Purpose of Insurance Flashcards

Questions and Answers

What is insurance?

The significance of insurance is its promise to substitute future economic certainty for uncertainty and to replace the unknown with a sense of security.

What is a risk?

Uncertainty regarding financial loss.

What are the two types of risk?

Pure risks and speculative risks.

Which risk is insurable, and why?

Pure risks because they involve only the chance of loss; there is never a possibility of gain or profit. Signup and view all the answers

What specific event causes a loss and gives rise to a risk?

Peril; such as fire, accident, or flood. Signup and view all the answers

What is a hazard?

Any factor that gives rise to a peril. Signup and view all the answers

List and describe the types of hazards for purposes of life and health insurance.

<ol> <li>Physical: Individual characteristics that increase the chance of a peril, such as blindness or medical history. 2. Moral: Tendencies that people have that may increase risk and chance of loss, such as smoking or drinking. 3. Morale: Tendencies that arise from an attitude or state of mind causing indifference to the loss, like jaywalking or careless driving.</li> </ol> Signup and view all the answers

List and describe the 4 ways to handle risk.

<ol> <li>Avoidance - Simply avoiding the risk (choose not to fly). 2. Reduction - Lessen the possibility of loss (install a smoke alarm). 3. Retention - Accepting the risk and confronting it when it occurs (self-insured). 4. Transference - The loss is handled by another party (buy insurance).</li> </ol> Signup and view all the answers

What are the 6 elements that make pure risk insurable?

<ol> <li>Due to chance - Chance of loss beyond insured control. 2. Must be definite and measurable - Loss must have definite time, place, and amount. 3. Must be predictable - Number of losses must be statistically predictable. 4. Loss cannot be catastrophic - There must be limits that loss can't exceed. 5. Exposure must be large - Insurer must be able to predict losses based on the law of large numbers. 6. Exposure must be randomly selected - Insurer must have fair proportion of both good and bad risks.</li> </ol> Signup and view all the answers

What is the concept that predicts the appropriate number of deaths that should occur within a similar group of people within a given period of time?

Law of Large Numbers. Signup and view all the answers

What is adverse selection?

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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.