Insurance Basics

Insurance Basics

1. Transfers

   • The risk of loss from an individual/business entity to an insurance co., which in turn spreads the cost of unexpected losses to many individuals; without the cost would borne solely by the individual who suffered the loss.
   • Risk
     • Uncertainty/chance of a loss occurring 
     • Pure Risk
       • refers to situations that can only result in a loss/no change No oppurtunity for financial gain only type of risk that insurance co. will accept
     • Speculative Risk
       • invloves the opportunity for either loss/gain  ex. gambling
     • Risk Management Key Terms
       • Exposure
         • unit of measure  used to determine rates charged for insurance coverage
         • Determining rates
           • 1. age of insured 2. medical history 3. occupation 4. sex
       • Homogenous
         • large number of units having the same/ similar exposure to loss
       • Hazards
         • conditions/situations that increase the probability of an insured loss occuring
         • Physical
           • Individual characteristics that increase the chances of the cause of the loss ex. physical conditions/ past medical history/conditions at birth
         • Moral
           • (tendencies towards increased risk) evaluating the character and reputation of the proposed insured ex applicantes who lie on applications/submitted fraudulent claims against insurer
         • Morale
           • similair to moral hazards except they arise from indifference to loss ex. actions taken w/out forethought may cause physical injuries
           • Peril
             • are the causes of loss insured against in an insurance policy.
             • Life insurance
               • insures against the financial loss caused by premature death
             • Medical insurance
               • insures against the medical expenses and/ or loss of income by the insureds sickness/accidental injury
             • Property insurance
               • insures against the loss of physical property/the loss of its income producing abilities 
             • Casualty insurance
               • insures against the loss/damage of proerty and resulting in liabilities
           • Loss
             • reduction/decrease/disapperence of value of the person/propery insured in a policy caused by a named peril
     • Methods of handling risk
       • Avoidance
         • eliminating exposure to a loss ex. risk avoidance is effective but seldom practical
       • Risk retention
         • is the planned assumption of risk by an insured through the use of deductibles/co-pays/self insurance self insurance insured accepts the resonsibility for the loss before the insurace pays Purpose of retention is; reduce expenses and improves cash flow increase control of claim reserving and claim settlements fund for losses that cannot be insured
       • Sharing
         • method of dealing with risk for a group of individual persons/businesses w/ the same/similar expossres to loss to share that losses that coccur w/in that group
       • reduction
         • attempt to lessen the possibility/ severity of a loss
       • transfer
         • the most effective way to handle risk is to transfer it so that the loss is borne by another party *insurance relieves the insured of the fincancial losses these risks bring
     • Elements of inurable risks
       • loss most be due to chance (accidentical
       • loss must be definite and measurable
         • definite as to cause/time/place/amount insurer must be able to determine how much the benefit wil be and when it becomes payable
         • *legal contracts conditions must be exact as possible
       • loss must be statistically predictable
         • enables insurers to estimate the average frequency and severity of future loss and set app. premium rates
       • loss cannot be castastrophic
         • need to be resonably certain that the losses will not exceed certain limits
         • exclude coverage for loss covered by nuclear wars/nuclear
       • loss exposure to be insured must involve large homogenous exposure units
         • grouped into classes w/ similair risks so the insurer is able to predict losses based upon the law of large numbers
         • law of large numbers
           • the use of mortalily tables allows the insurer to project losses based on stats
       • insurance must not be required to issue a policy to each applicant applying for coverage
         • ability to require that certain underwriting guidelines be met

2. Adverse selection