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Assuming that losses do occur, deals with sources pf funds to pay for losses.
what are the three sources of funds to pay for losses that are of the risk financing type?
- 1. External funds
- 2. internal funds
- 3. Alternative risk financing schemes
Selling a house is an example of ____ing a loss exposure.
What are the two types of risk transfers of the financing type?
Insurance and non insurance risk transfer.
Seeking funds from unrelated third parties to pay for losses.
risk transfers of the financing type
______transfers the financial responsibility of a loss to a third party
risk transfers of the financing type
a lease is an example of____
a non insurance risk transfer of the financing type
A hold harness agreement is an example of a_________
non insurance risk transfer of the financing type
A firm/individual engaging in______ assumes financial responsibility for losses that do occur
What 2 Rm financing techniques are illustrated by using insurance with a deductible?
- 1. risk transfer of the financing type
- 2.Active retention
Knowingly retaining a loss
Unknowingly retaining a loss
_______usually results from a failure to properly identify the loss exposure or from an underestimation of a loss exposure.
A firm sets aside funds every time period to pay for losses.
When losses do occur, they are paid from current revenue or borrowed funds.
______ retention is better for losses that are higher severity and more predictable.
______retention is better for losses that are lower in severity and lower in frequency.
Active, funded retention
What are the 4 types of retention
What are two things that are commonly self insured?
- 1. health insurance benefits for employees in an employee benefit plan
- 2.Workers compensation
Self insured retention(SIR)
insuring for losses up until a certain limit.Ex. alter hall first 10 million of losses is retained by temple. after that, fm global insures.
What are the ideal characteristics of self insurance?(2)
- 1. fairly predictable(if a firm is large enough)
- 2.long payout period(workers comp)
Long tailed loss
A recurring loss that lasts for a long time
What is an example of a long tailed loss?
Workers compensation for an injury.
Why are long tailed losses easy to retain?
They allow for the possibility of pre-funding the "known" losses occurring in the future
What is an example of a short tailed loss?why?
a building burning down because the loss only occurs once.
What are the advantages of self insurance?(4)
- 1.Potentially less expensive
- 2.the time value of $
- 3.Firms can retain the full benefits of successful loss prevention and loss reduction programs
- 4.flexibility in the design of their "insurance" programs
(___1___cost of self insurance)<(___2___cost of Market insurance)
cost of self insurance
formula for the insurance premium
reasons for savings from self insurance?
- no risk charge
- no distribution expense
- no advertising
- no commissions
- no state premium taxes
Time value of $
money can be invested internally at a higher rate of return (ROR) than is credited by the insurer
When using market insurance, savings given to employees from successful loss prevention and loss reduction programs is___________.
not dollar for dollar.
Moral hazard is more prevalent in________(market insurance or self insurance) contracts.
Market insurance contracts
For firms that self insure;the flexibility in the design of their insurance programs is only prevalent for________________.
Why is their flexibility in the design of their insurance programs for firms that self insure?
health insurance contracts are regulated and full of state mandated benefits. self insurance does not have to abide by those rules.
What are the disadvantages of self insurance vs. market insurance?(3)
- 1. the possibility of a catastrophic loss
- 2. firms have to perform many of the administrative activities associated with insurance.
- 3. There are potential employee "PR" problems when denying claims.
Stop loss insurance
basically insurance with a very large deductible
Specific/individual stop loss
When a firm retains the first_$___ of an INDIVIDUALloss.
Aggregate stop loss
Retaining a total amount of losses from all events up to a specified amount.
What is an ASO contract?
Stands for administrative services only. A contract for firms that self insure.
Third party administrator
What are the two ways for self insure firms to eliminate the extra administrative activities associated with insurance.(2)
A wholly owned subsidiary of a firm(not in the insurance business).
What is the primary purpose of a captive insurance company
to insure the risk s of the parent company/companies
What are the two types of insurance captives?
- Single parent captives
- association captives
a captive for a group of companies, insurers, or municipalities
Risk retention group
A group captive formed under the requirements of the liability risk retention act of 1986 to insure parent organizations.
Each decision has two types of costs which are___________ and _________.
- 1. monetary cost(EL)
- 2. cost of uncertainty(worry value)
The cost of uncertainty associated with a particular decision.
The worry value of a person is________ to a decision maker.
Insurance for P* only.
maximum premium a person is willing to pay for insurance against a particular risk.
Choosing the option that minimizes total cost
Risk neutral WV
What are four rm options?
- partial insurance
- full insurance
- deductible insurance
formula for total cost of a rm option
A firm or person's WV will increase as:(6)
- size of max possible loss increases
- prob of max possible loss increases
- variability in losses increases
- The level of confidence in estimate of P* decreases
- the financial strength of a firm or person decreases
- the level of insurance coverage decreases
qualitative decision making techniques
choice of rm options based on characteristics of the loss exposure
best options for low frequency low severity rm options
best options for high frequency low severity rm options
funded retention or loss prevention
best options for low frequency high severity rm options
insurance or loss reduction
best options for high frequency high severity rm options
- avoidance(1st choice)
- loss prevention,loss reduction(2nd best)
- captives and RRG's
Adding another person to the risk pool_____'s the insurers risk.
As the risk pool increases in size the risk faced by the insurer decreases and eventually approaches_________.
0 because of the (law of large #'s)
Insurance is a device that(3):
- Pools exposures of loss of individuals into a group
- uses funds paid by members of the group to pay for losses as they occur
- group as a whole is engaged or involved in a loss/risk sharing arrangement.
premiums paid by people who had a loss
When purchasing insurance, what is the commodity being purchased?
- promise to pay the loss
- peace of mind
- enhancement of credit worthiness
when buying insurance you are essentially trading an_______ for a __________.
unknown loss for a known loss
Insurance involves_____ and _____
pooling and transfer
What is transferred to an insurer when buying insurance?
The financial responsibility to pay for a loss to an insurer.
Insurer agrees to_____ the insured in the event of a covered loss.
place the insured in the same position financially after the loss as they were in prior to the loss.
Does it make sense for insurers to provide contracts which always provide full indemnification?
nope, that would create a lot of moral hazard
What are two ways an insurer deals with moral hazard?
offering deductible or partial insurance instead of insurance contracts that fully indemnify an individual.
What are some forms of indemnification?(3)
- paying or reimbursing the insured
- repair /replace an asset
- provide services
What are two types of ways insurers pay for losses?
- paying after the loss occurs and determine the amount paid to the insured after the loss.
- paying for the loss after it occurs, but the amount of the loss is determined in advance
What are some items that have amounts paid determined in advance
one of a kind items/life insurance/items lost at sea
principle of indemnity
In the event of a loss, the insured should not collect more than the actual cash value of the loss.
simply a way to value/measure a loss(actual cash value)
formula for actual cash value(ACV)
Replacement cost-depreciation based on replacement cost
what it would cost to replace an asset with like workmanship and materials (replicate what you have)
What is the purpose of having the principle of indemnity?
to control moral hazard.
what are 3 common violations of the principle of indemnity
- life insurance
- insurance for one of a kind items
- homeowners insurance
General requirements of an insurable risk
- a supply of an insurance
- a demand for insurance
- a market exists
Why might PI>pmax?
Pi is too high or Pmax is too low
Why might PI be too high?
- A. P* is too high
- b. R.c is too high
- c. adm costs are high
Why might Pmax be too low?
- A. underestimate the frequency/severity of a loss
- B. disaster relief
Specific requirements of an insurable risk (6)
- 1. loss should be fortuitous in nature
- 2. loss should be catastrophic in nature
- 3. definite and measurable
- 4. large number of exposure units
- 5.independent and not catastrophic
- 6. affordable
A risk is insurable if
A risk is not insurable if
who came up with the idea of charity hazard?
Loss should be fortuitous in nature
- requirement of an insurable risk
- random accidental or a matter of chance
- insured should have no control of the freq/severity of a loss
What are some solutions to the Moral hazard problem?(5)
- 1. deductibles,copayments
- 2. experience rating(ex. rate goes down with no accidents)
- 3. claims investigation
- 4. loss settlement rules
- 5. policy limits
Why are cat losses a problem for insurers?
- 1. Difficult to predict the overall expected loss
- 2. creates a risk of insolvency for the insurer
- 3.LLN's assumes that the random events in question are independent events
solutions to catastrophic losses for insurers.
diversify geographically or financially
How does an insurer diversify financially?
What are some contemporary examples of a catastrophic loss?
- 1. workers compensation
- 2. employee benefits
Terrorism risk and insurance act
Risk pools should be _____ and ______.
Large and homogenous
- Same P*
- same amount of risk
If pools are heterogeneous, the ___1___risked individuals subsidize the ___2____ risked individuals
Arises when the assumption of homogeneous exposure units is violated
insured has more information than the insurer concerning the risks(ex a person lying about smoking)
Why does Adverse selection occur?
- 1. Insured may give incorrect info on purpose
- 2. rates that the insurers can charge may be regulated
- 3. cannot ask insureds the right questions or use observable information (ex.gender rating)
How many rating bands are in the affordable care act
3 as opposed to the usual five
how is adverse selection controlled?
- 1. insurer gains more info or engages in more careful underwriting
- 2.compulsory insurance
5th requirement of an insurable risk
loss should be significant to the insured.
4th requirement of an insurable risk
definite and determinable
easy to verify that the loss has occured
easy to verify risks
- property damage
easy to place a dollar value on the loss
What do insurers do to make losses more definite?
- independent verification of losses such as
- claims investigators
- or police reports
What do insurers do to make losses more determinable?(2)
- settlement rules
- specifying the amount of the loss before it occurs
two types of compulsory insurance
- a. a single insurer(ex. social security)
- b. multiple insurers(ACA)
principle of utmost good faith
parties to an insurance contract are held to a higher standard of honesty than parties to an non insurance contract.
Can an insurer deny a claim of an insured if they lied about something?
- only if it is a material fact
- If they breached a warranty
- failure on he part of an insurer to reveal a material fact about the risk even though they were not asked.
- Insureds MUST volunteer material facts about the risk
Breach of warranty
Any breach of the warranty will void the contract even if unintentional.