Risk Management Concepts and Techniques, Exams of Insurance law

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RMI 211 EXAM 1 - Meek

uncertainty concerning the occurrence of a loss - ANS Risk the property or life that is being considered for insurance - ANS Insurance form of risk any situation or circumstance in which a loss is possible, regardless of whether a loss occurs - ANS Loss exposure the relative variation of actual loss from expected loss - ANS Objective risk uncertainty based on a person's mental condition or state of mind - ANS Subjective (perceived) risk the probability that an event will occur; can be same for two outcomes but may have different objective risks - ANS Chance of loss refers to the long-run relative frequency of an event based on the assumptions of an infinite number of observations and of no change in the underlying conditions - ANS Objective probability the individual's personal estimate of a chance of loss - ANS Subjective probability the cause of a loss - ANS Peril a condition that increases the chance of loss - ANS Hazard a physical condition that increases the frequency or severity of a loss - ANS Physical hazard

dishonesty or character defects in an individual that increases the frequency or severity of a loss - ANS Moral hazard carelessness or indifference to a loss, which increases the frequency or severity of a loss - ANS Attitudinal hazard refers to characteristics of the legal system or regulatory environment that increase the frequency or severity of losses - ANS Legal hazard a situation in which there are only the possibilities of loss or no loss (earthquake) - ANS Pure risk a situation in which either profit or loss is possible (gambling) - ANS Speculative risk affects only individuals or small groups; can be reduced or eliminated by diversification (car theft) - ANS Diversifiable risk affects the entire economy or large numbers of persons or groups within an economy; also called a fundamental risk (hurricane) - ANS Non-diversifiable risk encompasses all major risks faced by a business firm, which include: pure, speculative, strategic, operational, and financial risk - ANS Enterprise risk refers to uncertainty regarding the firm's financial goals and objectives - ANS Strategic risk results from the firm's business operations - ANS Operational risk refers to the uncertainty of loss because of adverse changes in commodity prices, interest rates, foreign exchange rates, and the value of money - ANS Financial risk

the risk of collapse of an entire system or market due to the failure of a single entity or group of entities that can result in the breakdown of the entire financial system - ANS Systemic risk risks that directly affect an individual or family; involve the possibility of a loss or reduction in income, extra expenses or depletion of financial assets due to premature death, inadequate retirement income, poor health, or unemployment - ANS Personal risks involve the possibility of losses associated with the destruction or theft of property - ANS Property risks a financial loss that results from the physical damage, destruction, or theft of the property, such as fire damage to a home - ANS Direct loss a financial loss that results indirectly from the occurrence of a direct physical damage or theft loss (EX: additional living expenses after fire) - ANS indirect or consequential loss involve the possibility of being held legally liable for bodily injury or property damage to someone else - ANS Liability risks -Need for larger emergency funds -Risk of liability lawsuit may discourage innovation and deprive public of goods/services -Fear and worry - ANS Burden of risk on society techniques that reduce the frequency or severity of losses (avoidance, loss prevention) - ANS Risk control refers to activities to reduce the severity of losses (duplication, separation, diversification) - ANS Loss reduction

activities to reduce the frequency of losses - ANS Loss prevention techniques that provide for the funding of losses - ANS Risk financing means that an individual or business firm retains part or all of the losses that can result from a given risk

• ANS Retention means that an individual is aware of the risk and deliberately plans to retain all or part of it - ANS Active retention means risks may be unknowingly retained because of ignorance, indifference, or laziness - ANS Passive retention a special form of planned retention by which part or all of a given loss exposure is retained by the firm - ANS Self-insurance transfers a risk to another party (hold-harmless clause; hedging) - ANS Non-insurance transfer a technique for transferring the risk of unfavorable price fluctuations to a speculator by purchasing and selling futures contracts on an organized exchange - ANS Hedging the spreading of losses incurred by the few over the entire group, so that in the process, average loss is substituted for actual loss - ANS Pooling of losses the larger the number of individuals that are randomly drawn from a population, the more representative the resulting group will be of the entire population - ANS Law of Large Numbers one that is unforeseen and unexpected by the insured and occurs as a result of chance - ANS Fortuitous loss

a pure risk is transferred from the insured to the insurer, typically someone in a stronger financial position - ANS Risk transfer the insured is restored to his or her approximate financial position prior to the occurrence of the loss - ANS Indemnification

1. Large number of exposure units
2. Accidental and unintentional loss
3. Determinable and measurable loss
4. No catastrophic loss
5. Calculable chance of loss
6. Economically feasible premium - ANS Characteristics of an ideally insurable risk the tendency of persons with a higher-than-average chance of loss to seek insurance at standard rates (if not controlled by underwriting, can result in higher-than-expected loss levels) - ANS Adverse selection the process of selecting, classifying, and pricing applicants for insurance - ANS Underwriting insurance paid to named beneficiaries when the insured person dies - ANS Life insurance covers medical expenses because of sickness or injury - ANS Health insurance indemnifies property owners against the loss or damage of real or personal property - ANS Property insurance

covers the insured's legal liability arising out of property damage or bodily injury to others - ANS Liability insurance refers to insurance that covers whatever is not covered by fire, marine, and life insurance - ANS Casualty insurance personal lines and commercial lines - ANS Categories of private insurance coverages Life Health Property Liability Casualty - ANS Types of Private Insurance social security, medicare, medicaid, unemployment, workers comp - ANS Types of Government Insurance -Financed entirely or in large part by contributions from employers and/or employees

• Benefits are heavily weighted in favor of low-income groups
• Eligibility and benefits are prescribed by statute - ANS Social insurance programs indemnification for loss; reduction of worry and fear; source of investment funds; loss prevention; enhancement of credit - ANS Social benefits of insurance cost of doing business, fraudulent claims, inflated claims - ANS Social costs of insurance

the amount needed to pay all expenses, including commissions, general administrative expenses, state premium taxes, acquisition expenses, and an allowance for contingencies and profit - ANS Expense loading a process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating such exposures - ANS Risk management -Prepare for potential losses in the most economical way -Reduce anxiety -Meet any legal obligations - ANS Risk management: pre-loss objectives -Survival of the firm -Continue operating -Stability of earnings -Continued growth of the firm -Minimize the effects that a loss will have on other persons and on society - ANS Risk management: post-loss objectives

1. Identify potential losses
2. Measure and analyze the loss exposures
3. Select the appropriate combination of techniques for treating the loss exposures
4. Implement and monitor the risk management program - ANS Risk management process risk analysis questionnaires, physical inspection, flowcharts, financial statements, historical loss data - ANS How do risk managers identify loss exposures? refers to the probable number of losses that may occur during some given time period - ANS Loss frequency

refers to the probable size of the losses that may occur (more important than frequency) - ANS Loss severity the worst loss that could happen to the firm during its lifetime - ANS Maximum possible loss the worst loss that is likely to happen - ANS Probable maximum loss avoidance, loss prevention, loss reduction, duplication, separation, diversification - ANS Methods of risk control a certain loss exposure is never acquired or undertaken, or an existing loss exposure is abandoned - ANS Avoidance refers to having back-ups or copies of important documents or property available in case a loss occurs - ANS Duplication means dividing the assets exposed to loss to minimize the harm from a single event - ANS Separation spreading the loss exposure across different parties, securities, or transactions, to reduce the chance of loss - ANS Diversification

1. Retention
2. Non-insurance transfers
3. Commercial insurance - ANS Methods of risk financing no other method of treatment available; worst possible loss is not serious; losses are highly predictable - ANS When is retention effectively used?

the dollar amount of losses that the firm will retain - ANS Retention level -Current net income: losses treated as current expenses -Unfunded reserve: losses deducted from bookkeeping account -Funded reserve: losses are deducted from a liquid fund -Credit line: funds borrowed to pay losses as they occur - ANS Ways risk managers pay retained losses an insurer owned by a parent firm for the purpose of insuring the parent firm's loss exposures - ANS Captive insurer -Parent may have difficulty obtaining insurance -Take advantage of a favorable regulatory environment -Costs may be lower than commercial insurance -Easier access to a reinsurer -Can become profit source - ANS Reasons for forming captive insurer a special form of planned retention by which part or all of a given loss exposure is retained by the firm - ANS self-insurance (self-funding) a group captive that can write any type of liability coverage except employers' liability, workers compensation, and personal lines - ANS Risk retention group -save on loss costs -save on expenses -encourage loss prevention -increase cash flow - ANS Advantages of retention

1. Possible higher losses
2. Possible higher expenses
3. Possible higher taxes - ANS Disadvantages of retention
4. Can transfer some losses that are not insurable
5. Less expensive
6. Can transfer loss to someone who is in a better position to control losses - ANS Advantages of non- insurance transfers
7. Contract language may be ambiguous, so transfer may fail
8. If the other party fails to pay, firm is still responsible for the loss
9. Insurers may not give credit for transfers - ANS Disadvantages of non-insurance transfer a specified amount of money that the insured must pay before an insurance company will pay a claim - ANS Deductible the insurer pays only if the actual loss exceeds the amount a firm has decided to retain - ANS Excess insurance policy a policy specially tailored for the firm - ANS Manuscript policy
10. Firm is indemnified for losses
11. Uncertainty is reduced Insurers may provide other risk management services
12. Premiums are tax-deductible - ANS Advantages of insurance

1. Premiums may be costly
2. Negotiation of contracts takes time and effort
3. The risk manager may become lax in exercising loss control - ANS Disadvantages of insurance cyclical pattern in underwriting stringency, premium levels, and profitability - ANS Underwriting cycle profitability is declining, underwriting standards are tightened, premiums increase, and insurance is hard to obtain - ANS Hard market profitability is improving, standards are loosened, premiums decline, and insurance become easier to obtain - ANS Soft market an organization's written statement that sets out its approach to an appetite for any hazard or negative occurrence. - ANS Risk management policy used to describe the risk management program and train new employees - ANS Risk management manual -Enables firm to attain its pre-loss and post-loss objectives more easily -A risk management program can reduce a firm's cost of risk -Reduction in pure loss exposures allows a firm to enact an enterprise risk management program to treat both pure and speculative loss exposures -Society benefits because both direct and indirect losses are reduced - ANS Benefits of risk management refers to the identification of pure risks faced by an individual or family, and to the selection of the most appropriate technique for treating such risks - ANS Personal risk management the identification, analysis, and treatment of speculative financial risks - ANS Financial risk management

the risk of losing money if the price of a commodity changes - ANS Commodity price risk the risk of loss caused by adverse interest rate movements - ANS Interest rate risk the risk of loss of value caused by changes in the rate at which one nation's currency may be converted to another nation's currency - ANS Currency exchange rate risk a risk treatment technique that combines coverage for pure and speculative risks in the same contract - ANS Integrated risk management program a provision that provides for payment only if two specified losses occur - ANS Double-trigger option a process used by a company to identify its risks and develop responses to them that enable it to be reasonably assured of meeting its goals - ANS Enterprise risk management a computer-assisted method of estimating losses that could occur as a result of a catastrophic event - ANS Catastrophe modeling involves calculating the worst probable loss likely to occur in a given time period under regular market conditions at some level of confidence - ANS Value at risk (VAR) analysis the analysis of data to generate information that will help make more informed decisions - ANS Predictive analytics a grid detailing the potential frequency and severity of risks faced by the organization - ANS Risk map

a computerized database that permits the risk manager to store, update, and analyze risk management data - ANS Risk management information system a web site with search capabilities designed for a limited, internal audience - ANS Risk management intranet a probability distribution of losses that could occur - ANS Loss distribution characterizes the relationship between two or more variables and then uses this characterization to predict values of a variable - ANS regression analysis insurable risk is transferred to the capital markets through creation of a financial instrument - ANS Securitization of risk an option that derives value from specific insurable losses or from an index of values - ANS Insurance option combining small orders or shipments into one larger shipment to take advantage of transportation economies - ANS Consolidation paid losses + loss adjustment expenses + underwriting expenses / premiums - ANS Combined ratio