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RMIN Test 1
1,3,4 Appendix 2
97
Insurance
Undergraduate 3
02/14/2011

Additional Insurance Flashcards

 


 

Cards

Term
Risk
Definition

 

  • uncertainty concerning the occurrence of loss
  • the possibility of an adverse deviation from a desired outcome that is expected or hoped for

 

Term
Pure Risk
Definition
uncertainty to whether a loss will occur. No possibility for gain-only the potential for loss (car gets stolen)
Term
Speculative Risk
Definition
uncertainty about an event that can produce either a profit or a loss (mutual fund)
Term
Subjective Risk
Definition

Mental state of an individual who experiences doubt or worry as to the outcome of a given event.

 

It is essentially the psychological uncertainty that arises from an individual's mental attitude or state of mind

Term
Objective Risk
Definition

The relative variation of actual loss from expected loss.

 

more precisely observable and therefore measurable.

Term
Risk Neutral
Definition

Indifferent towards Risk.

Value of Risky Situation is Expected Loss

Term
Risk Averse
Definition

Prefer to avoid Risk.

 

Willing to pay more than expected loss to avoid risk.

 

People who buy insurance

 

people are risk averse in general

Term
Risk Seeker
Definition

Prefer Risk

 

Would pay more than expected return to engage in risky situation

 

Lottery Players

 

Insurance charges more than the expected loss to account for overhead. If everyone was a risk seeker there would be no insurance.

Term
Static Risk
Definition
probability that doesn't change much over time (weather)
Term
Dynamic Risk
Definition
Probability changes a lot over time (politics)
Term
Measurements of Objective Risk
Definition

measures both dimensions-probability of loss and severity of loss- simultaneously.

 

Probable variation of actual from expected losses.

 

Term
Measures of objective Risk
Definition

 

  • Variance
  • Standard Deviation
  • Coefficient of Variation

 

Term
Loss Occurrence
Definition

 

  • If a loss has already occurred the probable variation of actual from expected losses is zero (therefore the objective risk is 0)
  • If it is impossible for loss to occur the probable variation is also zero
  • In measuring objective risk, results are meaningful only in terms of a group large enough to be analyzed statistically

 

Term
Property Risks
Definition
Risk that property may be damaged, destroyed or stolen
Term
Liability Risks
Definition

Legal judgments may result in payments made to compensate injured parties as well as to punish those responsible for the injuries even if the individual is absolved of liability the expenses involved in the defense may be substantial.

 

All individuals who own or use real property are suscpetible to liability losses if others are injured on the premises. 

Term
Personal Risks (Life and Health and Loss of Income)
Definition

 

Life and health and loss of income risks
  • The possibility of the untimely death of a star salesperson
  • The potential death of a parent with young children
  • Employees who become ill or injured in accidents
  • Insufficient income for retirement
  • Unemployment

 

Term
Financial Risks
Definition
  • Include credit risk, foreign exchange risk, commodity risk, and interest rate risk
  • These risks must be identified and assessed in order for the firm to achieve its business goals
ex: bank with a large portfolio of Treasury Bonds may incur losses if interest rates rise
Term
Peril
Definition

Specific contingency that may cause a loss (accident)

 

(cause of a loss)

Term
Loss Exposure
Definition
unit or object subject to a potential loss (car)
Term
Hazard
Definition
conditions that exist which either increase the probability of a loss for a particular peril or tend to make the loss more severe once the peril has occured
Term
Physical Hazard
Definition
a condition stemming from the material characteristics of an object. (An icy street makes the occurence of collision more likely to occur)
Term
Moral Hazard
Definition

 

dishonesty or character defects in an individual that increase the frequency or severity of a loss
  • stems from an individual's mental attitude
  • associated with intentional actions designed either to cause a loss or to increase its severity
  • also describes the change in attitude that can occur when insurance is available to pay for loss (such as the tendency for individuals to consume more health care if the costs are covered by insurance)
  • ex: fraud

 

Term
Attitudinal (Morale) hazard
Definition

Carelessness or indifference to a loss which increases the frequency or severity of a loss

 

The mental attitude of a careless or accident-prone person

Term
Societal Hazard
Definition

Legal and Cultural

 

characteristics of the legal system or regulatory environment that increase the frequency or severity of losses

Term
Cost of Risk include:
Definition

 

  • outlays to reduce risk
  • opportunity cost of activities forgone due to risk considerations
  • expenses of strategies to finance potential losses (buying insurance)
  • The cost of unreimbursed losses

 

Term
Risk Management
Definition
Process used to systematically manage risk exposures
Term
Enterprise Risk Management/ Integrated Risk Management
Definition
intent to manage all forms of risk, regardless of type
Term
Risk Management Process
Definition

 

  • Identify Risks
  • Evaluate Risks
  • Select Risk Management techniques
  • Implement and review decisions

 

Term
Diversifiable Risk
Definition
risk that only affects individuals or small groups and not the entire economy (stock portfolio)
Term
Nondiversifiable Risk
Definition
risk that affects the entire economy or large number of persons (war, floods)
Term
Human Life Value
Definition
present value of the family's share of the deceased's future earnings
Term
Loss prevention
Definition
aims at reducing the probability of loss so the frequency of loss is reduced
Term
Loss Reduction
Definition
reduce the severity of loss
Term
Pre-Loss objectives
Definition

 

  • survival and growth
  • compliance with government regulations
  • efficiency
  • procedures and principles are implemented and followed
or
  • prepare for potential losses in the most economical way
  • reduce anxiety
  • meet any legal obligations

 

Term
Post-Loss Objetives
Definition

 

  • survive the loss
  • provide a foundation to grow and prosper
  • behave responsibly as a good corporate citizen

or:

  • survival
  • continue operating
  • stability of earnings
  • continued growth
  • minimize effects loss will have on others and society

Term
Loss Exposure
Definition

Unit or object subject to a potential loss

 

Term
Loss Exposure checklist
Definition

 

  • specifies numerous potential sources of loss from the destruction of assets and from legal liability
  • some are designed for specific industries
  • others focus on a specific category of exposure

 

Term
Financial Statement Analysis
Definition
all items on a firms balance sheet and income statement are analyzed in regard to risks that may be present
Term
Flowcharts
Definition
allows risk managers to pinpoint areas of potential losses. Only through careful inspection of the entire production process can the full range of loss exposures be identified
Term
Contract Analysis
Definition

 

  • It is not unusual for contracts to state that some losses, if they occur, are to be borne by specific parties
  • may be found in construction contracts, sales contracts and lease agreements
  • ideally the specification of who is to pay for various losses should be conscious decision that is made as part of the overall contract negotiation process

 

Term
On-site inspections
Definition
during these visits, it can be helpful to talk with department managers and other employees regarding their activities
Term
Risk Evaluation
Definition
once a risk is identified, the next step is to estimate both the frequency and severity of potential losses
Term
Maximum Probable Loss
Definition
an estimate of the likely severity of losses that occur.
Term
Maximum Possible Loss
Definition
an estimate of the catastrophe potential associated with a particular exposure to risk
Term
Risk Mapping/Profiling
Definition
  • Involves arraying risks in a matrix (one dimension is the frequency/the other is the severity)
  • Each risk is marked to indicate whether it is covered by insurance or not.
Term
Probability
Definition

long term frequency of occurrence.

 

Term
Probability Distribution
Definition
mutually exclusive and collectively exhaustive list of all events that can result from a chance process. 
Term
Law of Large Numbers
Definition

 

  1. As the number of homogeneous exposure units increases, the degree of risk decreases
  2. Given a constant number of exposure units as the probability of loss increases, the degree of risk decreases

 

Term
Central Limit Theorom
Definition
expected results for a pool or portfolio of independent observations can be approximated by the normal distribution (perfectly bell-shaped)
Term
Value at Risk (VAR) (Maximum Probable Loss)
Definition

constructs probability distributions of the risks alone and in various combinations. 

 

  • To obtain estimates of the risk of loss at various probability levels
  • yields a numerical statement of maximum expected loss in a specific time and at a given probability level
  • provides the firm with an assessment of the overall impact of risk on the firm
  • considers correlation between different categories of risk

 

Term
Risk-adjusted return on capital
Definition

 

  • attempts to allocate risk costs to many different activities of the firm
  • assesses how much capital would be required by the organizations various activities to keep the probability of bankruptcy below a specified level

 

Term
Two distributions with same mean
Definition
The distribution with the higher range is riskier
Term
Standard Deviation/Risk
Definition
higher standard deviations relative to the mean are associated with greater uncertainty of loss; therefore, risk is higher
Term
Risk Avoidance
Definition

 

  • a conscious decision not to expose oneself or one's firm to a particular risk
  • can be said to decrease one's chance of loss to zero
  • when risk is avoided, the potential benefits as well as costs are given up

 

Term
Loss Control
Definition

 

  • When particular risks cannot be avoided, actions may be taken to reduce the losses associated with them
  • The firm or individual is still engaging in operations that give rise to particular risks
  • Involves making conscious decisions regarding the manner in which those activities will be conducted

 

 

Term
Frequency Reduction
Definition
loss control measures designed to reduce loss frequency
Term
Domino Theory
Definition

 

  1. Heredity and social environments which cause a person to act a particular way
  2. personal fault which it the failure of individuals to respond appropriately in a given situation
  3. an unsafe act or the existence of a physical hazard
  4. accident 
  5. injury

If any of the dominos prior to the final one are removed the injury will not occur. Emphasis on loss control should be on the third domino.

 

Term
Severity Reduction
Definition
airbags, etc.
Term
Separation
Definition

involves the reduction of the maximum probable loss associated with some kinds of risks. (spreading exposure units out separately)

 

Term
Duplication
Definition
Spare parts or supplies are maintained to replace immediately damaged equipment or inventories
Term
Pre-loss activities
Definition
implemented before any losses occur. (safety training)
Term
Concurrent loss control
Definition
activities that take place concurrently with losses (fire sprinklers)
Term
Post-loss activities
Definition
always have a severity-reduction focus. trying to salvage damaged property
Term
Benefits of loss control
Definition

 

  • repair/replacement of damaged property
  • income losses due to destruction of property
  • extra costs to maintain operations following a loss
  • adverse liability judgments
  • medical costs to treat injuries
  • income losses due to death or diabilities

 

Term
Potential Costs of Loss Control
Definition
installation and maintenance expenses.
Term
Risk Retention
Definition
Involves the assumption of risk. If a loss occurs an individual or firm will pay for it out of whatever funds are available at the time
Term
Planned Retention
Definition

 

  • Put money aside in case of event
  • involves a conscious and deliberate assumption of recognized risk
  • sometimes occurs because it is the most convenient risk treatment technique or because there are no alternatives short of avoidance

 

Term
Unplanned Retention
Definition

when a firm or individual does not recognize that a risk exists and unwittingly believes that no loss could occur.

 

sometimes occurs even when existence of a risk is acknowledged

if the maximum possible loss associated witha recognized risk is significantly underestimated.

Term
Unfunded Retention
Definition
intention to pay for losses as they occur without making any funding arrangements in advance of a loss
Term
Funded Retention
Definition
Preloss arrangements are made to ensure that money is readily available to pay for losses that occur.
Term
Credit
Definition

 

  • may provide some limited opportunities to fund losses that result from retained risks
  • usually not viable source of funds for the payment of large losses
  • credit line established with bank, and borrowed funds may be used to pay losses as they occur. Interest must be paid.

 

Term
Reserve Funds
Definition

Sometimes established to pay for losses arising out of risks a firm has decided to retain.

When the maximum possible loss is quite large a reserve fund may not be appropriate

Term
Self-Insurance
Definition

If the firm has a group of exposure units large enough to reduce risk and thereby predict losses, the establishment of a fund to pay for those losses is a special form of planned funded retention. 

 

Will not involve a transfer of risk

 

Need existence of a group of exposure units that is sufficiently large enough to enable accurate loss prediction.

 

 is a risk management method in which a calculated amount of money is set aside to compensate for the potential future loss.

If self insurance is approached as a serious risk management technique, money is set aside using actuarial and insurance information and the law of large numbers so that the amount set aside (similar to an insurance premium) is enough to cover the future uncertain loss.

Term
Captive Insurers
Definition

Insurer owned by a parent firm for the purpose of insuring the parent firm's loss exposures

 

combines the techniques of risk retention and risk transfer

Term
Large Companies and Risk Retention
Definition
larger companies can often use risk retention to a greater extent than a small firm can. 
Term
Risk Transfer
Definition
Involves payment by one party to another. Transferee agrees to assume a risk that the transferor desires to escape
Term
Hold-Harmless Agreements
Definition

 

  • Provisions inserted into many different kinds of contracts
  • can transfer responsibility for some types of losses to a party different than the one that would otherwise bear it.
  • Also known as indemnity agreements
  • intent of these clauses is to specify the party that will be responsible for paying for various losses (usually no dollar amount is listed)

 

Term
Hold Harmless Agreement Forms
Definition

 

  • Limited- clarifies that all parties are responsible for liabilities from their own actions
  • Intermediate- transferee (receiver) agrees to pay for any losses in which both are jointly liable
  • Broad- requires the transferee (receiver) to be responsible for all losses arising out of a particular situation regardless of fault

 

Term
Incorporation
Definition

risk transfer where a firm is a sole proprietorship the owners personal assets can be attached by creditors for satisfication of debts. 

 

The most that an incorporated firm can ever lose is the total amount of its assets. Personal assets of the owners in a firm cannot be attached to help pay for business losses. 

Term
Diversification
Definition

Results in transfer of risk across business units

combining businesses or geographic locations in one firm can even result in a reduction in total risk

Term
Hedging
Definition
Involves the transfer of a speculative risk. a business transaction in which the risk of the price fluctuations is transferred to a third party
Term
Burden of Risk on Society
Definition

 

  • The size of an emergency fund must be increased
  • Society is deprived of certain goods and services
  • Worry and Fear are present

 

Term
Model Building Process
Definition

 

  1. Problem-Real World
  2. "Translated" problem-Model World
  3. Model Solution
  4. Solution

 

Term
Steps for selecting among available risk management techniques:
Definition

  • Avoid Risks if possible
  • Implement appropriate loss control measures
  • Select the optimal mix of risk retention and risk transfer

Term
Frequency/Severity Matrix
Definition

 

  • Low Frequency/Low Severity- Retention
  • Low Frequency/High Severity- Transfer (Insurance)
  • High Frequency/Low Severity-Retention/Loss Prevention
  • High Frequency/High Severity- Avoidance

 

Term
Present Value
Definition
P(1+i)^n=Q
Term
General Guidelines
Definition

  • Risk Retention is optimal for losses that have a low expected severity, with the rule becoming especially appropriate when expected frequency is high
  • Risk Transfer is the optimal choice in situations with low frequency but high severity
  • When losses have high severity and high frequency it is likely that risk transfer, risk retention, and loss control all need to be used in varying degrees

Term
Selecting a Deductible
Definition

  • selecting a deductible is one way of mixing retention and risk transfer
  • Deductibles help lower the cost of insurance as well as increase its availability
  • Deductibles may also make management more loss conscious because a firm must absorb losses 

Term
Risk Managers do not accept deductibles unless:
Definition

  • the firm can afford the associated losses
  • sufficient premiums savings will result

Term
Deductible
Definition

  • provision by which a specified amount is subtracted from the loss payment otherwise payable to the insured.
  • a deductible is used to eliminate small claims and the administrative expense of adjusting these claims
  •  portion of any claim that is not covered by the insurance provider. It is the amount of expenses that must be paid out of pocket before an insurer will cover any expenses. 

Term
Self Insurance Decision
Definition

  • Management may prefer stable predictable insurance premiums each year rather than use self-insurance
  • some companies prefer to avoid details of managing self-insurance programs instead focus on their main operations

Term
Advantages of Self Insurance
Definition

  • plan may be tailored to fit the needs of the group
  • has lower fixed costs than a fully insured plans
  • can use independent measures to save the most money
  • Interest accumulated is considered income
  • reasonably and competitively priced
  • simplifies budgeting
  • simpler, faster

Term
Risk Manager versus Insurance Agent
Definition

  • do not perform identical functions
  • broker is not as familiar with the internal affairs of the company
  • Risk manager's primary concern is the firm
  • responsibility is too important for an outsider

Term
Organization for Risk Management
Definition

  • Risk manager supervises a variety of activities including all kinds of insurance, self-insurance programs, foreign risks, and safety administration
  • Claims and Loss Records are under Risk Manager control
  • Risk manager is only 2 levels below the president and may have 5-10 professional employees too assist

Term
Risk Management Policy
Definition
plan, procedure, or rule of action followed for the purpose of securing consistent action over a period of time
Term
Risk Management Information Systems
Definition
computerized database that permits the risk manager to store and analyze risk management data and use such data to predict and control future loss levels.
Term
Best way to handle subjective risk
Definition
add knowledge through research, training, and education
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