Nature of Insurance and Risk Concepts

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Questions and Answers

What is defined as the tendency of individuals with higher risks to seek insurance more than those with lower risks?

Adverse Selection (correct)

Loss Exposure

Moral Hazard

Homogeneous Exposure

Which term describes an increased possibility that a peril will actually occur?

Loss Exposure

Indemnify

Hazard (correct)

Indemnity

What principle states that grouping a larger number of individual risks leads to more accurate predictions of loss?

Law of Large Numbers (correct)

Principle of Indemnity

Law of Average

Theory of Risk Management

What is the purpose of an indemnity contract?

To return the insured to their original financial position Signup and view all the answers

What does 'loss exposure' refer to?

The risk of a possible loss Signup and view all the answers

Which of the following statements best defines 'moral hazard'?

A risk due to the insured's personal characteristics Signup and view all the answers

What is meant by 'indemnity' in the context of insurance?

The amount needed to restore financial condition after a loss Signup and view all the answers

Which term refers to individual units that share similar risks and perils in insurance?

Homogeneous Exposure Units Signup and view all the answers

What kind of hazard is demonstrated by leaving a can of gasoline near a furnace?

Physical Hazard Signup and view all the answers

Which of the following is an example of a moral hazard?

Driving under the influence Signup and view all the answers

What best describes a morale hazard?

An indifferent attitude towards loss prevention Signup and view all the answers

Which statement is true regarding speculative risk?

It presents the chance for both loss and gain Signup and view all the answers

Which of these is NOT an example of a physical hazard?

A lack of driving skills Signup and view all the answers

How does a moral hazard increase the likelihood of a loss?

Through the insured's predisposition toward dishonest behavior Signup and view all the answers

Alex leaving his car running unattended is an example of which type of hazard?

Morale Hazard Signup and view all the answers

What is the primary feature of a speculative risk?

It involves both potential gains and losses. Signup and view all the answers

What is the primary purpose of risk sharing?

To spread the cost of risks over a large group Signup and view all the answers

What does self-insurance primarily involve?

Maintaining reserves to cover potential losses Signup and view all the answers

How does the Law of Large Numbers contribute to risk management?

It allows for predictable losses across a larger group Signup and view all the answers

What is adverse selection in the context of insurance?

A scenario where one party holds more accurate information about risk Signup and view all the answers

Which of the following describes speculative risk?

It involves the possibility of both loss and gain Signup and view all the answers

What does risk transfer involve?

Exchanging risk for a smaller, predetermined cost Signup and view all the answers

How can insurance underwriting help mitigate adverse selection?

By collecting comprehensive data about risks Signup and view all the answers

What is the significance of indemnity contracts in insurance?

They reimburse for actual loss incurred Signup and view all the answers

What characteristic of an insurable loss ensures that the loss is outside the insured's control?

Due to chance Signup and view all the answers

Which of the following is NOT an element of an insurable risk?

Must be capable of substantial gains Signup and view all the answers

What does a 'definite and measurable' insurable loss refer to?

Losses that can be documented in terms of time, place, and amount Signup and view all the answers

Why must an insurable loss be predictable?

To avoid adverse selection Signup and view all the answers

What describes risks that are considered to have an average potential for loss?

Standard risks Signup and view all the answers

What is the implication of a loss exposure being deemed catastrophic?

It is too large and uncertain for the insurer to cover Signup and view all the answers

Why is it necessary for the number of loss exposures to be substantial?

To predict losses accurately using the law of large numbers Signup and view all the answers

What does it mean for a premium to be economically feasible?

It is affordable and small compared to the loss exposure Signup and view all the answers

What distinguishes self-insurance from having no insurance?

Self-insurance is based on planned strategies and reserves. Signup and view all the answers

What is loss prevention primarily concerned with?

Identifying and controlling potential losses. Signup and view all the answers

Which principle ensures that insured individuals are restored to their original financial state after a loss?

Principle of Indemnification Signup and view all the answers

How does the law of large numbers relate to insurance?

It improves accuracy in predicting aggregate risk. Signup and view all the answers

What does a policy that covers 'specified or named perils' do?

Lists and specifically covers only certain perils. Signup and view all the answers

Which term refers to the immediate cause of a financial loss?

Peril Signup and view all the answers

What is meant by 'indemnity' in insurance terms?

The act of financially restoring an insured after a loss. Signup and view all the answers

What is the main consequence of adverse selection for an insurance company?

It results in taking on more risk than is adequately compensated. Signup and view all the answers

What is the purpose of sound underwriting in insurance?

To reduce the chances of adverse selection. Signup and view all the answers

Which of the following best describes a peril in insurance terms?

An immediate event causing loss. Signup and view all the answers

How do Special or Open Peril insurance policies define coverage?

By stating all direct causes of loss except those specifically excluded. Signup and view all the answers

What type of insurance covers legal responsibilities due to negligence?

Liability insurance Signup and view all the answers

Which of the following is true about Named Perils policies?

They list specific perils that are covered in the policy. Signup and view all the answers

Which statement accurately reflects group life insurance?

It aims to reduce the chance of adverse selection. Signup and view all the answers

What does accident and health insurance primarily cover?

Losses caused by illnesses and accidents. Signup and view all the answers

Study Notes

Nature of Insurance, Risk, Perils, and Hazards

Adverse Selection: People with higher risks are more likely to buy insurance than those with lower risks. This leads to a higher percentage of high-risk individuals in the insured population than actuaries expected.
Hazard: A factor, condition, or situation that increases the possibility of a loss occurring.
Homogeneous Exposure Units: Similar objects of insurance exposed to the same perils (e.g., all cars in a city).
Indemnify: Restoring someone to their financial condition before a loss. This can be through reimbursement or a fixed dollar amount.
Indemnity Contract: Aims to return the insured to their original financial position before the loss.
Law of Large Numbers: Predicting loss amounts becomes more accurate with a larger number of insured objects.
Loss: Reductions in the value of assets due to unintentional decrease caused by a peril.
Loss Exposure: The potential for a loss.
Loss Exposure Unit: Individual (e.g., a person, an organization, or an asset) that has the potential for a loss. Combining loss exposure units gives a total potential loss.
Moral Hazard: Insureds may act more carelessly or dishonestly since they are protected from loss.
Morale Hazard: Insureds become indifferent toward losses due to insurance coverage. This often comes from a careless attitude.
Peril: An immediate specific event that directly causes a loss (e.g., fire, flood).
Physical Hazard: A tangible or physical condition that makes a loss more likely (e.g., faulty wiring).
Primary Insurance Company: In cases of multiple policies covering one claim, this is the first policy to pay. It also functions as the original insurer of a risk, passing some of the risk to a reinsurer.
Pure Risk: Exposure to loss only, no chance of gain.
Reinsurance: An insurance company (reinsurer) takes on a portion of the risk from another insurance company (primary insurer) for a premium. This allows the insurer to manage risks and potential large losses.
Reinsurer: An insurance company that accepts a portion of another insurer's risk.
Risk: The probability of a loss occurring.
Risk Avoidance: Avoiding all risk-related activities.
Risk Management: Analyzing risk exposures and designing programs to address them.
Risk Reduction: Actions to decrease the likelihood or severity of a loss.
Risk Retention: Analyzing potential loss from a risk and accepting the risk if it's deemed acceptable.
Risk Sharing: Individuals or groups share risk, distributing costs.
Risk Transfer: Shifting risk to another party (for a cost).
Self-Insurance: Maintaining reserves (funds) to cover potential losses rather than purchasing insurance.
Speculative Risk: Risk with potential loss and gain. It is not insurable.

Primary Insurance Company

In cases of multiple policies covering one claim, the "primary" insurance company is the first to pay.
This company initially insures the risk, and part of the risk might be transferred to another company to accommodate large risks.

Perils, Loss, and Hazards

Peril: The specific event causing a loss.
Loss: An unintended reduction in the value of an asset or liability.
Hazard: A condition, event, or situation that increases the chance of loss occurring.

Insurable Loss

Must be due to chance (unintentional).
Must be definite and measurable (time, place, amount).
Must be predictable (frequency & severity).
Cannot be catastrophic (too big or unpredictable).
The number of exposures (units) must be substantial to use "Law of Large Numbers".
Premium cost must be economically feasible.

Types of Risks

Standard Risks: Average potential for loss.
Substandard Risks: Higher-than-average potential for loss, so require a higher premium.
Preferred Risks: Lower-than-average potential for loss, so require a lower premium.

Risk Management Methods

Risk Avoidance: Eliminating activities that expose someone to risk.
Risk Reduction: Actions taken to reduce the likelihood or magnitude of loss (e.g., installing alarms).
Risk Retention: Accepting the risk and setting aside funds to cover potential loss (e.g., deductibles).
Risk Transfer: Shifting risk to another party (e.g., insurance).
Risk Sharing: Sharing risk among multiple parties (e.g., insurance pools).
Risk Pooling: Spreading the risk of loss among numerous individuals.
Reinsurance: Passing risk to another insurance company.

Adverse Selection

Tendency of higher risk individuals to seek insurance more and results in the insured population having a larger number of high risk individuals than expected.

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Description

This quiz explores fundamental concepts related to insurance, such as adverse selection, hazards, and indemnity contracts. Understand the principles that govern risk assessment and loss exposure in insurance. Test your knowledge on how these elements interact within the insurance industry.