Nature of Insurance and Risk Concepts

The tendency of higher-risk individuals to seek or maintain insurance more than those with lower risk.

A factor increasing the possibility of a loss occurring.

Similar items insured, exposed to the same perils.

Restoring someone to their financial condition before a loss.

The amount to restore someone to their pre-loss financial stance.

Predicting losses more accurately with more insured risks.

Unintentional decrease in asset value due to a peril.

Risk increased due to insured's actions or behavior.

A risk management technique where individuals share the possibility of loss and spread the cost over a large group, transferring risk from individual to group.

Exchanging the responsibility for a potential loss to another party in exchange for a premium.

A risk retention process where individuals maintain money reserves to cover potential losses.

Risk involving both potential loss and gain, not insurable.

The principle of insurance contracts that aims to reimburse for losses, restoring the insured to their pre-loss financial condition.

The process used by insurance companies to evaluate risks and ensure fair compensation for the risks they undertake.

A risk that meets specific criteria making it suitable for insurance coverage.

The loss must be unpredictable and outside the insured's control, meaning it happens randomly.

The loss must be clearly documented with details like date, time, amount, and the cause.

Insurance companies must be able to estimate the average frequency and severity of future losses.

The loss must be reasonable for insurance coverage, not too large or uncertain for the insurer to handle.

There must be enough similar risks (loss exposures) to allow the insurance company to apply the law of large numbers.

The cost of the insurance premium must be affordable for the insured and relatively small compared to the potential loss.

A risk considered average in terms of potential loss, typically insured at a standard premium.

A tangible condition that increases the likelihood of a loss. It can be seen, touched, or even smelled.

Physical hazards are tangible conditions that increase the chance of loss, while moral hazards arise from the insured's dishonesty or tendency to cause a loss.

An example of a morale hazard is an individual leaving their car unlocked and running unattended in cold weather, increasing the risk of theft due to their carelessness.

A risk that offers the possibility of both loss and gain. It is not insurable due to the unpredictable nature of the outcome.

Speculative risks offer the possibility of gain, while traditional insurance risks only involve potential losses. This is why speculative risks are not typically insurable.

Speculative risks are not typically insurable because they involve the potential for gain, unlike traditional insurance, which focuses on covering potential losses. This makes it challenging for insurance companies to accurately assess and price the risk.

A planned strategy where individuals hold reserves to cover potential losses, essentially self-financing them.

The immediate and specific cause of a loss, like fire, flood, or theft.

Actions taken to eliminate or significantly reduce the risk of damage or loss.

An unintended reduction in value, often financial, caused by a covered peril.

An insurance policy that names and covers losses only from specific perils listed in the policy.

An insurance policy covering losses from any peril not specifically excluded in the policy.

A financial principle in insurance that aims to restore the insured to their original financial position after a loss.

Higher-risk individuals seeking insurance more frequently than lower-risk ones, possibly leading to higher premiums for everyone.

A balanced mix of low-risk, average-risk, and high-risk individuals within an insurance pool. This helps ensure the insurance company can cover claims while staying profitable.

The process of carefully assessing and evaluating potential policyholders to reduce the risk of adverse selection. It involves understanding the risks and pricing policies accordingly.

The immediate event or cause of a loss. This can be anything from a fire to a storm to a car accident.

Insurance policies that explicitly list the specific events or perils that they cover. If the cause of loss isn't on this list, it's not covered.

Insurance policies that cover all direct causes of loss, except those specifically excluded. It's like having a blanket coverage.

Several factors influence the risk of adverse selection, including the nature and extent of the risk pool, the quality and effectiveness of underwriting, and the availability of information about potential policyholders.

Sound underwriting is crucial for insurance companies because it helps to mitigate the risk of adverse selection. It involves careful evaluation of potential policyholders, setting appropriate premiums, and limiting coverage for high-risk individuals. This ultimately contributes to the financial stability of the insurance company.