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Questions and Answers
What is the benefit of insuring a large group of people?
What is the benefit of insuring a large group of people?
- It increases the number of claims from customers who suffer serious injuries
- It reduces the confidence that policyholders will pay sufficient premiums
- It allows for a more accurate prediction of future losses (correct)
- It increases the risk of serious and expensive injuries
Why is an insurance company better off issuing 500 rather than 150 fire insurance policies?
Why is an insurance company better off issuing 500 rather than 150 fire insurance policies?
- Because it increases the chance of a serious and expensive injury
- Because it is a company requirement
- Because it increases the risk of loss exposure
- Because it reduces the risk of loss exposure due to a stable and independent probability distribution (correct)
What is the primary purpose of pooling in insurance?
What is the primary purpose of pooling in insurance?
- To reduce the variation in possible outcomes as measured by the standard deviation (correct)
- To provide a higher premium for policyholders
- To increase the variation in possible outcomes
- To predict future losses with absolute certainty
What is a characteristic of a fortuitous loss?
What is a characteristic of a fortuitous loss?
What is the law of large numbers based on?
What is the law of large numbers based on?
What is the result of pooling a large number of exposure units?
What is the result of pooling a large number of exposure units?
What is the purpose of insurance in relation to fortuitous losses?
What is the purpose of insurance in relation to fortuitous losses?
Why can an insurance company be more confident that 150 policyholders will collectively pay sufficient premiums?
Why can an insurance company be more confident that 150 policyholders will collectively pay sufficient premiums?
What is the literal meaning of the term 'Indemnity'?
What is the literal meaning of the term 'Indemnity'?
What is the primary purpose of the principle of indemnity?
What is the primary purpose of the principle of indemnity?
What would happen if the insurer pays the full amount of the insurance policy despite the partial loss?
What would happen if the insurer pays the full amount of the insurance policy despite the partial loss?
What is the purpose of the principle of indemnity in relation to moral hazard?
What is the purpose of the principle of indemnity in relation to moral hazard?
What is the exception to the principle of indemnity?
What is the exception to the principle of indemnity?
How is the value of life determined in life insurance?
How is the value of life determined in life insurance?
Why can't the principle of valuing material property be applied to determine the monetary value of life?
Why can't the principle of valuing material property be applied to determine the monetary value of life?
What is the result of the insurer paying up to the amount of loss?
What is the result of the insurer paying up to the amount of loss?
What is the principle of insurable interest based on?
What is the principle of insurable interest based on?
What happens if the insured has no insurable interest over the life or a property?
What happens if the insured has no insurable interest over the life or a property?
What is the principle of utmost good faith based on?
What is the principle of utmost good faith based on?
What type of products are sold in insurance?
What type of products are sold in insurance?
What is the duty of the parties to an insurance contract?
What is the duty of the parties to an insurance contract?
What is required to be disclosed in an insurance contract?
What is required to be disclosed in an insurance contract?
Why is insurable interest necessary in insurance?
Why is insurable interest necessary in insurance?
What is the consequence of non-disclosure of material facts in an insurance contract?
What is the consequence of non-disclosure of material facts in an insurance contract?
What is the consequence of concealing necessary facts in an insurance policy?
What is the consequence of concealing necessary facts in an insurance policy?
Which of the following facts need not be disclosed by the insured?
Which of the following facts need not be disclosed by the insured?
What is a representation in an insurance contract?
What is a representation in an insurance contract?
When can the insurance contract be considered voidable by the insurer?
When can the insurance contract be considered voidable by the insurer?
What is the primary mechanism of insurance?
What is the primary mechanism of insurance?
What does 'material' mean in the context of insurance representations?
What does 'material' mean in the context of insurance representations?
What is the main objective of the principle of indemnity?
What is the main objective of the principle of indemnity?
What principle explains the pooling of losses as an insurance mechanism?
What principle explains the pooling of losses as an insurance mechanism?
What is the result of the law of large numbers in insurance?
What is the result of the law of large numbers in insurance?
Who has the duty of disclosure in an insurance contract?
Who has the duty of disclosure in an insurance contract?
What happens to the probability that the pool's resources will be insufficient to pay all claims as more policyholders are added?
What happens to the probability that the pool's resources will be insufficient to pay all claims as more policyholders are added?
What is the consequence of laxity in disclosing necessary facts by the insured?
What is the consequence of laxity in disclosing necessary facts by the insured?
What is the effect of an increase in the number of policyholders on the insurance?
What is the effect of an increase in the number of policyholders on the insurance?
What is the economic implication of the law of large numbers in insurance?
What is the economic implication of the law of large numbers in insurance?
What is the result of the law of large numbers in practical terms?
What is the result of the law of large numbers in practical terms?
What is the primary advantage of having more policyholders in an insurance class?
What is the primary advantage of having more policyholders in an insurance class?
Study Notes
Definition of Insurance
- Insurance can be defined from multiple disciplines, including law, economics, history, actuarial science, risk theory, and sociology.
- Insurance is the pooling of fortuitous losses by transferring risks to insurers, who agree to indemnify insureds for such losses or provide other pecuniary benefits.
Law of Large Numbers in Insurance
- The law of large numbers states that the average of a large number of independent, identically distributed random variables tends to fall close to the expected value.
- This principle is used to show that the entry of additional risks to an insured pool tends to reduce the variation of the average loss per policyholder around the expected value.
- As the number of policyholders increases, the probability that the actual loss per policyholder will equal the expected loss per policyholder is higher.
- This means that there are returns to scale in insurance production, making it easier to establish the correct premium and reduce risk exposure for the insurer as more policies are issued.
Basic Characteristics of Insurance
Pooling of Losses
- Pooling involves the grouping of a large number of exposure units to provide a substantially accurate prediction of future losses.
- The primary purpose of pooling is to reduce the variation in possible outcomes, thereby reducing risk.
- Pooling implies the sharing of losses by the entire group and prediction of future losses with some accuracy based on the law of large numbers.
Payment of Fortuitous Losses
- A fortuitous loss is one that is unforeseen and unexpected by the insured and occurs as a result of chance.
- The law of large numbers is based on the assumption that losses are accidental and occur randomly.
Principle of Insurable Interest
- Insurable interest is the legal right to insure arising from a financial relationship recognized under the law, between the insured and the subject matter of insurance.
- The insured must have a pecuniary or monetary interest in the property, which they have insured.
- If the insured has no insurable interest over the life or property they insure, the insurance contract is considered unenforceable.
Principle of Utmost Good Faith
- The principle of utmost good faith stems from the doctrine of "Uberrimae Fides".
- It implies that in a contract of insurance, the concerned contracting parties must rely on each other's honesty.
- There must be a positive duty to voluntarily disclose, accurately and fully, all facts material to the risk being proposed, whether requested or not.
- Any concealment of necessary facts is deemed intentional and will make the policy void.
Principle of Indemnity
- Indemnity is the protection or security against damage or loss, providing financial compensation to place the insured in the same pecuniary position after the loss as enjoyed just before it.
- The principle of indemnity ensures that the insurer is liable to pay up to the amount of loss, but not more than that.
- The two fundamental purposes of the principle of indemnity are:
- To prevent the insured from profiting from a loss.
- To reduce moral hazard, preventing dishonest policyholders from deliberately causing the loss to collect the insurance proceeds.
- Exception to the principle of indemnity: life insurance, where the value of life is determined by qualitative factors and is subject to one's opinion.
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Description
Understanding the concept of insurance from multiple disciplines, including law, economics, and actuarial science. Learn about the pooling of fortuitous losses and the role of insurers.