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RMI- Chapter 2: Insurance and Risk

by: Cara Johnson

RMI- Chapter 2: Insurance and Risk RMI3011

Cara Johnson
GPA 3.5
Risk Management and Insurance
L. McChristian

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About this Document

Insurance definition, differences between insurance and gambling or hedging, types of insurance offered, costs of insurance to society
Risk Management and Insurance
L. McChristian
Class Notes
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This 4 page Class Notes was uploaded by Cara Johnson on Tuesday September 15, 2015. The Class Notes belongs to RMI3011 at Florida State University taught by L. McChristian in Summer 2015. Since its upload, it has received 68 views. For similar materials see Risk Management and Insurance in Risk Management And Insurance at Florida State University.


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Date Created: 09/15/15
RMI 3011 Risk Management and Insurance L McChristian Chapter 2 Insurance and Risk Insurance The pooling or fortuitous losses by transfer of such risks to insurers who agree to indemnify insureds for such losses to provide other pecuniary bene ts on their occurrence or to render services connected to risk Basic Characteristics of Insurance Pooling of losses 0 Spreads losses over entire group 0 Risk reduction is based on the law of large numbers Law of large numbers states that the greater the number of exposures the more closely will the actual results approach the probable results that are expected from an in nite number of exposures o If insurers can predict future losses the objective risk is reduced 0 Payment of Fortuitous Losses 0 A fortuitous loss is one that is unforeseen and unexpected by the insured and occurs as a result of chance 0 Ex Slip on an icy sidewalk and break a leg 0 Risk Transfer 0 A pure risk is transferred to the insurer who typically is in a stronger nancial position to pay the loss than the insured 0 Ex Premature death poor health disability destruction or theft of property personal liability lawsuits o Indemni cation o The insured is restored to his or her approximate nancial position prior to the occurrence of the loss 0 Ex If you become seriously disabled a disabilityincome insurance policy will restore at least part of the lost wages Six Characteristics of Insurable Risk 0 Large number of exposure units 0 Accidental and unintentional loss Determinable and measureable Loss is not catastrophic Chance of loss can be calculated 0 Premium must be feasible Adverse Selection and Insurance Adverse Selection the tendency of persons with a higherthan average chance of loss to seek insurance at standard rates If not controlled by underwriting adverse selection results in higherthanexpected loss levels Adverse selection can be controlled by 0 Careful underwriting 0 Policy provisions Insurance Gambling Technique for handling existing pure risk Always socially productive Both parties have a common interest in the prevention of the loss Creates new speculative risk Socially unproductive The winner s gain comes at the expense of the loser Insurance Hedging Risk is transferred by a contract Insurance involves transfer of pure risk Can reduce the objective risk of an insurer by application of the law of large numbers Risk is transferred by a contract Involves risks that are typically uninsurable Typically only involves risk transfer not risk reduction Types of Insurance Private Insurance 0 Life Insurance Pays death bene ts to designated bene ciaries when the insured dies 0 Health Insurance Medical expense plans pay for hospital and surgical expenses physician fees prescription drugs wide variety of additional medical costs Ex Blue Cross Blue Shield AETNA UnitedHealth Group WellPoint 0 Property and Liability Insurance Property indemni es property owners against the loss or damage of real or personal property caused by variety perils such as re lightning windstorm tornado Liability covers the insured s legal liability arising out of property damage or bodily injury to others legal defense costs are also paid Casualty broad eld of insurance that covers whatever is not covered by re marine and life insurance 0 Includes auto liability burglary and theft workers compensation health insurance 0 Government Insurance 0 Social Insurance Programs Government insurance programs Financed entirely by mandatory contributions from employers employees or both Ex Social Security Medicare unemployment workers compensation compulsory temporary disability insurance Railroad Retirement Act Railroad Unemployment Insurance Act Bene ts of Insurance to Society Indemni cation for loss 0 Permits individuals and families to be restored to their former nancial position after a loss occurs 0 Also permits business rms to remain in business and employees to keep their jobs 0 Reduction of Worry and Fear 0 Insureds know that they have insurance that will pay for the loss 0 Source of Investment Funds 0 Increase society s stock of capital goods and promote economic growth and full employment 0 Loss Prevention 0 Employ wide variety of lossprevention personnel like safety engineers and specialists in re prevention Highway safety and reduction of auto accidents and deaths Fire prevention Reduction of workrelated injuries and disease Prevention of auto thefts Prevention and detection of arson losses Prevention of defective products that could injure the user Prevention of boiler explosions Educational programs on loss prevention 0 Enhancement of Credit 0 Insurance makes a borrower a better credit risk because it guarantees the value of the borrower s collateral or gives greater assurance that the loan will be repaid Costs of Insurance to Society 0 Cost of doing business 0 Insurers consume scarce resources land labor capital business enterprise 0 Expense loading the amount needed to pay all expenses including commissions general administrative expenses state premium taxes acquisition expenses and an allowance for contingencies and pro t Fraudulent claims 0 Auto accidents are faked or staged to collect bene ts Dishonest claimants fake slipandfall accidents Phony burglaries thefts or acts of vandalism are reported False health insurance claims Dishonest policyholders take out life insurance policies on unsuspecting insureds and later arrange to have them killed In ated claims 0 Attorneys for plaintiffs sue for highliability judgments that exceed the true economic loss of the victim o lnsureds in ate the amount of damage in auto collision claims so that the insurance payments will cover the collision deductible 0 Disabled persons often malinger to collect disability income bene ts for a longer duration 0 lnsureds exaggerate the amount and value of property stolen from a home or business 0000


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