HS 311 - Fundamentals of Insurance Planning - Chapter 1

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Basic Concepts of Risk and Insurance

Possibility

Something could occur. A possibility either exists or does not exist; it cannot be measured.

Risk

The possiblity of loss.

Probability

The proportion of times that events will occur in the long run. Can be expressed numerically as a number between 0 and 1 or as a percentage from .0 percent to 100 percent.

Loss

A decline in value, usually in an unexpected or relatively unpredictable manner.

Loss Exposure

A loss that might occur.

Direct Loss

The first loss or losses that arise immediately from the occurrence of a peril. Ex. The cost to repair a dented fender following an accident.

Indirect Loss

A loss that occurs only as a secondary result following the occurrence of a peril. Ex. The additional living expenses a family might incur to pay for a hotel following fire damage to their home.

Uncertainty

A state of mind that arises from the presence of risk and is characterized by not being sure about something. Offen charecterized by worry and fear.

Peril

A cause of loss. Ex. Fire, earthquake, flood.

Hazard

An act or condition that increases the likelihood of the occurrence of a loss and/or increases the severity of a loss. 3 types; physical / moral / attitudinal.

Physical Hazard

A physical condition relating to location, structure, occupancy, exposure, and the like.

Moral Hazard

A dishonest tendency that is likely to increase loss frequency and/or severity.

Attitudinal Hazard

A condition of carelessness or indifference on the part of an individual as to whether a loss occurs and/or the size of a loss if one does occur.

Law of Large Numbers

A mathematical principle stating that as the number of independent trials or events is increased, the actual results from those trials or events will come closer and closer to the results that one would expect to occur based on the underlying probability.

Mass

As a characteristic of a statistical group or an insured group, sufficient size within such a group as to allow the true underlying probability to emerge.

Homogeneity

The quality or state of being of the same or a similar kind or nature.

Independence

A requirement of the law of large numbers that the occurrence of a loss to one exposure unit should not affect the lielihood of loss to another exposure unit.

Financial Risk

A category of risk for which the possibility of loss involves a decrease or a disappearance of monetary value, usually in an unexpected or relatively unpredictable manner.

Nonfinancial Risk

A category of risk for which the possibility of loss does not represent a reduction in monetary value, although sometimes such losses are compensated by the award of money. Ex. Pain and suffering.

Particular Risk

A loss possibility that affects only indeviduals or small groups of individuals at the same time, rather than a large segment of society. Ex. The theft of one's wallet.

Fundamental Risk

A loss possibility that can affect a large segment of society at the same time. Ex. Wide spread unemployment during an economic downturn.

Static Risk

In contrast with dynamic risk, a possibility of loss that exists even in the absence of changes in socity. Ex. Hurricanes.

Dynamic Risk

A possibility of loss that results from changes in society or in the economy. Ex. A retailer's inventory becoming obsolete because of a sudden change in consumer tastes.

Pure Risk

A possibility of loss that involves only two outcomes, loss or no loss.

Speculative Risk

A possibility of loss with 3 possible outcomes; loss / no loss or gain / gain.

Hedging

A procedure to protect against losses from price fluctuations. Ex. Taking a "long" position and a "short" position in shares of common stock.

Gambling

The deliberate creation of a speculative risk by betting on an uncertain outcome. Ex. Playing poker for money.

Personal Risk

A loss possibility associated with death, injury, illness, old age, or unemployment.

Property Risk

A loss possibility associated with the loss or destruction of property.

Liability Risk

A possibility of loss as a result of being held legally responsible for an injury to another, usually for bodily injury or damage to property.

Insurable Risk

A risk that meets the following; amount of loss must be important / the loss must be of an accidental nature / future loss must be calculable / the loss must be definite / the risk cannot be excessibely catastrophic.

Risk Tolerance Level

The degree to which an individual is attracted to or averse to the possibility of loss.

Insurance

An economic system that reduces financial risks when policyowners transfer risks to an insurer that combines their potential losses.

Adverse Selection

Selection against the insurance company. It is the tendency for those who know that they are highly vulnerable to specific pure risks to be most likely to acquire and to retain insurance to cover related losses.

Private Insurance

All forms of insurance that privately owned insurers provide. Contrast with government insurance.

Government Insurance

Various types of insurance operated by state or federal governments. Includes both social insurance programs and other programs.

Social Insurance

Government run or government regulated insurance programs designed primarily to solve major social problems that affect a large portion of society. Distinguishing characteristics are compulsory employment related coverage, partial or total employer financing, benefits prescribed by law, benefits as a matter of right, and emphasis on social adequacy.

Social Adequacy

A principle emphasized by social insurance programs in which benefits are designed to provide a minimum floor of benefits to all beneficiaries, regardless of their economic status. Reflected in the provision of disproportionately large benefits relative to contributions for some groups of beneficiaries, particularly lower income groups.

Individual Equity

The principle that each individual's insurance premium payments are based on an actuarial analysis that reflects the insurer's cost of providing benefits for the risks faced by that individual.

Individual Insurance

In contrast with group insurance, insurance purchased and owned by individuals and families.

Group Insurance

In contrast with individual insurance, all types of private insurance that cover many people under one master contract issued to a sponsoring organization, such as an employer.

Master Contract

A contract issued to someone other than the persons insured that provides benefits to a group of individuals who have a specific relationship to the policyowner.

Certificate of Insurance

A description of the group insurance coverage provided to employees, but it is not part of the master contract.

Evidence of Insurability

Documentation or other evidence submitted to the insurance company regarding the physical condition or other attributes of the applicant for insurance coverage, which is taken into account when the insurer determines whether to accept the risk.

Applicant

The person or organization that applies for insurance.

Policyowner

The person or entity that owns an insurance policy. Generally has the right to change, renew, or cancel the policy and the obligation to comply with policy conditions, such as premium payments.

Insured

A party to whom or on whose behalf insurance benefits may be payable.

Line of Insurance

A type of insurance. Ex. Life, medical expense, disability income, homeowners, or auto liability.

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