Principles of Risk and Insurance Flashcards
Risk
the possibility of an adverse deviation from a desired outcome that is expected or hoped for.
Peril
An event that causes a loss, such as fire, theft, hail
Hazard
A condition or situation that either increases or creates the chance that a loss will occur from a given peril. Ex: building a house in a flood plain increases the chance for a loss from flood.
Law of Large Numbers
recognition that as the more trials of a certain activity are observed, the greater the reliability in predicting the outcome.
Adverse Selection
individuals who are most likely to need insurance benefits are the ones most likely to buy it. Happens when poorer risk individuals are permitted to purchase insurance without paying adequate premiums for the risk assumed.
4 elements that make a risk insurable
1) there must be a sufficient number of large and similar (homogeneous) type of events to make the loss reasonably certain to occur.
2) the losses must be definite and measurable
3) the losses must be fortuitous or accidental
4) the losses must not be catastrophic to society
Self-Insurance
the concept of insuring oneself or others (such as company employees) without transferring the risk to a third party. Typically, large companies will self-insure by establishing a separate fund for losses and assuming the liability to predict future losses.
5 ways to manage risk
1) Retention (risk financing)
2) Transfer (risk financing)
3) Diversification (risk control)
4) Reduction (risk control)
5) Avoidance (risk control)
High Severity of loss and High probability of loss
Avoid the risk
Low severity of loss and High probability of loss
Reduce the risk
High Severity of loss and low probability of loss
Transfer the risk
Low severity of loss and low probability of loss
Retain the risk
Principle of Indemnity
- a principle stating that the insured will only be reimbursed for the amount of his or her actual loss and cannot make a profit from the loss.
- heath insurance policies use this principle in underwriting the assumed risk
Insurable Interest
- the point in time when an insurable risk must exist
- for P&C insurance an insurable interest must exist both at the time the policy is first written and at the time that the loss is claimed.
- for life insurance an insurable interest only needs to exist at the time the policy is first underwritten
Subrogation
-the insured is required to assign his or her right of recovery against a third party to the insurance company if the company pays for a loss caused by a third party.
