manufacturing plant

Retention. The firm is retaining the earthquake exposure

For each of the following, what method for handling risk is used?

The installation of an automatic sprinkler system in a hotel

Risk control. If a fire occurs, the sprinkler system will operate automatically to extinguish the fire, thereby reducing the severity of the loss

For each of the following, what method for handling risk is used?

The decision not to produce a product that might result in a product liability lawsuit

Avoidance. The firm is avoiding a lawsuit by not manufacturing products that could injure customers who use the product.

For each of the following, what method for handling risk is used?

Requiring retailers who sell the firm’s product to sign an agreement releasing the form form liability if the product injures someone

Noninsurance transfer. The firm manufacturing the product has transferred the risk of a liability suit to the retailers by such an agreement. This agreement is often called a hold-harmless agreement. For example, a manufacturer may insert a hold-harmless clause in a contract with a retailer by which the retailer agrees to hold the manufacturer harmless if a scaffold collapses and someone is injured

What is the meaning of risk management?

a systematic process for the identification and evaluation of pure loss exposures faced by an organization or individual and for the selection and administration of the most appropriate techniques for treating such exposures

Explain the objectives of risk management both before and after a loss occurs

Preloss risk management objectives include the goals of economy, reduction in anxiety, and meeting legal obligations.

Postloss objectives include survival of the firm, continued operations, stability of earnings, continued growth, and social responsibility

Describe the steps in the risk management process

(1) identify major and minor loss exposures; (2)
measure and analyze the loss exposures in terms of loss frequency and loss severity; (3) select the appropriate technique or combination of techniques for treating the loss exposures; and (4) implement and monitor the program

Identify the sources of information that a risk manager can use to identify loss exposures.

 Risk analysis questionnaire and checklists

 Physical inspection

 Flow charts

 Financial statements

 Historical loss data

What is the difference between the maximum possible loss and probable maximum loss?

The maximum possible loss is the worst loss that could possibly happen to the firm during its lifetime. The probable maximum loss is the worst loss that is likely to happen.

Explain the meaning of risk control

refer to techniques that reduce the frequency and severity of accidental losses.

Specific techniques are avoidance, loss prevention, loss reduction, duplication, separation, and
diversification

Explain the meaning of risk financing

refers to techniques that provide for the funding of losses after they occur.

Specific risk financing techniques include retention, noninsurance transfers, and insurance

What conditions should be fulfilled before retention is used in a risk management program?

Retention can be used if no other method of treatment is available, the worst possible loss is not serious, or losses are highly predictable.

What is self-insurance?

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

Explain the advantages of using insurance in a risk management program

The firm will be indemnified after a loss occurs.
 Uncertainty is reduced, which permits the firm to lengthen its planning horizon.
 Insurers can provide valuable risk management services, such as loss control, identification of loss exposures, and claims adjusting.
 Premiums are deductible for income tax purposes

Explain the disadvantages of using insurance in a risk management program.

 The payment of premiums is a major cost.

 Considerable time and effort must be spent in negotiating the insurance coverages.

 The risk manager may have less incentive to follow a risk control program, because the insurer will pay the claim if a loss occurs.

Scaffold Equipment manufactures and sells scaffolds and ladders that are used by construction firms. The products are sold directly to independent retailers in the United States. The company’s risk manager knows that the company could be sued if a scaffold or ladder is defective, and someone is injured. Because the cost of products liability insurance has increased, the risk manager is considering other technique to treat the company’s loss exposures.

Describe the steps in the risk management process.

(1) identify major and minor loss exposures; (2) measure and analyze the loss exposures in terms of loss frequency and loss severity; (3) select the appropriate technique or combination of techniques for treating the loss exposures; and (4) implement and monitor the program.

Scaffold Equipment manufactures and sells scaffolds and ladders that are used by construction firms. The products are sold directly to independent retailers in the United States. The company’s risk manager knows that the company could be sued if a scaffold or ladder is defective, and someone is injured. Because the cost of products liability insurance has increased, the risk manager is considering other technique to treat the company’s loss exposures.

For each of the following risk management techniques, describe a specific action using that technique that might be helpful in dealing with the company’s products liability exposure.
1. Avoidance
2. Loss prevention
3. Loss reduction
4. Noninsurance transfers

(1) Avoidance. The firm could discontinue manufacturing certain ladders and scaffolds that could result in a products liability lawsuit.

(2) Loss prevention. The firm could issue detailed instructions on how the ladders and scaffolds can be safely used.

(3) Loss reduction. Claims involving injured persons should be promptly investigated. Procedures

for providing immediate medical attention to injured persons should be established. Such measures can reduce the severity of a loss.

(4) Noninsurance transfers. A hold-harmless agreement could be used by which retailers agree to hold Scaffold Equipment harmless if someone is injured while using a ladder or scaffold manufactured by Scaffold Equipment.

The Swift Corporation has 5,000 sales representatives and employees in the United States who drive company cars. The company’s risk manager has recommended to the firm’s management that the company should implement a partial retention program for physical damage losses to company cars.

Explain the advantages and disadvantages of a partial retention program to the Swift Corporation.

The following advantages may result from the retention program:

(1) The Swift Corporation can save money if its actual losses are less than the loss allowance in the insurer’s premium.

(2) There may also be sizable expense savings.

(3) Loss prevention is encouraged.

(4) Cash flow may be increased since the firm can use the funds that normally would be held by the insured.

The major disadvantages include:

(1) The losses retained by the firm may be greater than the loss allowance in the insurance

premium that is saved by not purchasing the insurance, and there may be greater volatility in the firm’s loss experience in the short run.

(2) Expenses may actually be higher, since loss-prevention programs should be established, which may be provided by insurers more cheaply.

(3) Contributions to a funded reserve under a retention program are not usually income tax-deductible.

The Swift Corporation has 5,000 sales representatives and employees in the United States who drive company cars. The company’s risk manager has recommended to the firm’s management that the company should implement a partial retention program for physical damage losses to company cars.

Identify the factors that the Swift Corporation should consider before it adopts a partial retention program for physical damage losses to company cars

(1) Average frequency and severity of losses

(2) Company’s past loss experience

(3) Dollar amount of losses the firm will retain

(4) Added costs of retention (administrative problems)

(5) Elements of the premium that could be saved (potential premium savings)

(6) Predictability of losses

(7) Maximum possible loss and maximum probable loss

(8) Tax aspects

(9) Availability of excess of loss insurance coverage

(10) Availability of other alternatives

(11) Whether management is risk adverse

The Swift Corporation has 5,000 sales representatives and employees in the United States who drive company cars. The company’s risk manager has recommended to the firm’s management that the company should implement a partial retention program for physical damage losses to company cars.

If a partial retention program is adopted, what are the various methods the Swift Corporation can use to pay for physical damage losses to company cars?

Losses can be paid out of current net income, earmarked assets, funds borrowed from commercial lenders, or payment from a captive insurer if a captive insurer has been established. Losses in excess of the retention levels can be paid by commercial insurance.

The Swift Corporation has 5,000 sales representatives and employees in the United States who drive company cars. The company’s risk manager has recommended to the firm’s management that the company should implement a partial retention program for physical damage losses to company cars.

Identify two risk-control measures that could be used in the company’s partial retention program for physical damage losses

The company could avoid hiring drivers with poor driving records.

The company could also reduce losses by requiring drivers to take a defensive driving course

What is the major advantage of using the technique of avoidance in a risk management program?

the chance of loss is reduced to zero if the loss exposure is never acquired. Also, if an existing loss exposure is abandoned, the chance of loss is reduced or eliminated because the activity or product that could produce a loss has been abandoned.

Is it possible or practical for a firm to avoid all potential losses?

It is not feasible or practical for a firm to avoid all potential losses. Some losses will occur in the normal operations of the firm’s business. For example, a paint factory can avoid fire and explosion losses arising from the production of paint by not manufacturing paint. Without paint production, however, the firm will not be in business

Chris and Karen are married and own a three-bedroom home in a large midwestern city. Their son, Christian, attends college away from home and lives in a fraternity house. Their daughter, Kelly, is a
senior in high school. Chris is an accountant who works for a local accounting firm. Karen is a marketing analyst and is often away from home several days at a time. Kelly earns extra cash by babysitting on a regular basis. The family’s home contains household furniture, personal property, a computer that Chris uses to prepare business tax returns on weekends, and a laptop computer that Karen uses while traveling. The family owns three cars. Christian drives a 2010 Ford; Chris drives a 2015 Honda for both business and personal use; and Karen drives a 2017 Toyota and a rental car when she is traveling. Although the family has owned their home for several years, they are considering moving because of the recent increase in
violent crime in their neighborhood.

Describe briefly the steps in the personal risk management process

 Identify loss exposures

 Analyze the loss exposures

 Select appropriate techniques for treating the loss exposures

Chris and Karen are married and own a three-bedroom home in a large midwestern city. Their son, Christian, attends college away from home and lives in a fraternity house. Their daughter, Kelly, is a
senior in high school. Chris is an accountant who works for a local accounting firm. Karen is a marketing analyst and is often away from home several days at a time. Kelly earns extra cash by babysitting on a regular basis. The family’s home contains household furniture, personal property, a computer that Chris uses to prepare business tax returns on weekends, and a laptop computer that Karen uses while traveling. The family owns three cars. Christian drives a 2010 Ford; Chris drives a 2015 Honda for both business and personal use; and Karen drives a 2017 Toyota and a rental car when she is traveling. Although the family has owned their home for several years, they are considering moving because of the recent increase in
violent crime in their neighborhood.

Identify the major pure risks/pure loss to which Chris and Karen are exposed with respect to each other

Personal loss exposures
Property loss exposures
Liability loss exposures

Major personal loss exposures include the following:
 Premature death of Chris or Karen and the subsequent loss of financial support to
surviving family members
 Catastrophic medical bills incurred by Chris or Karen
 Catastrophic medical bills incurred by Christian or Kelly
 Total disability of Chris or Karen and the subsequent loss of financial support to the
surviving family members

Major property loss exposures include the following:
 Physical damage or theft of household personal property
 Physical damage or theft of family cars
 Theft of the laptop computer used by Karen while traveling
 Damage or theft of the business computer used by Chris
 Residing in a high crime-rate area, which increases the probability of theft or robbery

Major liability loss exposures include the following:
 Legal liability arising out of the operation of a family car by family members
 Legal liability arising out of the use of a rental car by Karen when she is traveling
 Legal liability arising out of other activities of family members that can result in bodily injury or property damage to others

Chris and Karen are married and own a three-bedroom home in a large midwestern city. Their son, Christian, attends college away from home and lives in a fraternity house. Their daughter, Kelly, is a
senior in high school. Chris is an accountant who works for a local accounting firm. Karen is a marketing analyst and is often away from home several days at a time. Kelly earns extra cash by babysitting on a regular basis. The family’s home contains household furniture, personal property, a computer that Chris uses to prepare business tax returns on weekends, and a laptop computer that Karen uses while traveling. The family owns three cars. Christian drives a 2010 Ford; Chris drives a 2015 Honda for both business and personal use; and Karen drives a 2017 Toyota and a rental car when she is traveling. Although the family has owned their home for several years, they are considering moving because of the recent increase in
violent crime in their neighborhood.

With respect to each of the aformentioned loss exposures, identify an appropriate personal risk management technique that could be used to treat the exposure

Chris and Karen should purchase adequate life insurance and disability income insurance to deal with the risk of premature death and total disability. Chris and Karen and the children should be insured under a group or individual health insurance policy to deal with the risk of catastrophic medical bills. Loss control could also be used by practicing healthy lifestyle habits.

A homeowners policy would cover the physical damage and theft of household property. Collision and comprehensive auto insurance would cover the possible physical damage or theft of a family car; retention could also be used by having a deductible for collision and comprehensive losses.

Chris and Karen should also check with their insurance agent to see if their homeowners policy provides adequate insurance on the business computer and laptop computer. Karen could also use risk control when she is traveling by not leaving the laptop computer unattended.

The legal liability loss exposures can be handled by a homeowners policy, which provides personal liability insurance. Auto legal liability insurance could insure the legal liability arising out of the negligent operation of a family car by family members

Pooling of losses

Losses incurred by the few are spread over the entire group so that in the process, average loss is substituted for actual loss

Payment of fortuitous losses

one that is unforeseen and unexpected, and occurs as a result of chance

Risk transfer

In private insurance, a pure risk is transferred from the insured to the insurer, which is typically in a better financial position to pay the loss than the insure

Indemnification

Compensation is given to the victim of a loss, in whole or in part, by payment, repair, or replacement

Explain the law of large numbers

The law of large numbers states that the greater the number of exposures, the more closely the actual results will approach the probable results expected from an infinite number of exposures

List the six characteristics of an ideally insurable risk

(a) There must be a large number of exposure units.

(b) The loss must be accidental and unintentional.

(c) The loss must be determinable and measurable.

(d) The loss should not be catastrophic.

(e) The chance of loss must be calculable.

(f) The premium must be economically feasible

What is the meaning of adverse selection?

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

Identify some methods that insurers use to control for adverse selection

careful underwriting, by charging higher premiums to substandard applicants for insurance, and by certain policy provisions

Identify the major fields of private insurance

life insurance, health insurance, and property and liability insurance (also called property and casualty insurance)

Identify several property and casualty insurance coverages

Personal lines include private passenger auto insurance, homeowners insurance, personal umbrella liability insurance, earthquake insurance, and flood insurance

Commercial lines include fire and allied lines insurance, commercial multiple peril insurance, general liability insurance, products liability insurance, workers compensation insurance, commercial auto insurance, accident and health insurance, inland marine and ocean marine insurance, professional liability insurance, directors and officers liability insurance, boiler and machinery insurance (also known as equipment breakdown insurance), fidelity and surety bonds, and crime insurance

Explain the basic characteristics of social insurance programs

Social insurance programs are government insurance programs with certain characteristics. The programs are enacted into law to deal with social and economic problems. The programs generally are compulsory and financed by contributions from covered employers and employees; benefits are paid from specifically earmarked funds; benefits are skewed or weighted in favor of lower income groups; benefit amounts generally are related to the covered individual’s earnings; and eligibility requirements and benefit rights are prescribed by statute.

Identify the major social insurance program in the United States

Social Security, Medicare, Unemployment insurance, Workers compensation

Compare the risk of fire with the risk of war in terms of how well they meet the requirements of an ideally insurable risk

	Risk of Fire	Risk of War
Large # of exposure unites	Met	Not met Based on the law of large numbers, it is difficult to estimate accurately the number of wars that will occur
Accidental and unintentional loss	Met	Not met
Determinable and measurable loss	Met	Although a war loss can be determined, the measurement of loss would be difficult.
No catastrophic loss	Met Since most homes do not burn at the same time.	Not meet
Calculable chance of loss	Insurers can estimate within ranges the probability of a fire loss	Not easily meet
Economically feasible premium	Met	Because of the catastrophic potential of war, the premiums would not be economically feasible

Indemnification for loss

insureds are restored to their former financial position after a loss occurs, either partly or wholly. As a result, individuals and families can maintain their economic security and are less likely to apply for public assistance or welfare, or seek financial assistance from relatives and friends.

Enhancement of credit

it guarantees the value of the borrower’s collateral, or gives greater assurance that the loan will be repaid

Source of funds for capital accumulation

Premiums are collected in advance, and funds not needed to pay immediate losses and expenses can be invested in financial securities, such as stocks, bonds, and loans, issued by business firms and government units. These funds typically are invested in capital goods, such as housing developments, shopping centers, new plants, machinery and equipment, and local government projects, such as water treatment plants. Since the stock of capital goods is increased, economic growth and full employment are promoted. In addition, since the supply of loanable funds is increased, the cost of capital to business firms is lower than it would be in the absence of insurance

Explain the major costs of insurance to society

 Cost of doing business

 Fraudulent claims

 Inflated claims

Buildings in flood zones are difficult to insure by private insurers because the ideal requirements of an insurable risk are difficult to meet

Identify the ideal requirements of an insurable risk

 Large number of exposure units

 Accidental and unintentional loss

 Determinable and measurable loss

 No catastrophic losses

 Calculable chance of loss

 Economically feasible premium

Buildings in flood zones are difficult to insure by private insurers because the ideal requirements of an insurable risk are difficult to meet

Which of the requirements of an insurable risk are not met by the flood peril?

The requirement of not having a catastrophic loss is not met because large numbers of exposure units in a flood zone would be incurring losses at the same time. Also, the requirement of an economically feasible premium generally is not met. Without a government backup, premiums for flood insurance in major flood zones generally would be unaffordable for many insureds.

Identify a private insurance coverage that would provide the desired

protection

Emily, age 28, is a single parent with two dependent children. She wants to make certain that funds are available for her children’s education if she dies before her youngest child finishes college

Life insurance can provide the needed funds for a college education

Identify a private insurance coverage that would provide the desired

protection

Danielle, age 16, recently obtained her driver’s license. Her parents want to make certain they are protected if Danielle negligently injures another motorist while driving a family car.

Auto liability insurance will protect the parents if Danielle negligently injures someone while driving a family car.

Identify a private insurance coverage that would provide the desired

protection

Jacob, age 30, is married with two dependents. He wants his income to continue if he becomes totally disabled and unable to work

An individual or group disability income policy will provide periodic income payments if Jacob becomes totally disabled

Identify a private insurance coverage that would provide the desired

protection

Tyler, age 35, recently purchased a house for $200,000 that is located in an area where tornadoes frequently occur. He wants to make certain that funds are available if the house is damaged or destroyed by a tornado.

A homeowners policy will provide the desired protection. Windstorm and hurricanes are covered perils

Identify a private insurance coverage that would provide the desired

protection

Nathan, age 40, owns an upscale furniture store. He wants to be protected if a customer is injured while shopping in the store and sues him for the bodily injury

A commercial general liability insurance policy will cover Nathan if a customer is injured in his store

How does rate making, or the pricing of insurance, differ from the pricing of other products?

Ratemaking differs from the pricing of other products. When other products are sold, the company generally knows in advance what its costs of production are, so that a price can be established to cover all costs and yield a profit. However, an insurer does not know in advance what its actual costs are going to be. The premium may be inadequate for paying all claims and expenses during the policy period. It is only after the period of protection has expired that an insurer can determine its actual losses and expenses.

Define the meaning of underwriting

is the process of selecting and classifying applicants for insurance

The basic principles of underwriting

(1) Attaining an underwriting profit

(2) Selecting insureds according to the company’s underwriting standards

(3) Providing equity among policyholders

Identify the major sources of information available to underwriters

In determining whether to accept or reject an applicant for insurance, underwriters have several sources of information. They include the application, agent’s report, inspection report, physical inspection, physical examination, attending physician’s report, and a Medical Information Bureau (MIB) report.

Briefly describe the sales and marketing activities of insurers

Production refers to the sales and marketing activities of insurers. Agents who sell insurance are frequently referred to as producers. The key to the insurer’s financial success is an effective sales force. Marketing activities include the development of a marketing philosophy and strategy, identification of short- and long-run production goals, marketing research, developing new products, and advertising the insurer’s products

Explain the basic objectives in the settlement of claims

a) Verification of a covered loss

(b) Fair and prompt payment of claims

(c) Personal assistance to the insured

Describe the steps involved in the settlement of a claim

(a) Notice of loss must be given to the company.

(b) The claim is investigated by the company.

(c) A proof of loss may be required.

(d) A decision is made concerning payment.

What is the meaning of 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

Briefly explain the reasons for reinsurance

(1) To increase the company’s underwriting capacity

(2) To stabilize profits

(3) To reduce the unearned premium reserve

(4) To provide protection against a catastrophic loss

(5) To retire from the insurance business or from a line or territory

(6) To obtain underwriting advice or assistance

Explain the meaning of “securitization of risk.”

Securitization of risk means that an insurable risk is transferred to the capital markets through the creation of a financial instrument, such as a catastrophe bond, futures contract, options contract, or other financial instrument. These financial instruments are used as alternatives to traditional reinsurance

Quota-share treaty

Under a quota-share treaty, the ceding insurer and reinsurer agree to share premiums and losses based on some agreed-on percentages. The ceding insurer’s retention limit is stated as a percentage rather than as a dollar amount. Premiums are also shared based on the same agreed-on percentages. However, the reinsurer pays a ceding commission to the primary insurer to help compensate for the expenses incurred in writing the business

Surplus-share treaty

Under a surplus-share treaty, the reinsurer agrees to accept insurance in excess of the primary insurer’s retention limit, up to some maximum amount. The primary insurer and reinsurer then share premiums and losses based on the fraction of total insurance retained by each party. Premiums are also shared based on the fraction of total insurance retained by each party. However, the reinsurer pays a ceding commission to the primary insurer to help compensate for the acquisition expenses incurred in acquiring the business

Excess-of-loss reinsurance

An excess-of-loss treaty is designed largely for a catastrophe loss. Losses in excess of the primary company’s retention limit are paid by the reinsurer up to some maximum limit.

Reinsurance pool

A reinsurance pool is an organization of insurers that underwrites insurance on a joint basis. Pools are formed because a single insurer alone may not have the financial capacity to write large amounts of insurance; the insurers as a group, however, can combine their financial resources to obtain the necessary capacity. Each pool member agrees to pay a certain percentage of every loss. Another arrangement is similar to the excess-of-loss reinsurance treaty. Pool members are responsible for their own losses below a certain amount. Losses exceeding that amount are shared by all pool members

Delta Insurance is a property insurer that entered into a surplus-share reinsurance treaty with Eversafe Re. Delta has a retention limit of $200,000 on any single building, and up to nine lines of insurance may be ceded to Eversafe Re. A building valued at $1,600,000 is insured with Delta. Shortly after the policy was issued, a severe windstorm caused an $800,000 loss to the building.

How much of the loss will Delta pay?

The total amount of insurance in force is $1,600,000. Delta Insurance has a retention limit of $200,000, or 1/8 of the total amount. Delta Insurance will pay 1/8 of the $800,000 loss, or $100,000