•                         Law of Large Numbers
                            Risk
                            Peril
                            Speculative Risk
                            Pure Risk



                                Risk Avoidance
                                Risk Reduction
                                Risk Retention
                                Risk Transfer
                                Adverse Selection



                      Reinsurance
                      Hazard
                      Moral Hazard
                      Morale Hazard

    THE NATURE OF INSURANCE

    Risk Pooling

    Risk Pooling, also known as loss sharing, spreads risk by sharing the
    possibility of loss over a large number of people. It transfers risk from an
    individual to a group.


    Law of Large Numbers

    The law of large numbers states that larger groups provide an increased degree of accuracy in loss predictions, based on past experience. The higher the exposure, the more likely the event can be predicted.




  • RISK

    Risk is defined as the potential for loss.

    Peril is something that can cause a financial loss, such as an
    earthquake or tornado. Perils can also be referred to as the
    accident itself.

    Loss is the unintentional decrease in the value of an asset due to a peril.

    Homogeneous exposure units are similar objects of insurance that are exposed to the same group of perils.

    Types of Risk

    Speculative risk is a risk that presents the chance for both loss and gain. Gambling is an example. Speculative risks are not insurable.

    Pure risks are the only insurable risks and present a potential for loss only with no possibility of gain, such as injury, illness, and death.

    Treatment of Risk – how people deal with risk:

    ► Avoidance – Don’t do anything - the elimination of a hazard is an example of risk avoidance
    ► Reduction – Minimizing the severity of a potential loss – smoke alarms, stop smoking
    ► Retention – Self insure - Used when losses are highly predictable and the worst possible loss is not serious.
    ► Transfer – Buying insurance is the best way to transfer risk. Incorporation and hold-harmless clauses are also examples
    ► Sharing- Each party assumes a portion of the risk receiving benefits under the system

  • RISK

    Elements of Insurable Risk:

    ► Loss must be due to chance (accident) – Outside the insured’s control
    ► Loss must be definite and measurable – Time, place, amount, and when payable
    ► Loss must be predictable – Estimate the average frequency and severity
    ► Loss cannot be catastrophic – Must be reasonable, 1 trillion dollar policy is not reasonable
    ► Loss exposure to be insured must be large – Insurance company must be able to predict loss
    ► Loss must be randomly selected – Adverse selection

    Risk Management

    The process of analyzing exposures that create risk and designing programs to handle them is called risk management.

    Principle of Indemnity

    The principle of indemnity involves making an insured whole by restoring them to the same condition as before a loss.

    Adverse Selection

    Insurers must minimize adverse selection, which is defined as the tendency for poorer than average
    risks to seek out insurance.     For example, a person who takes 12 prescriptions is a poor risk. If an insurer cannot
    compensate poor risks with better than average risks, then its loss experience will increase and its ability to pay
    claims may be compromised.

    Reinsurance

    One way insurers deal with catastrophic loss is through reinsurance, which is defined as spreading risk from one
    insurer to one or more other insurers. Many insurers are able to minimize exposure to loss by reinsuring risks.

  • HAZARDS

    Hazard

    A condition or situation that creates or increases a chance of loss is called a hazard.

    Hazard Examples: Icy roads, driving while intoxicated, improperly stored toxic waste.

    Types of Hazards

    Physical – Poor health, overweight, blind.
    Moral – Dishonesty, drugs, alcohol abuse.
    Morale – Careless attitude – reckless driving, jumping off a cliff, stealing, racing motorcycles, carefree, careless lifestyle