Principles and Practice Study 1 What is risk? Risk is uncertainty. Insurance is based on risk. Risk as it relates to insurance, is the possibility or chance of loss. There are different levels of risk. The more likely a loss is to occur the higher the frequency of that event. Severity of loss relates to the value at risk. Example: A cottage in the country, miles from the nearest water source, presents an increased possibility of a serious fire - it s riskier than a brick house that s across the street from a fire hydrant. Definitions A peril is an event that will give rise to a loss. Examples include: fire, theft, storm, explosion. A hazard is a factor which may influence the outcome of a loss. Examples include: slippery sidewalks, poorly maintained property. Classifications of Risk Speculative risk has a chance for profit or loss. Examples include: gambling, starting your own business. These risks are not insurable. Pure risk has a chance for loss only. Examples include: leaving your car unlocked, storing flammable liquid in your basement close to the furnace. Pure risk can be insured. Examples of Insurable Risk Individual Personal Property Liability Injury Home Legal obligations to others e.g., child Illness Belongings throws ball through neighbour s window; Death Your car keeping your sidewalks cleared of snow. Business Injury Buildings Legal obligations arising out of ownership, Death Equipment use and occupancy of premises; sale of Stock products; safety of employees. Risk management is the minimization of the detrimental effects of risk by identifying, measuring, and controlling the risk. Identify the Risk that is, know the exposure. How? Site inspection Financial analysis Historical records Employee interview Examples include: direct property damage, business interruption, liability, employer s liability, fidelity. Measure the Risk that is, assess what could happen? How serious a loss might occur (loss severity)? Is there a possibility of a loss happening over and over again (loss frequency)? Examples include: your store is located in a high crime area or on a natural flood plane.
Control the Risk Ways to control the risk: Reduce Eliminate the risk example: No Smoking allowed Prevention example: sprinkler systems; driver training Assume Self-insurance example: large deductible Captive a corporation s own insurance company Transfer that is, buy insurance Insurance Insurance is sharing the loss of the few (who have claims) among the many (who pay premiums). = peace of mind = a form of financial security Definition of Insurance Insurance is the undertaking of one person to indemnify another person against loss or liability for loss in respect of a certain risk or peril to which the object of the insurance may be exposed, or to pay a sum of money or other thing of value upon the happening of a certain event. The undertaking an agreement, or a promise Indemnify to put back in the same financial position as just prior to the loss One person to another insurance is a "two party" contract, usually an insurer and an insured. Against loss or liability for loss something that has monetary value Certain risk or peril to which the object of the insurance may be exposed that is, it was previously agreed (the undertaking) to protect against what happened Premiums pay for current losses reserve for outstanding losses reserve for return of unearned premium expenses (salaries, commissions, rent) profit Reserves are funds, required by law, to be set aside to pay for losses reported but not yet paid or not yet reported and to cover unearned premiums. Unearned Premium is that portion of the premium that has not yet been earned on a given policy.
Sample Exam Questions - Principles and Practices Study 1 - Risk and Insurance Multiple Choice Questions December 2001 1. In insurance terminology, risk is (a) an insured peril (b) speculative in nature (c) the chance or possibility of loss (d) uninsurable 2. A hazard is (a) a consideration (b) a factor that could influence the occurrence of a loss (c) an insurable peril (d) the risk if loss 3. Which of the following is true of risk? (a) A business operation is an example of pure risk (b) Insurance prevents risks (c) Some risks present the possibility of either profit or loss (d) There can be no risk without insurance 4. Risk management is the (a) the elimination of risk (b) insurance of risk (c) minimization of risk (d) science of loss prevention 5. In insurance terminology, a peril is (a) an event that may give rise to a loss (b) an imminent danger (c) something dangerous (d) the risk of immediate loss 6. An unearned premium is (a) an asset in the books of an insurer (b) the portion of original premium equal to the expired time (c) the portion of original premium for the unexpired term (d) used as a cushion in case of a high loss ratio July 2001 7. In insurance terminology, risk is (a) an insured peril (b) speculative in nature (c) the chance or possibility of loss (d) the equivalent of hazard 8. Risk management is (a) loss insurance (b) loss minimizing (c) loss prevention (d) loss underwriting 9. Which of the following is NOT true of insurance? (a) It deals with risk by spreading it. (b) It prevents perils from occurring. (c) It provides peace of mind (d) It reduces uncertainty related to possible losses.
10. In Insurance terminology, a peril is (a) a possible event that may give rise to a loss (b) pure risk (c) the equivalent of hazard (d) the measure of possible severity of a potential loss 11. In insurance terminology, reserves are the (a) funds required to be set aside for specific purposes for the benefit of policyholders (b) funds required to pay for the operation and management of the business (c) investment of shareholders in the business (d) reservations to the extent of the coverage as defined by policy exclusions 12. An unearned premium is that portion of the policy premium that (a) covers the policy period that has not yet expired (b) has not been paid out as a loss or losses (c) has not been paid out as losses or as commissions to agents/brokers (d) is left over after the payment of all losses, commissions and expenses April 2001 13. Insurance is based on the existence of (a) consideration (b) indemnity (c) loss (d) risk 14. Which of the following is true of risk? (a) A business operation is an example of pure risk (b) Insurance prevents risks (c) Some risks present the possibility of either profit or loss (d) There can be no risk without insurance 15. Which of the following is NOT true of insurance? (a) Insurance is the undertaking to indemnify someone against loss or liability (b) Insurance prevents losses (c) Insurance reduces the uncertainty related to possible losses. (d) Insurers can be said to be managers of the fund from which losses are paid to those who have paid into it. 16. Insurance can be best described as (a) a method of sharing the losses of the few among the many (b) protection from hazards (c) protection from perils (d) the assumption of the liability of others 17. In insurance terminology, a peril is (a) a condition that may aggravate a loss (b) an event that may cause a loss (c) an exclusion made under a policy (d) usually uninsurable December 2000 20. Which of the following is NOT a true statement? (a) Both chance and risk imply doubt about the future (b) Chance implies that the outcome in a given situation may be favourable (c) Risk implies that the outcome in a given situation may be unfavourable (d) Risk and uncertainty are totally unrelated
21. In insurance terminology a peril is (a) something dangerous (b) the risk of immediate loss (c) an event that may give rise to a loss (d) an imminent danger 22. In risk management, controlling a risk refers to (a) developing a plan that may include combining loss prevention and risk transfer techniques (b) identifying risk and being able to assume it (c) measure the risk carefully (d) using the services of a risk manager 23. Which of the following is not a reserve (a) Funds set aside to pay for known losses (b) Funds set aside to pay for losses still unknown (c) The cost of refunding premiums (d) The value of premiums not yet earned 24. Unearned premiums are (a) an asset in the books of the insurer (b) the portion of the original premium equal to the expired time (c) the portion of the original premium for the unexpired term (d) used as a cushion in the event of a high loss ratio July 2000 25. In the business of insurance risk is considered to be (a) the possibility of loss (b) speculative in nature (c) the equivalent of hazard (d) an event that will give rise to a loss 26. Pure risk: (a) is the kind of risk insurers will usually decline (b) entails a chance of loss (c) is speculative in nature (d) is the equivalent of peril 27. The first responsibility of a Risk Manager is to: (a) identify the loss exposure (b) remove all hazards (c) measure the risk (d) buy the very best insurance at the best possible price 28. A hazard: (a) is an insurable loss (b) is the risk of loss (c) is a consideration (d) is a factor that could influence the happening of a loss April 2000 29. In an insurance sense risk is: (a) always insurable (b) a hazard (c) the chance of loss (d) uncertainty
30. Risk management is (a) risk prevention (b) minimization of the possible detrimental effects of risk (c) inspection of the risk (d) insuring the risk Essay Questions December 2001 2. (a) Identify the THREE(3) general types of risk that could apply to individuals and and families. (3 marks) (b) (b) Give a formal definition of the term insurance. (5 marks) Explain THREE activities that are associated with a risk managers responsibility. (12 marks) 3. (a) For each of the following, indicate whether or not a risk is present, and explain why: July 2001 i) Developing a cancer ii) Eventual obsolescence of a personal computer iii) Rusting of an automobile in the first year of ownership iv) Rusting of an unprotected iron structure v) Genetic defect (for a newborn male) that affects 9 males out of 10 in a family (2 marks each = 10 marks) 1. (a) Contrast pure risk with speculative risk and give an example of each. (8 marks) (c) (c) Give a general definition of risk management. (4 marks) Insurance has been compared to a fund into which policyholders place their premiums. Identify and briefly explain FOUR things that this fund must provide for. (8 marks) December 2000 3. (a) Name and briefly describe the THREE main categories of insurance. Give TWO two examples of each category. (12 marks) Study 2 (b) Distinguish between peril and hazard. Give TWO examples of each. (8 marks) Study 1