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

2. 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

3. 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.

4. 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.

5. 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

6. 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

7. 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

8. 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…

9. 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.

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

11. 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