Nature and Operations of Insurance
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Questions and Answers

What determines the premium amount in insurance?

  • The length of the insurance policy
  • The age of the insured individual
  • The type of insured asset
  • The frequency and severity of the risk (correct)

What is considered a primary function of insurance?

  • Providing employment opportunities
  • Risk transfer mechanism (correct)
  • Investment of funds
  • Encouraging saving

How does insurance stimulate business enterprise?

  • By providing direct funding for startup costs
  • By offering lower premiums to investors
  • By allowing businesses to transfer risks to insurers (correct)
  • By covering all operational costs for businesses

What is one of the secondary functions of insurance?

<p>Release of funds tied in reserves (B)</p> Signup and view all the answers

What is the effect of insurance on individuals and businesses regarding fear and worry?

<p>It reduces fear and worry by providing peace of mind (B)</p> Signup and view all the answers

Which of the following is NOT categorized as a secondary function of insurance?

<p>Providing comprehensive risk coverage (D)</p> Signup and view all the answers

In the context of insurance, what does 'risk transfer mechanism' mean?

<p>The insured pays a premium to shift the responsibility of loss to the insurer (B)</p> Signup and view all the answers

What is a benefit of releasing funds from reserves in the context of insurance?

<p>It allows for more capital to be available for investments (C)</p> Signup and view all the answers

What is the primary reason insurers require a large number of similar risks?

<p>To accurately predict losses and calculate suitable premiums (C)</p> Signup and view all the answers

What is one benefit of insurance related to financial stability?

<p>It provides financial compensation against personal risks. (D)</p> Signup and view all the answers

Which characteristic must be true for a loss to be considered insurable?

<p>The loss must be accidental and unintentional (C)</p> Signup and view all the answers

What is the primary function of insurance according to the definition provided?

<p>To share the fortuitous losses among a group (C)</p> Signup and view all the answers

How does insurance help in risk management?

<p>By reducing losses in frequency and severity. (D)</p> Signup and view all the answers

What type of risks will insurers typically avoid insuring?

<p>Speculative risks (C)</p> Signup and view all the answers

In insurance operations, what is typically done with the premiums collected from policyholders?

<p>They are used to pay for the losses of a few individuals (D)</p> Signup and view all the answers

What role does insurance play in personal finance planning?

<p>It offers systematic saving through premium payments. (B)</p> Signup and view all the answers

Which aspect must be present in an insurance contract regarding insurable interest?

<p>The insured must have financial responsibility for the item (D)</p> Signup and view all the answers

What indirect function of insurance relates to economic growth?

<p>Investment of funds in public and private sectors. (D)</p> Signup and view all the answers

Why are catastrophic losses generally not insurable?

<p>They can lead to losses across many policies simultaneously (A)</p> Signup and view all the answers

Why is the common pool concept important in insurance?

<p>It enables sharing of losses among many insured individuals (A)</p> Signup and view all the answers

How does the Law of Large Numbers relate to insurance?

<p>It helps to stabilize loss estimates by pooling a large number of risks (D)</p> Signup and view all the answers

What does the term 'reasonable premium' refer to in insurance?

<p>A premium proportional to the potential loss (B)</p> Signup and view all the answers

Why is insurance considered important for societal welfare?

<p>It minimizes social problems resulting from personal risks. (A)</p> Signup and view all the answers

Which of the following is characteristic of pure risks?

<p>They have no possibility of gain (D)</p> Signup and view all the answers

What differentiates life insurance from general insurance regarding the duration of coverage?

<p>Life insurance usually extends beyond 12 months, often for many years (C)</p> Signup and view all the answers

How do insurers contribute to employment in society?

<p>By creating various employment opportunities in the insurance industry. (B)</p> Signup and view all the answers

What type of losses must be assessed and measurable in monetary terms for an event to be classified as insurable?

<p>Financial losses (A)</p> Signup and view all the answers

What is meant by the term 'invisible exports' in the context of insurance?

<p>Insurance coverage provided to other countries. (C)</p> Signup and view all the answers

What role does the insurer have in the process of pooling premiums?

<p>To create and manage the common pool for covering losses (D)</p> Signup and view all the answers

What can be inferred about policyholders in an insurance system?

<p>Policyholders share risk, even though only a few may suffer losses (B)</p> Signup and view all the answers

What psychological benefit does insurance provide?

<p>Peace of mind against future uncertainties. (A)</p> Signup and view all the answers

What aspect of risk does insurance primarily address?

<p>Risk sharing (B)</p> Signup and view all the answers

Flashcards

What is Insurance?

Insurance is an agreement where a group of people with similar risks share the costs of unfortunate events by paying premiums to an insurance company. This company then compensates those who experience losses.

How does insurance work?

The insurer collects premiums from a group of people with similar risks. These premiums are then pooled together to create a fund. The fund is used to pay out claims when insured individuals experience a covered loss.

What is the Common Pool Concept?

The common pool concept is the foundation of insurance. Contributions from many insured individuals are combined to pay for losses experienced by a small number of people.

Who manages the Common Pool?

The insurance company acts as the administrator of the common pool.

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How does the Common Pool work?

The insurance company collects premiums from the insured and pays for claims. This process is based on the Law of Large Numbers, which predicts that predictable patterns emerge from large numbers.

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Who establishes the common pool?

The insurance company typically sets up the common pool and collects premiums from the insured.

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What happens to the common pool funds?

The insurance company uses the collected premiums to pay for the claims of the insured who experience losses.

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Why is the Common Pool effective?

The Common Pool concept is successful due to the Law of Large Numbers, which ensures that predictable patterns emerge from large numbers. This allows the insurer to accurately manage risks and premiums.

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Law of Large Numbers

As the number of similar risks in a group grows, the actual losses experienced by the group will become more and more aligned with the expected average loss.

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Insurance Premium

The amount of money an insured must pay to an insurer for coverage against specific risks.

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Fortuitous Loss

The loss must be accidental, unintentional, and happen due to chance.

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Financial Value

The losses must be measurable in financial terms so that the insurer can calculate coverage and premiums.

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Insurable Interest

A legally recognized connection between the insured and the potential financial loss. The insured must stand to lose financially if the risk occurs.

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Large Number of Similar Risks (Homogeneous Exposure)

Having a large number of similar risks makes it possible for insurers to accurately predict losses and set fair premiums.

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Pure Risks

Risks where only a loss or no loss is possible, with no chance of profiting from the risk. This is what insurance typically covers.

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Legal and Not Against Public Policy

The insured item must be legal and not go against public policy. For example, insurance for illegal activities would be against public policy.

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Premium Calculation based on Risk

High frequency and high severity risks lead to higher insurance premiums compared to risks with low frequency and low severity.

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Primary Function of Insurance

The primary function of insurance is to act as a risk transfer mechanism, where the insured pays premiums to the insurer in exchange for coverage against potential losses.

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Release of Funds

Insurance enables businesses and individuals to free up funds that would otherwise be reserved for financial protection against potential losses, allowing these funds to be used for investments or other purposes.

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Stimulating Businesses

Insurance can play a crucial role in fostering business growth by providing financial protection against various risks, allowing companies to take on new ventures with less financial concern.

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Reducing Fear and Worry

Insurance can provide peace of mind to individuals and businesses by reducing anxiety about potential losses, fostering a sense of security.

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Encouraging Saving

Insurance encourages individuals and businesses to save for the future by providing a safety net in case of unexpected events.

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Social Benefits of Insurance

Insurance can provide social benefits by helping to mitigate the impact of large-scale events, such as natural disasters, providing support to affected communities.

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Investment of Funds

Insurance companies invest premiums collected from policyholders, contributing to economic growth and development.

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How does insurance reduce losses?

Insurance helps reduce the frequency and severity of losses by providing risk assessment services and recommendations.

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Why is insurance a form of saving?

Paying regular premiums creates a systematic savings plan, and the insured receives a lump sum payout at the end of the policy term.

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How does insurance offer social benefits?

Insurance provides financial protection against social risks like accidental death, unemployment, and disability, easing the burden on individuals and their families.

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How does insurance invest funds?

Insurance companies pool large amounts of funds from premiums, which they invest in various sectors to generate profits.

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What is the role of insurance in promoting invisible exports?

Insurance supports the growth of international trade by covering risks associated with exports, creating opportunities for businesses to expand globally.

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How does insurance create employment?

The insurance industry contributes to employment by creating various job roles and opportunities across different departments and sectors.

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What is the main benefit of insurance?

Insurance provides peace of mind by offering financial security and protecting against unforeseen risks.

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How does insurance contribute to loss control?

Insurance helps minimize losses by encouraging proactive risk management and preventative measures.

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Study Notes

Nature of Insurance

  • Insurance is an agreement where a group of individuals with similar risks share the losses of a unlucky few.
  • The insurance company (insurer) compensates the losses.

Operations of Insurance

  • Premium: Contributions from many insured.
  • Common Pool: Premiums pooled together.
  • Measuring Effectiveness: Paying losses suffered by the unlucky few.

How Insurance Works

  • Insurers collect premiums from a group of people in similar circumstances.
  • Not all will suffer losses in any one year, typically over a period of 12 months, though life insurance can be more than 12 months.
  • Premiums are pooled together to pay losses.
  • Losses are shared among all policyholders, not just a few unlucky ones.

Concept of Common Pool

  • Insurance uses a common pool concept, with contributions from many insured.
  • The pool pays for losses suffered by a few.
  • Insurance companies operate this pool with premiums from many insured.
  • The Law of Large Numbers is vital in determining the operations of the common-pool.

Insurance Premium

  • Insurers assess risk and set premiums, which reflect the hazard and risk associated.
  • Contribution from many insured.
  • A common pool where the funds are pooled together.
  • To pay losses suffered by a few.

Characteristics of Insurable Risk

  • Fortuitous Losses: Accidental, unintentional, randomly caused losses.
  • Financial Value: Losses are assessable and measurable.
  • Insurable Interest: Legal recognition of the relationship between insured and potential financial loss.
  • Large Number of Similar Risks (Homogenous Exposure): Allows for accurate loss predictions and premium calculation.
  • Pure Risks: Only losses or no loss, no profit potential.

Characteristics of Insurable Risk (continued)

  • Legal and Not Against Public Policy: Insured items must be legal and not against public interest.
  • No Catastrophic Loss: No huge losses occurring at the same time (like wars or natural disasters).
  • Reasonable Premium: Premium must be fair based on potential loss. High frequency/high severity = higher premium, while low frequency/low severity = lower premium.

Functions of Insurance

  • Primary Function (1): Risk transfer mechanism.
  • Secondary Functions (6):
    • Funds released otherwise tied up in reserves.
    • Stimulate business enterprise.
    • Reduce fear and worry for loss.
    • Reduce losses.
    • Encourage saving.
    • Offer social benefits.
  • Indirect Functions (3):
    • Investment of funds inside pool.
    • Invisible exports - insurance coverage sold to other countries.
    • Source of employment.

Primary Function - Risk Transfer Mechanism

  • Insurance transfers risk from the insured (individuals/businesses) to the insurer (insurance company).

Benefits of Insurance

  • Peace of mind.
  • Loss control
  • Invisible earnings
  • Social benefits
  • Investment of fund

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Nature of Insurance PDF

Description

This quiz covers the fundamental principles of insurance, including the nature of risk sharing and how premiums are collected and pooled. Learn how insurance companies manage losses and the concept of common pool within the insurance framework. Assess your understanding of these key concepts in insurance operations.

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