maryland life and health insurance ch 2

Learning Objective 1: Explain how risk pooling works in insurance operations

  • Risk pooling (loss sharing) fundamentals:

    • Combines a large number of exposure units

    • Units must face similar risks (homogeneous)

    • Losses must be accidental/unintentional

    • Exposure units must be independent

  • Benefits:

    • Policyholders: Transfer financial uncertainty for a known premium

    • Insurers: Use statistics to predict losses and set premiums

Learning Objective 2: Explain how adverse selection affects insurance operations and methods to control it

  • Adverse selection definition: Selection against the insurance company by higher-risk individuals

  • Warning signs:

    • Unusual urgency in the application

    • Incomplete information

    • Early or pattern of claims

    • Coverage amounts exceeding needs

  • Control methods:

    • Medical underwriting

    • Waiting periods

    • Preexisting condition limitations

    • Complete health information requirements

    • Risk classification

Learning Objective 3: Describe how the law of large numbers enables insurance companies to predict losses

  • Key requirements:

    • Independence: Each exposure unit is independent of the others

    • Similarity: Units face similar risks

    • Large number: Sufficient quantity of exposure units

  • Application:

    • More accurate loss predictions with larger groups

    • Enables proper premium calculations

    • Works with risk pooling for viable insurance operations

Learning Objective 4: Apply the principle of indemnity to insurance situations

  • Definition: Restoring the insured to the same financial position before the loss

  • Key points:

    • Prevents profit from insurance

    • Applies to most property, casualty, and health insurance

    • Exception: Life insurance (valued contract)

  • Purpose:

    • Maintain insurance as financial protection

    • Prevent insurance from being a source of profit

Learning Objective 5: Define and differentiate between perils, hazards, and losses in insurance contexts

  • Perils (cause of loss):

    • Specific events causing loss

    • Examples: fire, accident, illness, death

  • Hazards (conditions increasing loss likelihood):

    • Physical: Tangible conditions

    • Moral: Dishonest character/intentional

    • Morale: Careless attitude due to insurance

  • Losses:

    • Direct: Immediate damage from peril

    • Indirect: Consequential losses

    • Must be definite and measurable

Learning Objective 6: Identify three types of hazards and their impact on insurance

  • Physical hazards:

    • Tangible/observable conditions

    • Examples: poor health, dangerous occupation

    • Can often be measured or documented

  • Moral hazards:

    • Involve dishonesty/intentional acts

    • Examples: insurance fraud, application lies

    • Increases the likelihood of intentional losses

  • Morale hazards:

    • Carelessness due to insurance

    • Examples: skipping preventive care

    • Unintentional risk increase

Learning Objective 7: Distinguish between pure and speculative risks in insurance contexts

  • Pure risks (insurable):

    • Only the possibility of loss

    • No chance of gain

    • Examples: death, illness, injury

  • Speculative risks (not insurable):

    • Possibility of loss or gain

    • Examples: investments, gambling

    • Cannot be insured

Learning Objective 8: Explain methods of handling risk in insurance

  • Risk sharing: Spreading among multiple parties

  • Risk transfer: Moving risk to another party (insurance)

  • Risk avoidance: Eliminating risk-causing activity

  • Risk reduction: Decreasing loss likelihood/severity

  • Risk retention: Keeping risk (deductibles, self-insurance)

  •  Risk prevention: Actions to eliminate loss potential

Exam Tips

  • Pay special attention to distinguishing between:

    • Moral vs. morale hazards

      • Moral = Intentional/dishonest

      • Morale = Careless/unintentional

    • Pure vs. speculative risks

      • Pure = loss only (insurable)

      • Speculative = loss or gain (not insurable)

    • Direct vs. indirect losses

      • Direct = Immediate from peril

      • Indirect = Consequential

  • Common trick questions involve:

    • Life insurance is a valued contract (not indemnity)

    • Identifying correct hazard types in scenarios

    • Distinguishing between accidents (sudden/specific) and occurrences (can be gradual)

    • Recognizing proper risk management methods

  • When answering questions about:

    • Adverse selection: Look for intentional concealment or urgency

    • Law of large numbers: All three conditions must be met (independence, similarity, large number)

    • Risk pooling: Focus on homogeneous exposure units

    • Methods of handling risk: Remember STARR (Sharing, Transfer, Avoidance, Reduction, Retention)

Remember

  • Essential definitions:

    • Risk = Uncertainty of loss

    • Peril = Cause of loss

    • Hazard = Condition increasing the likelihood of loss

    • Loss = Unintentional decrease in value

  • Key principles:

    • Insurance only covers pure risks

    • Every accident is an occurrence, but not every occurrence is an accident

    • Self-insurance is different from no insurance (planned vs. unplanned)

    • Adverse selection works against the insurance company

  • Critical concepts:

    • Risk pooling requires similar risks

    • The law of large numbers enables accurate predictions

    • Indemnity prevents profit from insurance

    • Physical hazards can be observed

    • Moral hazards involve dishonesty

    • Morale hazards stem from carelessness

  • For the exam:

    • Read questions carefully for key terms

    • Look for qualifying words such as "EXCEPT" or "NOT"

    • Consider all elements of a concept before answering

    • When in doubt about risk type, ask: "Can this result in a gain?"

    • Remember that insurance is based on uncertainty and chance