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Risk Management Midterm


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Define Risk
Risk is a condition in which there is a possibility of an adverse deviation from a desire outcome that is expected or hoped for.
Whose job is it to predict the number and amount of losses and come up with a premium?
Define uncertainty
a state of mind characterized by doubt; likelihood of an event is judged to be between 0 and 1
Define "degree of risk"
related to the likelihood of occurence; events with higher probability of loss have a higher degree of risk
What is a peril?
A peril is a cause of a loss (eg. fire, theft, windstorm)
Is it possible for something to be both a peril and a hazard?
Yes. Sickness is a peril that can cause economic loss and it is also a hazard that can cause loss from premature death.
What is a hazard?
A hazard is a condition that may create or increase the chance of loss arising from a given peril.
What are the three classifications of hazards?
1. Physical - eg. type of construction of a building
2. Moral - dishonest people engaging in fraud
3. Morale - more careless attitude to preventing loss because of insurance
What is the 4th less traditional type of hazard?
Legal - increase of frequency and severity of loss that arise from the legislature (eg. new building codes)
What is a dynamic risk?
a risk resulting from changes in the economy. Not generally suited to insurance companies.
What is static risk?
Loses that would occur even if there was no change in the economy. (eg. fire) Because they are somewhat predictable, they are suited to insurance companies.
What is a fundamental risk?
Affect large segments or even all of the population such as economic, social and political phenomena. Handled by social programs.
What is a particular risk?
Losses that arise out of individual events and are felt my individuals. Handled by insurance.
What is speculative risk?
A risk where there is a possibility of loss but also a possibility of gain. (eg. gambling)
What is pure risk?
Designates situations that only involve the chance of loss or no loss.
What are the classifications of pure risk?
1. Personal risks - loss of the ability to earn income
2. Property risks - loss due to destruction or theft
3. Liability - unintentional injury to other persons or their property due to negligence
4. Failure of others - loss due to someone not performing as agreed
What is risk management?
A scientific approach to the problem of pure risk, which has as its objective the reduction and elimination of pure risk.
What significant change in college curriculum helped evolve risk management?
New courses focused on choices that should be made rather than studying what past choices were and why.
What are the techniques for dealing with risk (risk management tools)?
1. Risk control - avoidance, reduction
2. Risk financing - Retention, transfer
What are the two common misconception of risk management?
1. Applies only to large organizations.
2. Has an anti-insurance bias
What are the 6 steps in the 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
What is the primary objective of risk management?
Survival of the organization.
What are some risk identification techniques?
1. Analysis of documents
2. Flow charts
3. Internal communication system
What are some tools of risk identification?
1. Risk analysis questionnaires
2. Exposure checklists
3. Insurance policy checklists
4. Expert systems
What are three categories of evaluating risk?
1. Critical
2. Important
3. Unimportant
What is the loss unit concept?
The loss unit is the total of all financial losses that can result from a single event.
What is a risk management audit?
a detailed and systematic review of a risk management program.
What are the two fundamental characteristics of Insurance?
1. Transfering risk from one individual to a group
2. Sharing of losses by all members of the group
What is the law of large numbers?
By combining a large number of homogeneous exposures, the insurer is able to make predictions for the group.
What are the two interpretations of probability?
1. Relative frequency - the frequency given a large number of trials
2. Subjective - Measured by the degree of belief of likelihood of an occurrence
What are a priori probabilities?
Probabilities that can be determined in advance such as a coin toss.
What are a posteriori probabilities?
Probabilities interpreted as the relative frequency after examining a long series of trials.
How does the individual view insurance?
As a device where a small certain cost substitutes for a large uncertain loss.
How does society view insurance?
As a device for reducing and elimating risk through pooling.
What are the four ideal elements of an insurable risk?
1. Predictable (large number of homogeneous exposures)
2. Loss must be definite and measurable
3. Loss must be fortuitous or accidental.
4. Loss must not be catastrophic. (affecting a large percentage of the exposures at the same time)
What is the 5th attribute sometimes listed as a requirement of an insurable risk?
Economic Feasability - cost of insurance must not be high in relation to the possible loss
What characteristics are necessary for a successful "self insurance" program?
1. Organization is big enough to apply law of large numbers and make losses predictable.
2. Financially dependable plan.
3. Geographic distribution to prevent catastrophe.
What are the classes of insurance?
1. Private insurance
2. Social insurance
3. Public benefit guarantee programs
What are the three categories of private insurance?
1. Life insurance
2. Health insurance
3. Property and liability insurance
What is life insurance designed to provide against?
1. Premature death
2. Superannuation
What is the difference between named-peril coverage and open-peril coverage?
Named peril names all perils covered. Open peril names all perils not covered.
Name 8 property and liability insurances.
1. Marine insurance (Ocean marine, inland marine)
2. auto
3. liability
4. Workers comp
5. Equipment breakdown
6. Theft
7. Credit
8. Title
What are the parties to a bond?
1. surety - the payer
2. obligee - the receiver
3. principal - the one with the debt
What are the two types of bonding?
1. Fidelity - employee dishonesty insurance
2. Surety - the surety guarantees that the principal will meet the obligation
Name 6 Social insurances
1. Worker's comp
2. Social security
3. Unemployment
4. Railroad retirement
5. Medicare
6. State compulsory temporary disability funds
Name 6 public guarantee insurance programs
2. National credit union administration
3. Securities investor protection corporation
4. Pension Benefit Guarantee coporation
5. State insurer insolvency funds
6. Unsatisfied judgement funds
What are two theory used in risk management decisions?
1. Utility theory - preference of risk to loss
2. Decision theory - making the best decision
What are 3 decision theory strategies?
1. Cost-benefit analysis
2. Expected value
3. Pascal's wager/minimax
What are the simple rules of risk management?
1. Don't risk more than you can afford to lose
2. Consider the odds
3. Don't risk a little for a lot

Fill in this matrix

What are the most common errors that people make in buying insurance?
1. Buying too little
2. Buying too much
What is the priority ranking for insurance expenditures?
1. Essential
2. Important
3. Optional
What is the first rule of risk management?
When a risk exceeds the organization's risk bearing capacity, it must be reduced or transferred.
Name 3 tax consideration in risk financing decisions.
1. Insurance premiums are deductible
2. Uninsured losses are deductible to the extent of profits
3. Funded retention programs are not deductible
Name 4 factors for choosing a good insurance company.
1. A good agent who can advise
2. Financial stability (moody's, s&p, fitch)
3. Cost of insurance
4. attitude toward paying claims
What are some alternatives to commercial insurance?
1. Self-insurance
2. captive insurers
3. risk retention groups
4. risk sharing pools
What was responsible for the most recent wave of captive insurance companies?
Risk Retention Act of 1986
What are the total premiums written by the three segments of the industry and what is the breakdown?
more than 1 trillion

Life - 435 billion
Health - 340 billion
Property/Liability - 300 billion
What are the 3 classifications of incorporation and licensing?
Domestic - in the state
Foreign - in the US not in the state
Alien - outside the US
What are the 6 classifications of legal ownership for insurers?
1. Capital stock - owned by stockholders
2. Mutual - owned by policy holders
3. Reciprocal exchange(interinsurance) - property and casualty only
4. Lloyd's
5. Health expenses associations - eg. blue cross
6. Government
What is the difference between an agent and a broker?
1. agents represent the insurance company and can bind insurance in the field of property and liability
2. brokers represent the insured and can not bind insurance
What are the two classifications of property and liability insurance companies?
1. those who operate through the American Agency system (independent agents having ownership of renewals)
2. direct writers (exclusive agents that do not have ownership of renewals)
What is the direct response system of selling insurance?
No agents. Sold my mass media avertising such as mail, tv, and internet.
What is another name for Insurance Company Groups?
What is an underwriting syndicate?
It is when a group of insurers join together for the purpose of handling risks that would be beyond the capacity of an individual company.
What act prohibited banks from owning insurance companies or brokerage firms?
Glass-Steagall act of 1933
What act repealed the prohibition of a bank owning an insurance company or brokerage firm?
Financial Services Modernization Act (Gramm-Leach-Biley Act aka: GLBA)
What is an advisory organization and name 3 prominent ones.
A rating bureau that assists in ratemaking.

1. Insurance service office (ISO)
2. American Association of Insurance (AAIS)
3. National Council on Compensation Insurance
What is a shared market plan? Name some.
A euphemism for the involuntary markets in which insurance is provided to applicants that normally would not meet underwriting standards.

1. Auto Insurance Plan
2. Workers comp assigned risk pool
3. Medical malpractice
4. FAIR plans (inner city/high risk property)
5. Beach and windstorm pools
6. State health insurance
What are some examples of cooperations within the insurance industry?
1. Rating organizations
2. Distressed and Residual risk pools
3. Education organizations
4. Insurance trade associations
5. Reinsurance organizations
What are the two areas of competition in the insurance industry?
Price and Quality
What is cash flow underwriting?
Charging premiums less than needed to cover losses then investing the money to achieve profit.
What important bill for the insurance industry became law on March 9, 1945?
Public law 15 (McCarran-Ferguson act) - left regulation to the states rather than the fed government (paul v. virginia, 1869)
What is the only state that does not provide for regulation of insurance rates?
What are the requirements of rate regulators?
1. rate Adequacy
2. rates not excessive
3. rates not unfairly discriminatory
What are 5 systems to regulating rates in the field of property and liability?
1. Prior-approval system
2. No filing
3. File and use laws
4. Informational filing
5. Flex rating (range of rates)
What is redlining?
The decision of an insurer to avoid insuring property located in undesirable areas.
What costs are common to all insurance companies?
1. Losses and loss adjustment expense
2. Acquisition expense
3. Administrative expense
4. Taxes
5. Profits and contingencies
What are the 5 functions of insurers?
1. Ratemaking
2. Production (sales and marketing)
3. Underwriting
4. Loss adjustment
5. Investment
What is retrospective rating?
Provides a rebate if fewer claims are filed. Pay more if more claims are filed. Doesn't work because people leave rather than pay more.
What do insurance companies do to spread out their own risk?
Use reinsurance
What are the requirements of an enforceable contract?
1. Offer and acceptance
2. Consideration
3. Legal object
4. Competent parties
5. Legal Form
What is subrogation?
Letting the other insurance company pay rather than contact your own.
Why is life insurance (and annuities) referred to as unilateral?
Once a client hold a policy, he holds all the rights.
What are the three forms of agent authority to act on behalf of the insurer?
1. Express authority - specifically granted to the agent
2. Implied authority - reasonably necessary to execute express authority (e.g. collect premiums)
3. Apparent authority - not expressly granted but the public has come to expect it
What are the 4 sections of a policy construction?
1. declarations
2. insuring agent
3. exclusions
4. conditions
What does it mean to say Insurance is an aleatory contract?
It means that the outcome is affected by chance and the number of dollars given up by each party will be unequal
What is the difference between the capital conservation and capital utilization approaches to retirement?
Capital conservation is living off the interest and not depleting principal. Capital utilization can result in superannuation because the goal is to die with zero dollars.
How does human-life value and needs analysis approaches to life insurance differ?
Human-life - replace lost income
Need analysis - figure out what the future need is after applying credits
What are 4 characteristics of term insurance?
1. Temporary
2. Low cash flow
3. can be convertible
4. get a lot for a little
What are 3 characteristics of perm insurance?
1. Can withdraw the basis (FIFO)
2. Earns interest that is tax deferred and sometimes tax free.
3. Investment with a Life insurance benefit.
Why doesn't one want re-entry conditions in their policy?
Forces the insured to requalify after a period of time in order to renew
Name 4 permanent life insurance products
1. Universal - very low risk
2. Variable - mutual funds, high on fees
3. Indexed - tied to an index
4. Whole - expensive because it has a lot of guarantees
What is statuatory accounting?
As opposed to GAAP, it is how life and property insurance companies do their bookkeeping.
What are the three classification for taxing of insurance companies by the IRS?
1. Life
2. non life mututal
3. neither life not mutual
Is life insurance a contract of indemnity?
What are the 4 types of life insurance?
1. Ordinary
2. Industrial
3. Group
4. Credit
What is the contestability period of life insurance?
2 years
Who are the 3 people specified in a life insurance contract?
1. owner
2. beneficiary
3. insured
What are the 3 non-forfeiture values of permanent life insurance?
1. Cash option
2. Paid-up policy reduced amount
3. Extended term insurance
What is the difference between participating and non-participating life insurance?
Under a participating policy a substantial margin of safety is built into the premium with the understanding that if it is not needed it is returned as a dividend. The non-participating policy contains no dividend.
What is the exclusion ratio for annuities?
Amount per year x investment/total amount expected
How are annuities taxed?
A premature withdrawal has a 10% penalty. Premature is before 59 1/2 unless holder is disabled or distribution is over the life of the annuitant. Otherwise taxes are subject to the exclusion ratio formula.

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