Podcast
Questions and Answers
What is the primary purpose of the principle of indemnity?
What is the primary purpose of the principle of indemnity?
How does insurance reduce financial risk?
How does insurance reduce financial risk?
Which type of insurance contract is NOT a contract of indemnity?
Which type of insurance contract is NOT a contract of indemnity?
What role do premiums play in an insurance contract?
What role do premiums play in an insurance contract?
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According to the law of large numbers, what happens as the number of risks in a pool increases?
According to the law of large numbers, what happens as the number of risks in a pool increases?
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What is the result of transferring risk through the purchase of an insurance policy?
What is the result of transferring risk through the purchase of an insurance policy?
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Which principle allows premium charges to be very accurate?
Which principle allows premium charges to be very accurate?
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Why can't an insured profit from their loss according to the principle of indemnity?
Why can't an insured profit from their loss according to the principle of indemnity?
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Study Notes
The Nature of Insurance
- Insurance is the transfer of risk from one party to another through a legal contract or the pooling of funds.
- The policyowner transfers the chance of a possible financial loss to the insurer in exchange for premium payments.
- Insurance spreads the risk of loss from one person to a large number of persons through the pooling of premiums.
- Insurance reduces financial risk and spreads the risk of loss from one individual to many.
Principle of Indemnity
- Accident, health, property, and casualty insurance contracts are contracts of indemnity.
- The purpose of indemnity is to make the insured "whole" again financially, without making them better off than they were prior to the loss.
- The principle of indemnity ensures that an insured shall not profit or gain by their loss.
- In contrast, life insurance policies are valued contracts and pay a stated sum regardless of the actual loss incurred.
Law of Large Numbers (Spread of Risk)
- The law of large numbers states that larger groups provide an increased degree of accuracy in loss predictions, based on past experience.
- The higher the exposure, the more likely the event can be predicted.
- The law of large numbers allows premium charges to be very accurate and insurers to be more financially stable when accepting insurable risks.
- Predicting expected loss across a large group is also known as the "spread of risk," or risk spreading.
- The law of large numbers provides safety in larger numbers, enabling insurers to cover losses and make a profit.
Adverse Selection
- Adverse selection is the tendency for higher-than-average risks to seek out insurance.
- Insurers must minimize adverse selection, which occurs when one party has superior accurate information over another party.
- Insurance underwriting is designed to ensure fair compensation for the actual risks undertaken by insurers.
- Premiums for higher-risk individuals or properties are greater than those for lower-risk ones.
- Insurers must avoid risks that run against their own best interest to remain profitable and in business.
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Description
This quiz covers the basics of insurance, including the concept of risk transfer, insurance contracts, and the roles of policyowners and insurers.
