Purpose of Insurance Flashcards

Study Notes

Purpose of Insurance

Insurance provides economic certainty by replacing uncertainty with security.
It promises to compensate for potential future losses, giving individuals a sense of protection.

Understanding Risk

Risk is defined as uncertainty related to potential financial loss.
There are two main types of risk: pure risks (insurable) and speculative risks (not insurable).

Insurable Risks

Pure risks involve only the possibility of loss, with no chance of gain or profit.
Events that directly cause loss and generate risk are known as perils (e.g., fire, accidents, floods).

Hazards and Their Types

A hazard is any factor that increases the likelihood of a peril.
Types of hazards in life and health insurance:
- Physical Hazards: Individual traits (e.g., blindness, medical history) increasing peril risk.
- Moral Hazards: Behavioral traits (e.g., smoking, drinking) that elevate risk.
- Morale Hazards: Attitudinal factors (e.g., indifference leading to careless behavior) that heighten risk.

Risk Management Strategies

Avoidance: Completely avoiding the risk (e.g., choosing not to fly).
Reduction: Lowering the possibility of loss (e.g., installing smoke alarms).
Retention: Accepting risk and dealing with it when it occurs (e.g., being self-insured).
Transference: Shifting the potential financial loss to another party (e.g., purchasing insurance), which is the most effective risk management method.

Insurability Elements

Six elements make pure risk insurable:
- Due to Chance: Loss must arise from factors beyond the insured's control.
- Definite and Measurable: Loss must have specific characteristics (time, place, amount).
- Predictable: Losses should be statistically predictable in number.
- Not Catastrophic: Loss limits must exist to prevent overwhelming the insurer.
- Large Exposure: Insurers can estimate losses accurately based on large numbers.
- Random Selection: A fair mix of high and low-risk individuals is necessary.

Law of Large Numbers

This concept predicts the expected number of deaths in a group within a specified timeframe, enabling more accurate insurance calculations.

Adverse Selection

Adverse selection occurs when there is an imbalance in the information between the insured and insurer, leading to a higher likelihood of insuring high-risk individuals.

Description

Explore the fundamental concepts of insurance through these flashcards. This quiz covers essential terms such as insurance, risk, and the types of risk involved. Ideal for students seeking to understand the basics of insurance.