Chapter 8: An Introduction to Insurance and Risk Management Chapter 8 An Introduction to Insurance and Risk Management

 2005 Kaplan Financial 2 Chapter 8: An Introduction to Insurance and Risk Management What is Risk? The chance of loss There must be a chance of loss for risk to exist.

 2005 Kaplan Financial 3 Chapter 8: An Introduction to Insurance and Risk Management Risk Defined Chance/possibility of loss Uncertainty Variation of actual from expected results

 2005 Kaplan Financial 4 Chapter 8: An Introduction to Insurance and Risk Management Understanding Risk Pure vs. Speculative Dynamic vs. Static Subjective vs. Objective Particular vs. Fundamental Financial vs. Nonfinancial Probability of Loss Law of Large Numbers

 2005 Kaplan Financial 5 Chapter 8: An Introduction to Insurance and Risk Management Responses to Pure Risk Risk avoidance Risk reduction Risk retention or assumption Risk transfer

 2005 Kaplan Financial 6 Chapter 8: An Introduction to Insurance and Risk Management Causes of Insured Losses Perils Hazards Physical hazard Moral hazard Morale hazard Adverse Selection

 2005 Kaplan Financial 7 Chapter 8: An Introduction to Insurance and Risk Management Insurable Losses Insurance vs. Gambling Requisites for an Insurable Risk Large Number of Exposure Units Must Exist Insured Losses Must Be: Accidental from Insured’s Standpoint Measurable and Determinable Losses Must Not Pose Catastrophic Risk for Insurer

 2005 Kaplan Financial 8 Chapter 8: An Introduction to Insurance and Risk Management Elements of a Valid Contract Offer and Acceptance Legal Competency of all Parties Legal Consideration Lawful Purpose

 2005 Kaplan Financial 9 Chapter 8: An Introduction to Insurance and Risk Management Legal Principles of the Insurance Contract The Principle of Indemnity Subrogation Clause The Principle of Insurable Interest The Principle of Utmost Good Faith Warranty Representation Concealment

 2005 Kaplan Financial 10 Chapter 8: An Introduction to Insurance and Risk Management Distinguishing Characteristics of Insurance Contracts Adhesion (Take it or Leave it) Aleatory (Unequal Money Exchange) Unilateral (Only One Promise, Made By Insurer) Conditional (Conditioned on Paying the Premium)

 2005 Kaplan Financial 11 Chapter 8: An Introduction to Insurance and Risk Management The Law of Agency Agents & Brokers Agency Relationships Express authority Implied authority Apparent authority

 2005 Kaplan Financial 12 Chapter 8: An Introduction to Insurance and Risk Management Important Features of Insurance Contracts Exclusions Riders and Endorsements Valuation of Insured Losses Replacement Cost Actual Cash Value (ACV) Agreed-upon Value Deductibles and Copayments Coinsurance

 2005 Kaplan Financial 13 Chapter 8: An Introduction to Insurance and Risk Management Individual Loss Exposures and Insurance Coverages Perils that Can Reduce and/or Eliminate the Ability to Earn Income Dying too soon Living too long Disability Perils that Can Destroy or Deplete Existing Assets Damage to property Legal liability for injuries inflicted upon others

 2005 Kaplan Financial 14 Chapter 8: An Introduction to Insurance and Risk Management Selecting an Insurance Company Rating agencies A. M. Best’s Fitch Moody’s Standard and Poor’s Weiss NAIC Criteria

 2005 Kaplan Financial 15 Chapter 8: An Introduction to Insurance and Risk Management Characteristics of Insurance Companies Type of Ownership Capital Stock Insurance Mutual Insurance Insurance Underwriting Reinsurance Federal & State Regulation

 2005 Kaplan Financial 16 Chapter 8: An Introduction to Insurance and Risk Management The Risk Management Process Determining the objectives of the risk management program Identifying the risk exposure Evaluating identified risks as to the probability of outcome and potential loss

 2005 Kaplan Financial 17 Chapter 8: An Introduction to Insurance and Risk Management The Risk Management Process (cont.) Determining and selecting the best risk management alternative Risk Avoidance Loss Control Risk Retention or Assumption Risk Transfer Implementing a risk management plan based on selected alternatives Periodically evaluating and reviewing the risk management program