Notes
1: Why Do We Have Insurance?
Content of the notes (5)
Page 1
What is Insurance?
Insurance addresses people's and business's concerns about the possible financial effects of an unforeseen event, like a fire, or an auto accident.
It is also a risk management technique that transfers the risk of financial consequences resulting from loss exposures to an insurer.
Loss Exposure
A loss exposure is any condition or situation that presents a possibility of loss, whether or not an actual loss occurs.
Page 2
Key Components of Insurance
1. Risk
Risk is uncertainty about outcomes, and can be negative or positive.
Example: Purchasing a home.
Negative Risk = House could catch fire.
Positive Risk = Could potentially sell the home for more than what you initially paid.
2. Transfer
Even though risk management is concerned with both positive and negative risk, insurance alleviates the uncertainty associated with negative financial consequences.
How does this affect the insured's budget?
Example: Homeowner's Insurance
The policyholder has to budget for a monthly premium that covers property damage.
The policyholder does not have to budget for the cost of rebuilding their home, should disaster strike.
3. Pooling
Pooling means that all insureds share the cost of each other's losses.
All premiums collected by an insurer are pooled together collectively into a fund that is used to pay losses as they occur.
There are two major benefits to this:
It helps keep premiums affordable.
It helps the insurer cover large losses when they occur.
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The Benefits of Insurance
Key Term: Indemnify
Indemnify means to restore an individual to the state they were in before the loss occurred.
1. Pay for Losses
Insurance indemnifies individuals and organizations for covered losses.
2. Manage Cash Flow Uncertainty
As long as a loss is covered by insurance, the financial effect on the insured's cash flow will be reduced to deductible payments or loss amounts that exceed the policy limits.
*This was addressed in the last slide. An individual has to budget for deductibles/premiums, but no longer has to budget for potential disasters.*
3. Comply with Legal Requirements
For example, Workers' Compensation insurance and Personal Auto insurance meet state legal requirements.
4. Promote Risk Control Activity
Insurance policies may require or provide incentives to insureds who undertake risk control activities. And collected data can be used to prevent or limit losses.
5. Other Benefits
Allows individuals/organizations to use their resources wisely.
Facilitates loans.
Insurance is a source of investment funds.
Reduces the burden of losses and injuries on society.
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Common Types of Insurance
Key Term: Insured
A person or organization covered by an insurance policy is called an "insured".
Key Term: Property-Casualty Insurance
This term is used to refer to property and liability coverage.
Key Term: Commercial Package Policy
A bundled policy that provides business owners with property, crime, and liability coverages.
Personal Insurance
Property: Protects an insures assets by covering the cost of repairing or replacing property that is damaged, lost, or destroyed. It can also cover related lost income or extra expenses.
Liability: Provides payments for injury to others or damage to others' property for which the insured is legally responsible. It also covers the cost to defend the insured against related lawsuits.
Life: Replaces the income earning potential lost through death. It also helps to pay expenses related to an insured's death.
Health: Protects individuals and families from financial losses caused by sickness and accidents.
Personal Property-Casualty Insurance
Homeowners: Provides protection when peoples' homes and/or belongings are damaged or stolen and liability coverage for situations such as the family dog biting a guest.
Personal Auto: If the insured is at fault in an accident, provides coverage for bodily injury to another person or damage to another person's auto. Typically legally required. May provide coverage for damage to the insured auto (not wear and tear).
Personal Umbrella: Provides additional protection for people with a high potential for large liability losses. Policy limits are usually in the millions, above the limits offered in a homeowners or an auto policy.
Commercial Property-Casualty Insurance
Commercial Property: Covers damage to the buildings or their contents that results from fire, vandalism, and other causes of loss.
Commercial Crime: Protects against losses from theft of business property and money, including employee theft.
Commercial General Liability: Protects a business against its legal liability to others for bodily injury and property damage.
Commercial Auto: Covers liability for bodily injury and property damage caused by the use of the business's autos and also damage to the business's own autos when they are in an accident.
Workers Compensation: Covers legally required benefits that businesses are required to pay to their employees for job-related injuries and illnesses.
Commercial Umbrella: Provides additional liability limits beyond those provided by other commercial policies, protecting a business in the event of a large liability loss.