Insurance Exam
Loss control
Actions taken and strategies implemented to reduce the frequency or severity of a loss. Insurance companies commonly incentivize their customers to implement loss controls by offering discounts that reduce insurance premiums.
Risk
The chance or uncertainty that a loss will occur.
Pure risk
The only type of risk considered to be potentially insurable. To be considered a “pure risk,” the risk must only present the chance for loss.
Speculative risk
Any kind of risk that could result in either loss or gain and is typically not insurable.
Loss exposure
Possibility of financial loss due to risk. The severity of an individual or entity’s loss exposure increases or decreases depending on their habits, location, and many other characteristics.
Property loss exposure
The possibility of loss to the value or usability of property or a physical, tangible asset.
Liability loss Exposure
Loss resulting from injuries or damages the insured causes to another party as a result of negligence, requiring the insured to compensate the other party for the injuries or damages caused.
Loss
Any injury or damage suffered by the insured because of an accident or event covered under an insurance policy.
Peril
An event, situation, or circumstance that results in property damage or loss.
Hazard
A condition, circumstance, or situation that increases the chance of a loss occurring or increases the severity of a loss.
Insurance
A means of managing financial risk by transferring the risk from one party to another through a legal contract or other arrangement.
Indemnity
Refers to compensation that is paid or promised to be paid to a party for losses that have already occurred or may occur in the future.
Principle of indemnity
States that the purpose of an insurance contract is to make a policy whole again after a loss is experienced and that an insured may not profit from a loss
Risk-retention
When the person, business owner, or professional decides to retain part or all of an exposure to a given risk. This means that they will be fully responsible for any losses that occur regarding the retained risk.
Risk sharing (also known as risk distribution)
Occurs when multiple entities form a group for the purpose of creating a plan where each group member pays into a fund to be used for anticipated future losses that any group member may experience.
Risk avoidance
When the person, business owner, or professional consciously seeks to avoid or eliminate loss exposure to a specific type of risk
Risk reduction
When the person, business owner, or professional is making a conscious effort to minimize the frequency or the severity of losses.
Risk transfer
The strategy of shifting the risk of potential losses to another party, typically through a formal contract and in exchange for some form of compensation. Insurance is the most common risk transfer method used today.
Elements of Insurable Risks
Generally, the following elements must be present for a risk to be considered insurable:
Losses must be definite and definable;
Loss must be great enough to create a hardship for the insured;
Losses must not be completely catastrophic in nature (war or nuclear attack, for instance);
Losses must be accidental; and
The insurance company must be able to calculate the chance of a loss occurring.
Adverse selection
Refers to situations where one party entering into a contract has more knowledge about information relevant to the contract than the other.
Law of Large Numbers
A probability theory stating that as a sample size grows larger, the average of the sample results will begin to approach the expected value more closely. The Law of Large Numbers also applies to insurance. As an insurance company increases the number of policyholders it has issued policies to, its estimated losses in the form of claims payments become closer to what is estimated or expected
The purpose of reinsurance
Is to limit the liability of the original insurer, allowing the original insurer to assume more risk than they could handle otherwise. This could be done for the purpose of transferring the risk of catastrophically large losses that would lead to the company’s bankruptcy or to give the original insurer some breathing room and allow it to expand its business.
The Insurance Services Offices (ISO)
An advisory organization responsible for developing standard policy forms, coverages, structure, provisions, agreements, clauses, deductibles, definitions, conditions, exclusions, endorsements, and other conventions for use by the insurance industry. ISO standards and forms are the most common found in use throughout the industry.
The American Association of Insurance Services (AAIS)
An organization responsible for collecting statistical data, distributing rating information, developing standard policy forms, and filing information with state regulators on behalf of insurers that purchase its services.
The Surety and Fidelity Association of America (SFAA)
A trade association working with all segments of the surety and fidelity bonding industry, acting as a resource to promote and maintain outreach to the public as well as industry and government regulators.
The National Council on Compensation Insurance (NCCI)
Provides comprehensive data, statistics, and solutions for the workers’ compensation industry.
The Gramm-Leach-Bliley (GLB) Act of 1999
(also known as the Financial Modernization Act of 1999)
Dictates how financial institutions such as banks and insurance companies are to handle the private information of consumers.
Under the Gramm-Leach-Bliley (GLB) Act, financial institutions are also required to:
Deliver privacy policy notices that detail the institution's information-sharing practices and inform consumers of their rights.
The Fair Credit Reporting Act (FCRA)
Is federal legislation created for the purpose of promoting the accuracy, fairness, and privacy of consumer information that is held and provided by credit reporting agencies.
The FCRA places the following responsibilities upon companies that use credit information:
Users can only obtain consumer reports for permissible purposes under the FCRA;
Users must notify the consumer when an adverse action is taken on the basis of such reports (such as a higher insurance rate); and
Users must identify the company that provided the report, so that the accuracy and completeness of the report may be verified or contested by the consumer.
Because insurers also provide information back to credit reporting agencies, they must also:
Provide complete and accurate information to the credit reporting agencies;
Investigate consumer disputes received from credit reporting agencies;
Correct, delete, or verify information within 30 days of receipt of a dispute; and
Inform consumers about negative information which is in the process of or has already been placed on a consumer's credit report within one month.
The Telemarketing Sales Rule, as defined by the FTC
Requires telemarketers to make specific disclosures of material information, prohibits misrepresentations, sets limits on the times telemarketers may call consumers, prohibits calls to a consumer who has asked not to be called, and sets payment restrictions for the sale of certain goods and services.
The Controlling the Assault of Non-Solicited Pornography and Marketing (CAN-SPAM) Act of 2003 established the United States' first national standards for the sending of commercial emails. The most relevant section of the law involves rules surrounding the sending behavior of a company that sends a commercial email:
A message cannot be sent without an unsubscribe option;
A message cannot contain a false header;
A message should contain at least one sentence;
A message cannot be null; and
An unsubscribe option should be below the message.
The Terrorism Risk Insurance Act (TRIA)
Was initially enacted as a temporary three-year program to calm insurance markets through the creation of a government reinsurance program that would share in terrorism-related losses. The TRIA will pay certain claims in the event of a loss due to a certified act of terrorism.
The Violent Crime Control and Law Enforcement Act of 1994
Made it illegal for any individual convicted of a crime involving dishonesty, breach of trust, or other related crimes to work in the insurance industry.
Property insurance contracts are designed
To transfer risk of unexpected financial loss from the property owner to the insurance company for an exchange of a unit of cost called an insurance premium.
Liability contracts
(also referred to as casualty policies)
Focus on reimbursement to third parties when the insured engages in negligent acts that lead to the third party suffering bodily injury, property damage, or personal injury.
Insurable interest
means that an individual has a financial stake in something, known as the subject of insurance, and would experience monetary loss if that something was lost, damaged, or destroyed.
An insurance policy
Is only legally enforceable if the insured possesses insurable interest in the subject of insurance at the time a loss occurs.
Underwriting
Is the process of assessing risks to determine if they are acceptable and, if so, how much premium will be charged by the insurance company for accepting the risk.
Risk appetite
Is a term used to describe what risks an insurer finds acceptable and is currently willing to underwrite
A company’s risk appetite can change over time and is determined by a variety of factors, including the following:
The types of risks currently insured by the company;
The types of risks the company now wishes to insure;
The amount the company expects they will be required to pay to settle claims from current risks; and
The amount of competition from other insurers in the same area of risk.
Underwriters use multiple sources of information when evaluating a risk for insurance coverage. Sources can include any or all of the following:
Statements made by the applicant in the policy application;
Underwriting maps that track the frequency of certain loss types in specific areas; and
Information from third-party sources to verify statements made by the applicant in the policy application.
Standard rates are the normal, average rates assessed on an average risk for coverage. Greater risks are “rated up,” increasing the premium rate to reflect the higher level of risk.
The loss ratio
Compares a company’s incurred losses (i.e., the total amount paid out for claims) to the amount of earned insurance premiums collected by the company and expresses this relationship as a percentage. A loss ratio under 100% indicates that the insurer is collecting more premium than it is paying out in claims, meaning that the company is achieving an underwriting profit.
Expense ratio
Shows what percentage of premiums collected from insureds has been used to pay the expenses associated with acquiring, writing, and servicing the company’s insurance policies (often referred to as “operating expenses”). As with the loss ratio, a value of under 100% is desirable and means that the company is operating with an underwriting profit.
The combined ratio
Is a combination of an insurance company’s loss ratio and expense ratio.
Insurer reserves
Are funds that are set aside by an insurance company to make sure it has enough money to meet its financial obligations as they become due. Insurer reserves must be large enough to cover obligations that are currently due as well as obligations that are anticipated to become due in the future.
Loss reserve
Is determined by estimating the value of current outstanding claims and the value of claims that the company may be required to pay in the future.
Statutory funds
State insurance regulators mandate minimum funds that must be maintained by insurance companies operating in their state. They are dictated by state laws, rules, or regulations.
Field Underwriting
In most cases, a producer is able to make some underwriting decisions before the application is submitted to the underwriting department based on guidelines of insurability that the insurer provides. Field underwriting greatly streamlines the application and underwriting process by eliminating obviously ineligible risks before they even reach the underwriting department.
Most insurers use an applicant’s credit information to develop an ---------------------
Insurance score
The Fair Credit Reporting Act (FCRA)
Governs the use of consumer credit information and ensures that applicant’s information remains safe and is not obtained or used in an unfair manner.
Most insurance companies will want
To inspect any property an applicant is seeking to insure to determine if it meets the company’s eligibility guidelines. If the inspection is not completed, the insurer withholds the right to cancel the policy or remove any policy discounts that were contingent upon a satisfactory inspection.
An insurance rate
Is the price charged per unit of exposure. This can be expressed as “x amount of dollars” per “x amount of exposure.”
When developing rates, there are four (4) basic standards that must be followed:
Rates must be fair and not unfairly discriminatory;
Rates must be adequate to meet expected loss amounts as well as turn a profit;
Rates must be revised as often as necessary to reflect current expected costs; and
Rates should encourage loss prevention methods among insureds.
A manual rate
(sometimes referred to as a class rate)
Separates risk exposure units into predetermined classes or groups that all share certain risk characteristics. From there, the same rate is applied uniformly to all exposure units that fall within a certain class or group.
A merit rating
Will consider a risk’s individual characteristics when determining what premium to charge. The premium is determined on the merits of the individual risk.
A judgment rating
Is an insurance rate that is assigned to a risk directly by an underwriter. Instead of being based on empirical data such as a manual or merit rating, it is based on the personal, subjective evaluation of the underwriter that is assigning the rating.
Earned premium
Is the amount of a policy’s premium that applies to the expired portion of an insurance policy.
Unearned premium
Is the amount of a policy’s premium that has yet to be “earned” by the insurance company.
A first-party claimant
Is a person who is making a claim against their own insurance company.
A third-party claimant
Is a person who is making a claim against someone else’s insurance company for damages the company’s insured caused them.
Hazard
Is a condition that increases the probability or severity of a loss.
Physical hazard
is a physical or tangible condition surrounding a risk that increases the probability or severity of loss.
Moral hazard
Exists when an insured begins to behave in a riskier way because they know that their insurance will have to pay any losses that occur. They are purposeful behavioral changes that increase the risk of loss.
Morale hazard
Is an insured’s indifference to loss because they know they are covered by insurance. This indifference towards loss results in unintended behavioral changes that increase the risk of loss.
Legal hazard
Represent an increased likelihood or severity of loss due to legal or court actions.
Peril
(perils are also commonly referred to as causes of loss).
Is a specific event or circumstance that causes loss
Covered perils
Every property insurance policy will describe in some way which perils are insured against
Named perils policies
When a policy covers broad perils, using a broad cause of loss form, it means that the policy will only provide coverage for perils that are specifically listed in the policy.
Polices that use a special, all-risk, or open peril cause of loss forms
Provide coverage against loss from all perils except those that are specifically excluded.
A loss
An unintended, unforeseen reduction or destruction of financial or economic value. it can be further classified as either a direct loss or an indirect loss.
An accident
Is an unforeseen, unexpected, unintended, and sudden event that causes property damage or bodily injury.
An occurrence
Includes losses that are caused by repeated or continuous exposure to the same harmful conditions over time.
Direct loss
Refers to damage inflicted to property directly by a peril.
Indirect losses
(also called consequential losses)
Losses that arise as the consequence of a peril; they are not a direct result of the peril itself.
Time element coverages
(also business interruption insurance).
A common form of indirect loss commonly appears in commercial insurance
Contingent loss
Another form of indirect loss present primarily in commercial insurance. It refers to losses that result from lost profits and expenses that result from the interruption of a customer or supplier’s business operations.
Concurrent causation
Refers to occurrences where multiple perils cause damage either simultaneously or sequentially, but not all of the perils are covered by the insurance policy.
Proximate cause
Is the peril that set the other perils in motion.
The proximate cause doctrine
States that if both a covered occurrence and an excluded occurrence occur simultaneously or in sequence.
Generally, when the proximate cause of a loss is a covered peril, an insurance company is required to pay for the entire loss, even the damages caused by excluded perils.
Replacement cost
Is the amount needed to replace or repair damaged property with items or materials of like kind and quality, with no deduction to account for the property’s depreciation in value.
Functional replacement cost
Is the amount needed to replace or repair damaged property so that its original intended use is restored, without the requirement that the replacement or repairs use materials of like kind and quality.
Guaranteed replacement cost
Will cover the entire cost to repair or replace damaged property, even if the cost to do so exceeds the stated policy limits.
Actual cash value (ACV)
A property’s replacement cost minus depreciation.
Market value
The price at which property will sell in the regular marketplace.
Agreed value
When the value of insured property is agreed upon between the insured and the insurance company.
Stated amount
(or stated value)
A property amount stated by the insured when purchasing an insurance policy. The insurer can choose to pay either the --------------- or the actual cash value of the property, whichever is less.
A valued policy
Will pay a predetermined loss amount in the event of a loss. This predetermined amount is not related to the actual loss incurred.
Actual loss sustained
The difference between what a company could have earned if a loss had not occurred versus what the company actually earned after a loss occurred.
Pair and Set clause
If part of a pair or set is lost or damaged, the insurance company has the option to either restore the pair or set to its previous value through repair or replacement or pay the difference between the value before and after the loss.
The broad evidence rule
All documentation, circumstances, or other facts that reflect the value of property can be considered when determining the property’s value for insurance purposes.
Specific insurance
covers real and personal property at one, specific location, is also most commonly seen in personal lines insurance.
Blanket insurance
Covers multiple locations under one contract and one set of contract terms, is primarily utilized in commercial lines insurance.
Describe six (6) construction categories rated from least to most fire resistant in the following order:
Frame (ISO 1);
Joisted Masonry (ISO 2);
Noncombustible (ISO 3);
Masonry Noncombustible (ISO 4);
Modified Fire Resistive (ISO 5); and
Fire Resistive (ISO 6).
The coinsurance clause,
(also known as insurance to value)
States how much insurance an insured must carry on a property to receive the full value of the property when a loss occurs. Generally, an insured must have coverage on a property that is equal to at least 80% of the replacement cost of the property
Legally liable
When a person (the first party) causes injuries or damage to another person (the third-party) or their property through negligence, they are said to be ----------- for the losses the other person has incurred.
Liability insurance
(also referred to as casualty insurance)
Insurance that protects an insured from claims resulting from injuries or damages the insured inflicts upon a third party.
Absolute liability
Assigned to a person who, through their negligence, causes injury or damage to another person because they have created a hazardous or potentially dangerous situation. No proof of fault or negligence is required for the injured party to hold a person liable for their damages.
Strict liability
Allows the person who caused damages certain defenses to prove that they are not liable for those damages, where there are no defenses allowed under absolute liability.
When defending strict liability cases, the following four defenses are allowed:
Plaintiff’s fault: If damages are caused due to the injured third party’s fault;
Act of God: If damages are caused by an event beyond the activity of humans;
Act of third party: If damages are caused by impossible to foresee actions of a third party; and
Consent of the plaintiff: If damages were caused by an activity the injured was willingly participating in.