Chapter 8
An Introduction to Insurance and
Risk Management
Chapter 8: An Introduction to
Insurance and Risk Management
2
What is Risk?
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The chance of loss
There must be a chance of loss for risk
to exist.
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
3
Risk Defined
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Chance/possibility of loss
Uncertainty
Variation of actual from expected
results
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
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Understanding Risk
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Pure vs. Speculative
Dynamic vs. Static
Subjective vs. Objective
Particular vs. Fundamental
Financial vs. Nonfinancial
Probability of Loss
Law of Large Numbers
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
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Responses to Pure Risk
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Risk
Risk
Risk
Risk
avoidance
reduction
retention or assumption
transfer
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
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Causes of Insured Losses
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Perils
Hazards
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Physical hazard
Moral hazard
Morale hazard
Adverse Selection
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
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Insurable Losses
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Insurance vs. Gambling
Requisites for an Insurable Risk
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Large Number of Exposure Units Must Exist
Insured Losses Must Be:
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Accidental from Insured’s Standpoint
Measurable and Determinable
Losses Must Not Pose Catastrophic Risk for
Insurer
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
8
Elements of a Valid Contract
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Offer and Acceptance
Legal Competency of all Parties
Legal Consideration
Lawful Purpose
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
9
Legal Principles of the
Insurance Contract
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The Principle of Indemnity
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Subrogation Clause
The Principle of Insurable Interest
The Principle of Utmost Good Faith
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Warranty
Representation
Concealment
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
10
Distinguishing Characteristics of
Insurance Contracts
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Adhesion (Take it or Leave it)
Aleatory (Unequal Money Exchange)
Unilateral (Only One Promise, Made By
Insurer)
Conditional (Conditioned on Paying the
Premium)
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
11
The Law of Agency
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Agents & Brokers
Agency Relationships
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Express authority
Implied authority
Apparent authority
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
12
Important Features of
Insurance Contracts
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Exclusions
Riders and Endorsements
Valuation of Insured Losses
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Replacement Cost
Actual Cash Value (ACV)
Agreed-upon Value
Deductibles and Copayments
Coinsurance
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
13
Individual Loss Exposures and
Insurance Coverages
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Perils that Can Reduce and/or Eliminate the
Ability to Earn Income
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Dying too soon
Living too long
Disability
Perils that Can Destroy or Deplete Existing
Assets
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Damage to property
Legal liability for injuries inflicted upon others
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
14
Selecting an Insurance Company
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Rating agencies
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A. M. Best’s
Fitch
Moody’s Standard and Poor’s
Weiss
NAIC Criteria
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
15
Characteristics of Insurance
Companies
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Type of Ownership
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Capital Stock Insurance
Mutual Insurance
Insurance Underwriting
Reinsurance
Federal & State Regulation
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
16
The Risk Management Process
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Determining the objectives of the risk
management program
Identifying the risk exposure
Evaluating identified risks as to the
probability of outcome and potential
loss
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial
17
The Risk Management Process
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Determining and selecting the best risk
management alternative
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(cont.)
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
Chapter 8: An Introduction to
Insurance and Risk Management
 2005 Kaplan Financial