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Risk is the possibility (uncertainty)that a loss might occur and the reson people buy insurance.
Two types of risks are:
- 1.Speculative risk
- 2.Pure risk
What is speculative risk?
Is a risk situation that offers the opportunity for gain as well as the possibility of loss. Insurance will not cover this type of risk, e.g. gambling.
What is Pure Risk?
Pure risk is the type of risk insurers accept. With pure risk, there is the possibility that an event will occur, such as an accident or illness. However, it is purpose of insurance to restore the insured to the insured's original position, not to provide a person with the opportunity of making a profit on an accident or sickness.
A Peril is the cause of a loss, such as sickness, death, or accident.
- A hazard is a situation that increases the possibility of the loss occuring and could fall into 3 areas:
- 1.Physical cause
- 2.Moral cause
- 3. Morale cause
Define a hazard as a Physical cause.
Physical cause , such as a health condition or a dangerous occupation or hobby.
Define a hazard as a Moral hazard.
Moral hazard, which includes a false claim to defraud the insurance, orcommitting, an illegal act, then asking the insurer to pay for injuries sustained while committing the illegal act.
Define Morale condition as a hazard.
Morale condition, such as when a policy owner is unconcerned about the impact of unnecessary medical claims on a company's financial condition (e.g. a person asking for as many expensive tests as possible, just because he has Health Insurance.
Define an underwriter.
An underwriter in an insurance company evaluates risks for the probability of loss, severity, and potential dollar losses over time. Once the loss is exposures are identified and analyzed, the technique STARR, a risk management technique.
- 1. Shared
- 2. Transferred
- 3. Avoided
- 4. Retained
- 5. Reduced
Name the 5 ways to manage risk: STARR
- 1. Shared risk, is when insurance is purchased, and the burden of the risk is shared among a number of insureds who have the same chance and uncertainty of an event occurring. A pooling concept is used to make predictions.
- 2. Transferred is a risk of loss transferred to the insurance company when insurance is purchased.
is a risk to avoid a risk, a person with fear of flying may choose to drive instead; avoiding a risk may sometimes be difficult, but it usually not impossible.
is a risk when a person decides to assume financial responsibility for certain events by not buying an insurance policy, and instead considers his own personal assets.
risk is controlled, e.g., when a person with high blood pressure begins making a healthier lifestyle choices, such as losing weight or quitting smoking, thereby reducing his chances of a stroke.
Give an example of Retained risk.
Retaining a risk is observed through the deductible amount on a Health Insurance Policy. If the deductible amount is increased, the premium is reduced, because of this assumption of risk.
How does insurance company manage the burden of risk in shared risks?
Insurance companyies predict the potential losses of a large group by studying its prior experiences and applying the mathmatical principles of probability and statistics. Looking at a group of individuals (rather than the individuals themselves) to make predictions is called the pooling concept. Which is an accurate way of predicting potential losses.
What kind of pooling concept do Life Insurance companies use?
A Life Insurance company sets up a Mortality Pool. where people share the risk.
What kind of Pooling Concept do Health Insurance companies?
For Health Insurance products, the company sets up a Morbidity Pool.
What is Morbidity in respect to Health Insurance companies?
Morbidity is concerned with the severity of a loss, the duration of the sickness, and the frequency of its occurrence.
What are the characteristics for determining which group of individuals share a common risk?
age, gender, and occupation
What is the Law of Large Numbers?
- Insurance companies can predict only the number of losses expected for a group, not for any individual.
- An insurance company must protect losses on a homogeneous group.
- Risks are not considered insurable unless the insure has a large enough base of previous loss experience to be able to predict future losses.
- Mortality tables are based on groups of at least 10,000,000 people.
What is essential for the Law of Large Numbers to be accurate?
The basic principle of this law is that the larger the number of seperate, similar risks combined into one group, the more predictable the number of future losses of that group, within a given time period. It is Essentiall that a large number of exposure units be combined.
Explain Exposure Units in regard to the Law of Large Numbers.
- If enough exposure units are combined, the degree of error in predicting future losses decreases to a reasonable level.
- The larger the group, the more closely the predicted experiences will approach the actual loss experience.
- The insured who suffers loss are compensated, while many others do not experience sizable losses, e.g. some people live beyond life expectancy is immaterial, since they are balance by other people who die prematurely.