Life and Health Insurance - FIN-3660

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introduction20to20risk20and20insurance.ppt
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Introduction to
Risk and Insurance

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Basic Terminology

  • Risk

- not just uncertainty of financial loss;

- possibility of deviation between actual and expected outcomes

- measured in units called “exposures”

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Insurance

- not just transfer of risk;

- device for transferring, sharing, and reducing risk by combining a sufficient number of exposure units to make individual losses collectively predictable

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Law of Large Numbers

  • Statistical basis for insurance
  • Crucial to the success of the product
  • Most unique characteristic of insurance
  • Makes Insurance a financial product different from any other

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How Insurance reduces risk

  • Assume chance of a house loss is 1/100
  • If you have only one house, will yours be that one?
  • What if you have 10 house, will you have one burn?
  • What if you have 100 houses, will you likely have one burn?

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How risk is reduced

  • Need to examine
  • The number of # exposures (#)
  • Expected Losses (EL)
  • Actual losses (AL)
  • Difference between actual and expected (Risk)

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How risk is reduced (cont.)

# EL AL Risk

1 ? ?

100 1 2 100%

1000 10 11 10%

10,000 100 101 1%

100,000 1000 1001 .1%

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Risk Management

  • the process of identifying and analyzing all possible loss exposures, selecting a method of handling the exposure, and monitoring the method and exposure regularly
  • Who is a risk manager?
  • Who has practiced risk management personally?

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  • Basic Risk Management techniques:
  • risk avoidance
  • risk control (hazard or loss reduction)
  • risk retention
  • risk transfer

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Areas of Exposures

Traditional Areas

  • Property Losses
  • Liability Losses
  • Net Income Losses
  • Personnel Losses

Recently Added Areas

  • Corporate Governance
  • Management Liability Exposures

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Common Terminology

  • Loss, Peril, Hazard
  • Physical, morale, and moral
  • Law of Large Numbers
  • Liability/Casualty
  • Third Party Contracts
  • Named perils vs open perils
  • Deductible
  • to prevent over utilization of coverages
  • to prevent filing small claims

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Terms and Conditions

  • Negligence
  • Proximate Cause
  • Reasonable Person Rule
  • Accident vs occurrence
  • Bodily Injury
  • Property Damage
  • Personal Injury
  • Not physical injury
  • damage to reputation or mental state
  • Advertising Injury
  • Same as PI but to a business

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Conditions (Cont.)

  • Conditional
  • Utmost Good Faith
  • Unilateral
  • Adhesion
  • Personal
  • Aleatory
  • Indemnity

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Indemnity

  • Insurable Interest
  • Subrogation
  • ACV Loss Measurement (versus valued/face amount contracts)
  • Other Insurance Clause
  • Pro Rata Clause
  • Other Restrictive Clauses
  • Policies enforcing indemnity: property, business income and extra expense, and liability
  • Policies not contracts of indemnity: life insurance

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Insurable Interest

  • Life Insurance:
  • Self
  • Spouse
  • Dependency
  • Key Person
  • Property Insurance
  • Ownership
  • Creditor
  • some leasing situations
  • legal liability

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How losses may be measured:

  • Face Amount
  • Actual Cash Value
  • Replacement Cost
  • Functional Replacement Cost (Repair Cost for functionally equivalent materials if impossible to duplicate
  • Stated Value
  • after loss, insurer may challenge and pay less
  • Agreed Value
  • scheduled value
  • Fair Market Value

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Reasons for Exclusions:

  • May result in catastrophic loss
  • Should be covered elsewhere
  • Not fortuitous (unexpected and unforeseen)
  • To control moral or morale hazards
  • To eliminate duplicate coverage
  • To eliminate coverage not needed by the average insured

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Underwriting Concepts

  • Underwriter - one who selects and categorizes risks
  • Requisites of an insurable risk:
  • the Law of Large numbers must apply
  • the loss may not be intentional
  • the loss may not be susceptible to catastrophe
  • the loss must be economically significant to the applicant
  • the loss must be measurable
  • Adverse Selection

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Coinsurance

  • In Health Insurance
  • Purpose is to prevent unnecessary use of coverage
  • 100% paid if loss is “severe”
  • In Property Insurance
  • Purpose is to promote rate equity
  • Alternative system would be scaled rating system
  • Have / Should x Loss = $ amount paid

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Common Policy Clauses

  • Concealment and Fraud
  • Liberalization Clause
  • Proof of Loss
  • Appraisal Clause
  • Abandonment
  • Cancellation Provisions
  • Mortgagee Clause
  • Duties After a Loss
  • Assignment
  • No Benefit to Bailee