Topic 9. Characteristics of an Insurable Risk BUS 200 Introduction to Risk Management and Insurance Jin Park

Overview Requirements of An Insurable risk Types of Insurance Large number of similar exposure units Accidental and unintentional loss No catastrophic loss Determinable and measurable loss Calculable chance of loss Economically feasible premium Types of Insurance

Characteristic 1 Large Number of Similar Exposure Units Enable the insurer to predict loss based on the law of large numbers Exposure units = item, person, etc… If exposure units are dissimilar and an insurer treats them indifferently, there will be ___________ problem. If “large number” is violated, the insurer will not be confident in their estimations, and thus, high risk charge must be added in the premium.

Characteristic 2 Accidental and Unintentional Loss The loss should be fortuitous and outside of the insured’s control. The law of large number is based on the random occurrence of events. Thus, If non-random (intentional or non-accidental) loss is insured, the prediction on the probability of a loss would be highly inaccurate. If intentional loss is paid, moral hazard would be substantially increased and premium would rise as a result.

Characteristic 3 No Catastrophic Loss Act of terrorism Earthquake No excessive possibility of catastrophe for the group as a whole. An catastrophic event could imperil the insurer’s solvency. The pooling (loss sharing) mechanism of insurance breaks down and becomes unworkable if catastrophic loss occurs. In certain cases, insurers are forced to provide coverage for catastrophic losses. Act of terrorism Earthquake

Characteristic 3 No Catastrophic Loss Remedies for insuring a catastrophic loss Reinsurance Geographical dispersion CAT Bonds (Catastrophe bonds) Designed to pay for a catastrophic loss sustained by insurer

Characteristic 4 Determinable and Measurable Loss A loss must be definite in time, place, and amount. It enables an insurer to determine if the loss is covered under the policy, and if it is covered, how much should be paid. Easy to determine and measure Property Damage Death Difficult to determine and measure Disability income benefits Pain and suffering

Characteristic 5 Calculable Chance of Loss The insurer must be able to calculate both the average frequency and severity of future losses with some accuracy. It is necessary so that a proper insurance premium can be charged. Difficult to calculate chance of loss Wars, cyclical unemployment, acts of terrorism, etc…

Characteristic 6 Economically Feasible Premium The insured must be able to pay the premium. The premium paid must be substantially less than the potential loss. Would you like to buy an insurance policy covering losses to your “BIC® pen”? To have economically feasible premium, the chance of loss should be relatively low. A life insurance policy on a 99 year old man.

Types of Insurance Personal, Group, or Commercial Life/Health or Property/Casualty Private or Government Voluntary or Involuntary

Additional Reading Assignments As Promotional Contests Rise, Insurers Back Up the Marketers Practicing Without a Net No Terror Coverage, No Dice Nuclear war isn’t covered by your home insurance