Insurance Risk Management Overview
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Questions and Answers

Identify the risk management method that prevents extremely high insurance premiums.

Avoidance

What risk management method is involved when requiring an adequate spread of risk for insurance?

Control

Explain the risk management method utilized by Benson Pharmaceutical Company when deciding not to manufacture a drug.

Avoidance

Donna cancels her health insurance policy because she's always been healthy. Which risk management method is represented here?

<p>Retention</p> Signup and view all the answers

What risk management method does a company apply when installing a security system to reduce the risk of theft?

<p>Reduction</p> Signup and view all the answers

What peril occurred causing Mr. Reed's home to be destroyed in a fire?

<p>Fire</p> Signup and view all the answers

Veronica forgot to lock her front door, leading to theft. Identify the peril in this situation.

<p>Theft</p> Signup and view all the answers

In the scenario with Veronica's theft, identify the hazard that contributed to the loss.

<p>Veronica forgetting to lock her door</p> Signup and view all the answers

Explain why it's difficult to insure the risk of a suitcase wearing out.

<p>A suitcase wearing out is considered an expected outcome, not a risk, and therefore not insurable. The risk of a suitcase wearing out is not unexpected, unlike the risk of a train wreck.</p> Signup and view all the answers

Why are financially insignificant losses, such as losing inexpensive sunglasses, typically not insurable?

<p>Financially insignificant losses are not insurable because the potential financial hardship for the individual is negligible. The cost of insurance would not be worthwhile for such a small potential loss.</p> Signup and view all the answers

Describe the element of insurable risk that involves knowing the cost of the loss.

<p>The element of insurable risk that involves knowing the loss's cost is calculability. Insurable risks must have a calculable cost, allowing insurers to estimate potential claims and set premiums accordingly.</p> Signup and view all the answers

Explain the significance of requiring the risk to be definite in time and place for it to be insurable.

<p>It's crucial for a risk to be definite in time and place for insurability. This allows insurers to identify the specific event causing the loss, preventing fraud and ensuring clarity in claim processing.</p> Signup and view all the answers

Why is the cost of insurance being affordable to the insured an important element of insurable risk?

<p>Affordability of insurance is crucial. People need to be able to afford the premiums for the coverage they need, making insurance an accessible and beneficial risk management tool.</p> Signup and view all the answers

What is the primary reason why a risk of loss, like a suitcase wearing out, is not considered 'a risk' and therefore not insurable?

<p>The risk of a suitcase wearing out is not considered a 'risk' because it's a predictable and expected event, making it non-insurable. Insurance handles unexpected losses, not predictable wear and tear.</p> Signup and view all the answers

Explain the connection between insurable risk and the ability of insurers to accurately calculate premiums.

<p>The calculability of insurable risk directly enables insurers to accurately calculate premiums. They can estimate the frequency and severity of losses, setting premiums that cover potential claims while remaining affordable.</p> Signup and view all the answers

Why is death a good example of a risk that is definite as to time and place?

<p>Death is a definable event with a specific time and place of occurrence, making it a good example of an insurable risk. This clarity assists in verifying claims and assessing the risk.</p> Signup and view all the answers

Describe the principle of indemnity in insurance.

<p>The principle of indemnity states that an insured individual should be restored to their approximate financial condition before a loss, neither gaining nor losing financially.</p> Signup and view all the answers

What is the purpose of the principle of indemnity?

<p>The principle of indemnity aims to prevent the insured from profiting from a loss and ensures they are only compensated for their actual financial loss.</p> Signup and view all the answers

Give an example of how the principle of indemnity applies in practice.

<p>If an insured's car worth $6,000 is destroyed, they should receive no more than $6,000 from their insurance company, even if they originally paid more for the car.</p> Signup and view all the answers

Explain the relationship between the principle of indemnity and insurable interest.

<p>The principle of indemnity is connected to insurable interest because an insured can only be compensated for their financial interest in the property insured, preventing gains from a loss.</p> Signup and view all the answers

How does the principle of indemnity relate to speculative risks?

<p>The principle of indemnity prevents insurance from becoming a gambling opportunity, as it ensures compensation is based on actual loss, not potential profit.</p> Signup and view all the answers

In the example of a laptop destroyed in a fire, why can't the owner collect from both their friend and insurance company?

<p>The principle of indemnity prevents double compensation. Collecting from both the friend and the insurance company would result in the owner gaining financially from the loss.</p> Signup and view all the answers

What is the main goal of the principle of indemnity?

<p>The principle of indemnity aims to ensure fairness and prevent financial gain from a loss, restoring the insured to their pre-loss financial position.</p> Signup and view all the answers

How does the principle of indemnity contribute to the stability of the insurance industry?

<p>The principle of indemnity helps prevent excessive claims and financial instability within the insurance industry by ensuring compensation is limited to actual losses.</p> Signup and view all the answers

What are the two parties involved in an offer and acceptance contract?

<p>The two parties involved in an offer and acceptance contract are the one who makes the offer and the one who accepts it.</p> Signup and view all the answers

Why is an insurance contract considered a conditional contract?

<p>An insurance contract is considered conditional because it contains specific conditions that both the insured and the insurer must adhere to for the contract to be valid.</p> Signup and view all the answers

What is the purpose of an insurance contract being a contract of indemnity?

<p>The purpose of an insurance contract being a contract of indemnity is to restore the insured to their approximate financial condition prior to the loss.</p> Signup and view all the answers

What does the Declarations section of an insurance policy typically include?

<p>The Declarations section typically includes details like who is insured, what property or risk is covered, when and where coverage is effective, and the amount of coverage.</p> Signup and view all the answers

What kind of information is found in the Insuring Agreements section of an insurance policy?

<p>The Insuring Agreements section outlines what perils are covered by the policy and the specific risks the insurer agrees to protect against.</p> Signup and view all the answers

What is the purpose of the Conditions section in an insurance policy?

<p>The Conditions section clarifies the rights and duties of both the insured and the insurer under the policy.</p> Signup and view all the answers

What kind of information is typically excluded from coverage in an insurance policy?

<p>The Exclusions section lists property, perils, persons, or situations that are specifically not covered by the policy.</p> Signup and view all the answers

What is the purpose of Definitions in an insurance policy?

<p>The Definitions section clarifies the meaning of specific terms used throughout the policy.</p> Signup and view all the answers

What is an offer in the context of a contract?

<p>An offer is a promise that requires an act or another promise in exchange.</p> Signup and view all the answers

What constitutes acceptance in a contract?

<p>Acceptance occurs when the other party agrees to the offer or performs what was proposed.</p> Signup and view all the answers

In the scenario provided, who made the offer?

<p>Ted made the offer by filling out the insurance application.</p> Signup and view all the answers

Who accepted the offer in the scenario?

<p>XYZ Insurance Company accepted the offer by agreeing to provide the insurance.</p> Signup and view all the answers

What is consideration in a contract?

<p>Consideration is a thing of value exchanged for the performance promised in the contract.</p> Signup and view all the answers

What consideration does the insured provide in an insurance contract?

<p>The insured provides a premium payment as consideration.</p> Signup and view all the answers

What does the insurer provide as consideration in the contract?

<p>The insurer promises to pay for certain losses suffered by the insured.</p> Signup and view all the answers

What is one characteristic that makes an insurance contract unique?

<p>One unique characteristic is the Principle of Indemnity.</p> Signup and view all the answers

What type of hazard is Jerry's intention to burn down his business for insurance money?

<p>It is a moral hazard.</p> Signup and view all the answers

What type of hazard is Bill leaving his car unlocked because it is insured?

<p>It is a morale hazard.</p> Signup and view all the answers

What can be inferred about the building of Starfire Equipment Company in relation to hazards?

<p>It indicates a physical hazard.</p> Signup and view all the answers

How would Jerry's action of burning down his building affect insurance principles?

<p>It undermines the principle of indemnity.</p> Signup and view all the answers

What risk factor does Bill's behavior exemplify regarding automobile insurance?

<p>It exemplifies a morale hazard.</p> Signup and view all the answers

What is a common result of moral hazards in insurance?

<p>Increased claims and potential fraud.</p> Signup and view all the answers

What steps can insurers take to mitigate moral hazards like those presented in Jerry's example?

<p>Insurers can conduct thorough inspections and impose stricter underwriting guidelines.</p> Signup and view all the answers

Why is identifying the type of hazard important for insurance companies?

<p>It helps insurers assess risk and determine premiums.</p> Signup and view all the answers

Flashcards

Definite Loss

A loss that can be clearly identified in terms of when and where it occurred, making it difficult to fake or manipulate.

Unexpected Loss

An event that is not predictable or controllable, making it a true risk.

Financially Significant Loss

A loss that has the potential to significantly impact the financial well-being of the insured.

Calculable Loss

A loss that can be measured and assigned a monetary value, allowing for the calculation of insurance premiums.

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Affordable Insurance Cost

A risk where the cost of insurance is reasonable and affordable for the insured.

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Uninsurable Risks

Risks that do not meet the criteria for insurability and are better managed through other methods.

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Property and Casualty Insurance

An insurance policy that covers potential losses from accidents or other unforeseen events.

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Risk Management

The process of identifying, analyzing, and managing risks to minimize potential losses.

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Moral Hazard

A deliberate act with the intent to cause a loss and then collect insurance benefits. For example, intentionally setting a building on fire to collect insurance money.

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Morale Hazard

A condition that increases the likelihood of a loss due to carelessness or indifference to risk. Example: leaving a car unlocked and uninsured, increasing chances of theft.

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Physical Hazard

A hazard that arises from the physical characteristics of property or the environment. Example: a worn-out furnace, increasing fire risk in a building.

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Moral Hazard (Insurance)

A situation where an individual has a greater incentive to engage in risky behavior because they are insured against losses. Example: driving recklessly because you have car insurance.

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Morale Hazard (Insurance)

A hazard that relates to the mental attitude of the insured. Example: leaving a car unlocked with valuables inside, thinking insurance will cover the loss.

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Physical Hazard (Insurance)

A hazard that arises from the physical characteristics of the property itself, the environment it's in, or any physical object. Example: A building constructed with flammable materials or located in a fire-prone area.

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Morale Hazard (Insurance)

A situation where the insured's actions increase the likelihood of a loss, even without intentional wrongdoing. Example: Driving under the influence, putting a car at greater risk.

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Moral Hazard (Insurance)

A hazard that relates to the moral character of the insured, involving dishonest or fraudulent behavior to gain from insurance. Example: Filing a false insurance claim for a fake accident.

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Risk Avoidance

A risk management technique where the potential for loss is completely prevented by avoiding the risky activity or situation.

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Risk Control

A risk management technique where the potential for loss is reduced, but not eliminated, by implementing controls or safeguards.

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Risk Transfer

A risk management technique where the financial burden of potential loss is transferred to another party, typically through insurance.

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Risk Retention

A risk management technique where the potential for loss is retained by the individual or organization, meaning they are willing to accept the potential consequences.

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Peril

The actual cause of a loss, such as fire, theft, or natural disaster.

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Hazard

A condition that increases the likelihood or severity of a loss, such as a faulty wiring system or poor maintenance.

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Spread of Risk

The spreading of risk among a large number of individuals or entities, which helps to reduce the impact of any single loss.

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Law of Large Numbers

The principle that states that the larger the sample size, the more reliable the statistical data will be.

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Offer

A promise made by one party to another, requiring a specific action or another promise in exchange.

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Acceptance

An agreement to the terms of an offer, either through words or specific actions.

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Consideration

Something of value exchanged between parties in a contract, like a payment for a service.

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Principle of Indemnity

The principle that insurance aims to restore the insured to the same financial position they were in before the loss occurred, not making them richer.

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Premium

The amount paid by the insured to the insurer for coverage under the policy.

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Insurer's promise

The promise made by the insurer to pay certain losses suffered by the insured, in exchange for the premium.

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Insured

The individual or entity who is covered by the insurance policy and receives protection from financial losses.

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Limit of Indemnity

The amount of money someone is allowed to recover from an insurance company for a loss is limited to the actual value of the loss, not exceeding the insured amount.

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Insurable Interest

The insured can only receive compensation for a loss to the extent of their financial interest in the insured property.

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Insurance: Not Gambling

Insurance protects against unexpected losses that you have a financial interest in. It's not a way to gamble or profit financially from a loss.

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Indemnity, Insurable Interest & Speculative Risks

The principle of indemnity connects to the requirement of insurable interest and the exclusion of speculative risks because it prevents unfair profit and ensures losses are covered in a fair and transparent manner.

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No Double Recovery

The insured should receive compensation for the loss only once. They cannot claim from multiple sources for the same loss.

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Insurance: Not a Profit-Making Scheme

Insurance is not a scheme to make a profit. The purpose is to cover the financial losses of a covered event, not create a windfall for the insured.

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Offer and Acceptance

An insurance contract involves an offer (application) and acceptance (issuance of policy). The policyholder makes the offer, and the insurer accepts it.

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Endorsements

Documents attached to the policy to modify its terms. They can add, remove, or change coverage.

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Indemnity

The insured is compensated for losses only to the extent of their actual financial loss, not exceeding the pre-loss value.

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Exclusions

These outline the specific property, perils, persons, or situations that are not covered by the insurance.

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Insuring Agreement

This section describes the main coverage provided and details the specific risks covered under the policy.

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Conditions

This section outlines the requirements both the insured and insurer must follow throughout the policy's duration.

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Definitions

These clarify the meaning of terms used throughout the policy, ensuring everyone understands the same thing.

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Declarations

This section details vital information about the insured, the property, the risks covered, and the amount of coverage.

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Study Notes

Insurable Risks

  • Rules govern insurable risks; risks not meeting criteria are better managed otherwise
  • Loss must be definite in time and place, hard to counterfeit
  • Death is a good example of a definite loss
  • Risk must be unexpected; expected outcomes are not risks
  • Risk must cause financial hardship; insignificant losses are not insurable
  • Loss must be calculable; losses without a financial value are uninsurable
  • Insurance cost must be affordable

Types of Hazards

  • Physical Hazard: Example: worn-out furnace causing fires
  • Moral Hazard: Example: intentionally burning a building to collect insurance
  • Morale Hazard: Example: leaving a car unlocked because it's insured

Risk Management Methods

  • Avoidance: Not manufacturing a drug with serious side effects
  • Reduction: Installing a fire suppression system
  • Control: Cancelling health insurance due to good health
  • Retention: Forgetting to lock a door and having something stolen

Contract Requirements

  • Offer and acceptance: A contract involves an offer and acceptance (e.g., insurance application and acceptance by the insurance company)
  • Competent parties: Contracts require parties legally able to enter a contract (e.g. a minor is often considered incompetent)
  • Consideration: Exchange of value; insured pays a premium, insurer promises to pay for losses
  • Principle of Indemnity: Restores the insured to their pre-loss financial condition, not more or less

Insurance Contract Characteristics

  • Conditional contract: Parties must follow conditions
  • Contract of indemnity: Insured restored to pre-loss financial state
  • Insurable interest: Insured must have a financial stake in the insured property

Insurance Policy Components

  • Declarations: Details about the insured, the property/risks, coverage dates and amount
  • Insuring agreements: What is covered and the specific perils covered
  • Conditions: Rights and duties of the insured and insurer
  • Exclusions: Items, perils, or situations not covered
  • Definitions: Clarification of policy terms
  • Endorsements: Documents changing the policy

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Related Documents

Property & Casualty Insurance License Exam Manual PDF

Description

Explore the concepts of insurable risks, types of hazards, and effective risk management methods. Understand the criteria that define insurable losses and the implications of various hazards on insurance policies. This quiz will enhance your knowledge of how risks are evaluated and managed in the insurance industry.

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