Fundamentals of Risk and Insurance

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• Fundamentals of Risk and Insurance

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Chapter 1The Problem of Risk

• 1. The concept of risk
• Risk a condition in which there is a possibility
  of an adverse deviation from a desired outcome
  that is expected or hoped for

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Peril a cause of a lossHazard a condition
that may create or increase the chance of a loss
arising from a given peril

• Three categories of hazards
• Physical hazards
• Moral hazard
• Morale hazard

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2. Classifications of risk

• Pure risk and speculative risk
• Pure risk the situations that involve only the
  chance of loss or no loss
• Speculative risk a situation in which there is a
  possibility of loss, but also a possibility of
  gain

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Chapter 2 Introduction to risk management

• 1. Risk management
• Risk management is a scientific approach to
  dealing with pure risks by anticipating possible
  accidental losses and designing and implementing
  procedures that minimize the occurrence of loss
  or the financial impact of the losses that do
  occur

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2. Risk management tools

• Include two broad approaches
• (1) Risk control focuses on minimizing the risk
  of loss
• A. Risk avoidance
• B. Risk reduction loss prevention loss control
• (2) Risk financing focuses on finding funds to
  meet losses

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(2) Risk financing focuses on finding funds to
meet losses

• A. Risk retention (assumption)
• Intentional and unintentional
• B. Risk transfer
• Insurance, hedging
• Assume all risks that are not significant in
  relation to the companys financial strength
• Insure all risks not assumed

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3. Risk management process

• (1) Determination of objectives
• (2) Identification of risks
• (3) Evaluation of risks
• (4) Considering alternatives and selecting the
  risk treatment device
• (5) Implementing the decision
• (6) Evaluation and review

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Determination of objectives
Post-loss objectives Pre-loss objectives
Survival Economy
Continuity of operations Reduction in anxiety
Earning stability Meeting externally imposed obligations
Continued growth Social responsibility
Social responsibility
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Chapter 3The insurance device

• 1. The nature and functions of insurance
• (1) Risk sharing and risk transfer
• A. Transferring or shifting risk from one
  individual to a group
• B. Sharing losses, on some equitable basis, by
  all members of the group

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(2) Insurance defined from the viewpoint of the
individual

• Insurance is an economic device whereby the
  individual substitutes a small certain cost (the
  premium) for a large uncertain financial loss
  (the contingency insured against) that would
  exist if it were not for the insurance

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(3) Risk reduction through pooling

• The law of large numbers
• The larger the sample, the more accurate will be
  the estimate of the probability
• Once the estimate has been made, it must be
  applied to a sufficient large number of exposure
  units to permit the underlying probability to
  work itself out
• To make the estimate more accurate, we use
  variance and standard deviation
• The integration of inevitability and chance

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Each insured, and each class of insureds should
bear the mathematically fare share of the
insurance pools losses and expenses

• (4) Insurance defined from the viewpoint of
  society
• Insurance is an economic device for reducing and
  eliminating risk through the process of combining
  a sufficient number of homogeneous exposures into
  a group to make the losses predictable for the
  group as a whole

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(5) Elements of an insurable risk

• A. There must be a sufficient large number of
  homogeneous exposure units to make the losses
  reasonably predictable
• B. The loss produced by the risk must be definite
  and measurable
• C. The loss must be fortuitous or accidental
• D. The loss must not be catastrophic

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(6) The fields of insurance

• A. Private (Voluntary) insurance
• Life insurance
• Health insurance
• Property and liability insurance
• Including named-peril coverage and open-peril
  coverage
• B. Social insurance

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Chapter 5 the private insurance industry

• 1. Insurers classification by legal form of
  ownership
• A. Capital stock insurance companies
• B. Mutual insurance companies
• C. Reciprocals or interinsurance exchange
• D. Lloyds associations
• E. Health expense associations
• F. Government insurers

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2. Marketing systems

• The insurance occupations
• Agent
• Broker
• Underwriter
• Loss adjuster
• actuary

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(1) Life insurance distribution system

• A. General agents
• B. Branch office systembranch manager
• (2) Property and liability distribution system
  (refer to the book)
• A. Independent agents (U.S.A.)
• B. Direct writers

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Chapter 6 regulation of the insurance industry

• Regulation represents the rules by which the game
  is played
• The government as market regulator to protect
  the weak group

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1. The why of government regulation of insurance

• (1) Rationale for regulation of the insurance
  industry
• A. Vested-in-the-public-interest
• Solvency
• Complex nature of insurance contracts
• B. Destructive-competition
• Due to the unique nature of pricing

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(2) Goals of insurance regulationsolvencyequity

• 2. Regulation today
• The current regulatory structure
• Legislative branch
• Judicial branch
• Executive branch

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3. Areas regulated

• (1) Solvency regulation
• A. Licensing of companies
• B. Reporting and financial analysis
• C. Risk-based capital
• D. Examination of companies
• E. Regulation of reserves
• F. Investments admitted/nonadmitted assets
• G. Dealing with insolvencies

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(2) Market regulation

• A. Unfair practices
• B. Policy forms
• C. Competence of agents
• D. Consumer complaints and assistance

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(3) Regulation of rates

• Principles
• Adequacy
• Not be excessive
• Not discriminate unfairly
• Ways for rate regulation
• Prior approval
• No filing
• File-and-use
• Informational filing
• Flex-rating

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Chapter 7 functions of insurers

• Ratemaking
• Methods
• Judgment rating
• Schedule rating
• Experience rating credibility factor
• Retrospective rating

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(2) Principle of the rate of premium

• A. Fairness
• B. Solvency avoid vicious competition
• C. Comparative stability
• D. Encouraging loss reduction

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(3) Setting of the property premium rate

• Rate of losscompensationinsurance amount
• Credibility factor usual 10 percent
• (This is also the adjustment rate)
• Rate of property premium
• Rate of lossX(110)X(1g) (1y)
• g extra rate, y investment gain.
• (4) Rate of life premium

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Chapter 11 introduction to life insurance

• Life insurance is a risk-pooling plan
• Life insurance does not violate the requirements
  of an insurable risk, for it is not the
  possibility of death itself that is insured, but
  rather untimely death
• Life insurance is not a contract of indemnity

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1. Types of life insurance contracts
Term insurance (pure insurance protection) Cash value insurance (protection and savings)
Term insurance Whole-life insurance
Endowment insurance
Universal life insurance
Adjustable life insurance
Variable life insurance
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(1) Reasons for difference in term and cash value
insurance

• (2) The level premium concept
• 2. Current life insurance products
• (1) Term insurance
• Renewable term
• Convertible term
• Advantages of term life insuranceA. Greatest
  amount of protection for a given outlayB. meet
  temporary insurance needs

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Disadvantage adverse selection

• (2) Whole life insurance
• A. Straight whole life
• B. Limited-pay whole life
• (3) Universal life insurance
• Advantages of Universal Life Insurance
• Flexibility of Premium Payments
• Ability to earn a great return when interest
  rates rise
• Flexibility of death benefits

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Universal life insurance

• People buy a term policy and invest an additional
  amount with the insurance company.
• The minimum premium is to keep a term insurance
  in force.
• The insured is allowed to determine the amount
  and frequency of the premium payments within
  limits.
• A guaranteed rate is specified in the contract,
  while an excess interest rate is determined by a
  formula or by company declaration.

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(4) Variable life insurance

• A modification of universal life insurance
• One insured has two accounts an insurance
  account and a separate account
• (5) Adjustable life insurance
• (6) Endowment life insurance
• (7) Participating and nonparticipating life
  insurance
• The dividends

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3. General classifications of life insurance

• (1) Ordinary life insurance
• (2) Industrial life insurance
• Small amount but higher frequency of premiums
• (3) Group life insurance
• Provided to a well-defined group of people who
  are associated for some purpose other than
  purchasing life insurance
• Generally costs less than similar individually
  purchased insurance
• (4) Credit life insurance

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Chapter 13 The life insurance contract

• 1. Inception of the life insurance contract
• Conditional binding receipt usually called a
  binder, which is the temporary life insurance
  contract after the payment of a premium.
• The binder has the same legal effect as the
  formal insurance contract

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2. General provisions of life insurance contracts

• Entire contract clause
• Ownership clause
• Beneficiary clause primary or contingent
• Revocable or irrevocable
• Incontestable clause
• Misstatement of age clause
• Grace period
• Reinstatement

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Suicide clauseAviation exclusionsWar clause

• 3. Settlement options
• (1) Interest option
• (2) Installments for a fixed period
• (3) Installments of a fixed amount
• (4) Life income options
• Straight life income
• Life income with period certain
• Life income with refund
• Joint and survivor income

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Example of payments under any one of the above
life income options

• Chapter 15 Disability income insurance
• 1. General nature of disability income insurance
• Periodic payments to the person insured when he
  or she is unable to work because of injury or
  illness
• Benefit eligibility presumes a loss of income

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(1) Types of insurersProperty and liability
insurers, life insurers and specialty health
insurers

• (2) Methods of marketing
• Mainly sold on a group basis
• (3) Short-term versus long-term disability
  coverage
• Short-term up to 2 years with an elimination
  period (waiting period)
• Long-term from the date of disability to
  retirement with an elimination period. It is a
  logical complement to life insurance

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Chapter 16 coverage for medical expenses

• The insurance product
• 1. Traditional forms of medical expense
  insurance
• (1) Base plan coverage
• Hospitalization, surgical expense coverage and
  physicians coverage are written together
• Covers the costs of both hospitalization and
  outpatient
• First dollar coverage base plan coverage
  policies often have no-deductible provision

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A. Hospitalization insuranceBlue Cross service
plans provide a semiprivate room in a
participating hospital for a stated number of
days, rather than a cash benefit

• Hospital expense policies offered by commercial
  insurers reimburse some or all of the cost of
  room and board when the insured is confined to a
  hospital
• Policies of both Blue Cross and commercial
  insurance companies cover incidental hospital
  expenses

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B. Surgical expense insurance Specify a maximum
amount of coverage. If one patient needs more
than one procedures, the most expensive treatment
determines the payment

• UCR charges
• C. Physicians expense insurance
• (2) Major Medical Insurance
• Major medical policies have a substantial
  deductible provision
• Major medical policies have a participation
  provision
• Major medical policies have a high limit of
  liability
• See the example

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2. Exclusions under health insurance policies (12
exclusions)

• 3. Coordination of benefit
• In the double-income family, one or both partners
  may be covered under two policies
• The coordination of benefit is to eliminate
  double payment when two policies exist
• An individuals policy applies before the
  spouses policy
• Children are covered under the policy of the
  parent whose birthday is earliest in the year

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Chapter 19 the automobile and its legal
environment

• Automobile coverage is a type of property
  insurance with the apparent elements of life
  insurance
• The purchase of the automobile coverage is not a
  mere personal choice, instead, it is a social
  obligation

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1. A brief overview of automobile coverages

• (1) Automobile liability insurance (also called
  the third party liability), which covers the
  injuries to other persons and damages to caused
• Single limit of liability
• Split limits of liability
• Insureds---the named insured and her consentients
  
• Exclusions

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(2) Medical payments coverageIt is written with
a maximum limit per person per accident

• (3) Physical damage coverage, also called damage
  to the auto
• Insures against loss of the policyholders own
  automobile
• The coverage is written under two insurance
  agreements A. other than collision B. collision
• Exclusions

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(4) Uninsured motorists coverage

• Purpose protect people from the loss of accident
  caused by another uninsured motorist
• Uninsured motorist
• Drivers without insurance
• Drivers with less insurance than the minimum
  required by the state law
• Hit-and run Drivers
• Drivers with coverage provided by insolvent
  insurers

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2. The no-fault concept

• No-fault vs. tort system
• The no-fault insurance provides one more option
  to the insureds so that it is more flexible
• Under the no-fault system, there is no attempt to
  fix blame or to place the burden of the loss on
  the party causing it
• All parties receive compensation from their own
  insurer, regardless of who caused the accident
• No-fault insurance is to speed the compensation
  in less serious traffic accidents

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Pure no-fault proposalsthe tort system would be
abolished for bodily injuries arising from auto
accidents

• (2) Modified no-fault proposals
• Tort action would be retained for losses above
  the amount recovered under first-party coverage
• (3) Expanded first-party coverage
• No exemption from tort liability
• Most important, the responsibility of the
  negligent driver is retained by permitting
  subrogation by the insurer paying the first-party
  benefits

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3. Cost of automobile insurance

• Most automobile rating systems begin with three
  basic factors
• A. Age and sex of the driver
• B. Use of the automobile
• C. The drivers record
• In China, the region in which the automobile is
  used is also considered
• Poor vs. rich, plain vs. mountainous

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Chapter 20 commercial property insurance

• Can be classified into 7 broad categories
• 1. Commercial property insurance
• 2. Boiler and machinery insurance
• 3. Transportation insurance
• 4. Crime insurance
• 5. Commercial liability insurance
• 6. Commercial automobile insurance
• 7. Workers compensation and employers liability
  insurance

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Commercial Package PolicyInsureds must purchase
at least two of the packages components, and as
many as they need

• 1. Commercial property direct loss coverage
• (1) Building and Personal Property Form
• A. Property Covered
• Building
• Your Personal Property
• Personal Property of others

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B. Perils insuredbasic form, broad form, special
form

• C. Other provisions
• property excluded from coverage, deductibles,
  actual cash value
• D. Coinsurance
• Guard against the possible intentional inadequate
  coverage

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E. Reporting form coverage

• Reporting forms are designed to meet the needs of
  business firms whose stocks of merchandise
  fluctuate over time
• The insured must report 100 percent of the values
  of the property insured. Late reports or
  underreporting of values, intentional or
  otherwise, may result in a penalty at the time of
  a loss

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2. Commercial property coverage for indirect loss

• Commercial property forms do not provide coverage
  for the indirect loss resulting from damage to
  the insured property.
• Such protection must be obtained under a separate
  form for an additional premium

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(1) Business interruption insurance

• Business income forms
• Business income coverage (and extra expense)
• Business income coverage (without extra expense)
• If the business is interrupted, payment is made
  for the loss of business income, defined as the
  net profit that would have been earned and the
  necessary expenses that continue during the
  period of restoration

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(2) Contingent business interruption and extra
expenses

• A. Contributing property
• B. Manufacturing property
• C. Recipient property
• D. Leader property

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3. Transportation coverages

• (1) Ocean marine insurance
• A. Hull insurance
• Protects the owner of a vessel against loss to
  the ship itself
• The coverage is written on an open-perils basis
• B. Cargo insurance
• Main form of ocean marine insurance, written
  separately from hull insurance
• C. Freight insurance
• D. Protection and indemnity

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Perils insured---open perils agreementValuation

• Average conditions
• particular average general average
• (2) Inland marine insurance
• Not limited to the transportation in the rivers
• 6 forms of coverage

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4. Insurance against dishonesty

• (1) Employee crime coverage
• Also called fidelity bonds
• A. Schedule bonds
• Cover the specific person or position that is
  listed in the policy
• B. Blanket bonds
• Cover all the employees, regardless of position

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(2) Nonemployee crime coverageprotect against
burglary, robbery, theft, forgery, some of which
with evidence

• Chapter 21 commercial liability insurance
• 1. Employers liability and workers compensation
• To protect both the employees and the employer
• The largest firms self-insure

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(1) Workers compensation insurance

• A. The insuring agreement obligates the insurer
  to pay the benefits for which the insured is
  liable under the workers compensation law
• B. There are no exclusions under the coverage and
  no maximum limit on the insurers liability
• C. It makes the insurer directly and primarily
  liable to employees who are entitled to benefits

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D. The insurers obligation to employees is not
affected by any default of the insured

• E. The insurers liability to the employees is
  governed by the workers compensation law, the
  insurers obligation to the employer is governed
  by the policy terms
• (2) Employer liability insurance
• If an injured employee brought suit, the legal
  principles generally favored the employer

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2. General liability insurance

• Protect the firm against the peril of legal
  liability that involves injuries to persons other
  than employees of the insured
• (1) General liability exposure
• Every business firm is subject to one or a
  combination of the following liability exposures

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A. Ownership and maintenance of premises

• B. Conduct of business operations
• C. Products
• Negligence, breach of warranty, strict liability
• D. Completed operations
• E. Contingent liability
• F. Contractual liability

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3. Commercial automobile insurance

• Four commercial automobile forms
• Business auto coverage
• Garage coverage
• Truckers coverage
• Motor carriers coverage
• (1) Business auto coverage form
• Similar in all the aspects with that of the
  personal auto policy

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(2) Garage coverage form

• To provide comprehensive liability coverage for
  garages, sales agencies, repair shops, service
  stations, storage garages and public parking
  places
• Hazards covered
• Premises and operations
• Products and completed operations
• Automobile liability

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(3) Truckers coverage form

• A modified version of the Business Auto Coverage
  Form designed to meet the special needs of
  truckers.
• Extend the coverage from the licensed truckers to
  the independent owner-operators

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4. Aviation insurance

• Purchased by the owners and operators of
  aircraft, airport operators, and by companies
  building and supplying parts for aircraft, but
  not passengers
• Including planes, helicopters, hot air balloons,
  hang gliders and space satellites

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(1) Aircraft liability insurance

• A. Passenger
• B. Bodily injury excluding passengers
• C. Property damage liability
• (2) Hull coverage
• The core problem facing aviation insurers is the
  weakening of law of large numbers

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Chapter 22 surety bonds and credit insurance

• Both are designed to protect against financial
  losses from default by someone on whom the
  insured depends
• 1. Surety bonds
• It is reserved for the nonfidelity field

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One party (the surety) agrees to be held
responsible to a second party (the obligee) for
the obligations of a third party (the principal)

• The principal buys the surety bond. The surety
  lends its name and credit to guarantee the
  obligation of the principal. If the principal
  fails to perform, the surety is responsible to
  the obligee for the amount of the bond.

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(1) Suretyship distinguished from insurance

• A. The most frequently stated distinction is that
  a surety bond is a three-party contract, whereas
  the insurance policy is a two-party contract
• B. The most important distinction is one of the
  basic philosophy regarding losses. In the
  insurance field, the insurer generally expects
  losses. In the surety field, no losses are
  expected.

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C. Whereas actuarial science is the basis for
insurance rates, the fee for a surety bond is a
payment for investigation and certification

• The main categories of surety bonds
• Contract bonds
• Court bonds
• License and permit bonds
• Public official bonds
• Miscellaneous bonds

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2. Credit insurancePurchased by the creditor

• It is sold only to manufacturers and wholesalers,
  which protects against loss resulting from the
  inability to collect accounts due to insolvency
  or unwillingness or inability to pay by the
  purchasers
• Back coverage policies cover losses arising out
  of defaults during the policy period

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Forward coverage policies cover losses stemming
from sales during the policy period

• (1) Types of policies
• A. Extraordinary coverage
• Generally purchased by companies that deal with a
  limited number of buyers.
• It is issued after an investigation of the
  individual debtors and acceptance of each one by
  the insurer.
• The insurer is permitted to cancel coverage as to
  future shipments to any debtor.

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B. General coverageIt includes protection on all
policyholders customers with a credit rating

• Investigation of the individual customers is not
  needed because the coverage on each account is
  determined by a table of mercantile ratings,
  selected by the insured and incorporated into the
  contract.
• Only debtors whose credit rating comes within the
  limitations of the ratings adopted by the insured
  are covered.

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(2) Coinsurance and the normal loss

• The insured shall assume two proportions of each
  net loss
• A. Coinsurance percentage (10 or 20)
• B. Annual deductible (known as the primary loss
  or normal loss)
• It is calculated from the previous experience of
  the firm insured or as a percentage of the firms
  net sales from tables that express bad debt
  ratios for various industries

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Loss settlement is made on an annual basis, with
the coinsurance percentage applied to each loss
before the application of the normal loss
deductible

• (3) Collection service
• The collection service is one of the most
  attractive aspects of credit insurance
• If the insured is required or permitted to turn
  past due accounts over to the insurer, accounts
  that are overdue a stated period under the
  original terms of sale are turned over to the
  insurer for collection. If the insurer succeeds,
  a small service charge is made for the
  collection. If it is unsuccessful, the account
  becomes a loss under the policy.

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3. Credit enhancement insurance

• Also called financial guarantee, is a combination
  of suretyship and insurance
• The insurer insures the purchaser of bonds and
  other debt instruments that the debt will be paid
  and substitutes its financial strength for the
  financial strength of the borrower

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