RMI3011 Test 1 Study Guide Risk the possibility of loss involves uncertainty At least one outcome is undesirable Has negative financial consequences o Objective risk is measurable o Subjective risk is how we interpret the event o Law of large numbers the larger the sample size the more likely it is that you ll obtain the expected results o Pure risk loss no loss possible o Speculative risk gain possible gambling o Fortuitous losses are neither expected nor intended accidental o Fundamental risk affects us all o Particular risk is unique o Enterprise risk is all the things that can happen to a business or firm o Peril the cause of loss HOW o Hazard the condition that increases the possibility of loss WHY o Physical o Moral fraud arson o Morale carelessness or indifference o Legal a dog biting someone liability Types of Risk income o Personal premature death poor health unemployment outliving your retirement o Property direct loss indirect loss extra expense o Liability negligence warranty absolute defense cost Risk Treatment Methods o Avoidance o Prevention reducing frequency o Reduction reducing severity o Retention involves deductibles Active insurance Passive not buying insurance o Transfers transferring the negative financial consequence o Insurance Insurance a small certain sum in exchange for a large uncertain sum o Pooling of exposures everyone pays their fair share o Only works for fortuitous losses o Transfers the negative financial consequences o Indemnification putting you in the same place financially after the loss as you were before the loss o Large number of homogenous units o Calculates the loss probability using the Law of Large Numbers o Fortuitous random losses o Affordable premium Adverse Selection a higher risk person trying to obtain reasonable rates o Underwriting reduces this possibility o Policy Provisions also help control this o Application Process makes sure the person is being truthful Insurance vs Gambling gambling creates speculative risk Types of Insurance o Life Health Annuity o Property and Casualty o Private Insurance voluntary you can choose where to buy from o Government Insurance compulsatory Benefits of Insurance o Reduces uncertainty o Eliminates need for reserve fund o Creates capital o Compensation for loss o Promotion of loss avoidance techniques o Enhances credit Cost of Insurance o Cost of doing business taxes o Moral hazard fraudulent claims and inflated claims Risk Management the process to identify exposures and select the treatment of an economic entity s personal or business exposure to loss o Risk Control minimizing the frequency or severity of losses BEFORE THE LOSS o Risk Financing minimizing the financial impact of the loss once occurred AFTER THE LOSS Risk Management Objectives o Pre Loss affordability reduction of anxiety meets the legal obligations o Post loss survival of the firm continued operations stability of earnings continued growth social responsibility Risk Management Process o Identify loss exposures o Evaluate potential losses max possible vs max probable o Select treatment procedures o Implement and Administer the program Loss Ratio losses premiums Expense ratio overhead expenses premium Combined ratio add the two together Rate Making in Propery and Casualty Insurance adequacy not excessive not unfairly discriminatory o Class rating classifying people majority of insurance rating o Merit rating plus or a minus take the individual characteristics and gives them a credit or a debit Rewards penalizes Life Insurance Rates based on mortality tables based on rate per thousand law of large numbers Government Regulation of Insurance o Maintains insurance solvency o Compensates for consumer ignorance o Reasonable rates o Availability Historical development of insurance regulation o Paul vs Virginia 1868 Paul sued Virginia because he wanted to sell insurance there Said states should regulate the insurance o Southeastern Underwriters Association Case 1944 Supreme court ruled that Federal Government should regulate insurance o McCarran Ferguson Act 1945 Repealed the above act insurance should be regulated o Financial Modernization Act 1999 Allowed banks to own insurance companies and by the states vice versa Regulation Current Issues in Insurance Regulation o State and federal laws o Court system o Taxation o Contingent commissions o Accounting Practices o Modernization Legal Principals in Insurance Contracts o Indemnity o Insurable Interest must exist at time of loss for property and at time of application for life insurance o Actual Cash Value replacement cost less depreciation o Subrogation the at fault party is held liable for the damages Insurance is a Contract of Utmost Good Faith and has a higher standard of truthfulness o Misrepresentation during the application process may lead to a voided contract o Concealment is the failure to disclose something that a prudent person would think o Warranty is the unless clause in the contract ie you may not drive your boat more important to disclose than 50 miles offshore Enforceable Contracts o Must have Offer and Acceptance the application is the offer o Consideration paying the premium abiding by the terms The insurance company has a legally binding promise to abide by o Legal Purpose you can t insure cocaine a stolen car etc o Competent Parties 18 or older mental capacity not insane etc o Legal form not necessarily in writing Characteristics of Contracts o Adhesion take it or leave it o Unilateral only one party makes a legally binding agreement o Personal covers only the person stated o Aleatory values exchanged are not equal o Conditional if you do not abide by the terms the contract may be voided Legal Doctrines o Waiver voluntary relinquishment of a known legal right o Estoppel representation of fact by an Agent consumer relied on representation principal is bound by Agent s representation Parts of an insurance contract o Declarations page information page unique to you o Definitions o Insuring Agreement o Exclusions things that aren t covered by insurance o Conditions what you must abide by in order to have coverage o Endorsements add subtract modify or clarify the contract to change coverage o Deductibles used to eliminate small claims and to reduce premiums Coinsurance equity in rating is the purpose encourages consumer to insure to value Most contracts have an 80 requirement Liability and Negligence o Legal obligation to perform a duty and failure to perform it o
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