Insurance Fundamentals Flashcards

Question 1

What is insurance in its most basic form?

Accepted Answer

Insurance is a contract in which one party, the insurer, agrees to pay for specified financial losses suffered by another party, the policyholder, in exchange for a payment called a premium. The policyholder accepts a known, fixed cost in place of facing an uncertain and possibly much larger loss.

Question 2

What is risk pooling, and why does it make insurance possible?

Accepted Answer

Risk pooling is the practice of combining many people or businesses facing similar possible losses into one group, so that the costs of the few who suffer losses are shared by everyone who contributed premiums. Because most members will not have a claim in a given period, the pool can predict total losses.

Question 3

What is the difference between a peril and a hazard?

Accepted Answer

A peril is the event that causes a loss, such as fire, windstorm, theft, or illness. A hazard is a condition that increases the chance or severity of that peril, such as oil-soaked rags stored near a stove, which raises the likelihood of a fire. Insurers weigh both when pricing.

Question 4

What does the principle of indemnity require an insurer to do after a covered loss?

Accepted Answer

The principle of indemnity holds that an insurer should restore the policyholder to roughly the same financial position held just before the loss, without allowing a profit from the claim. Payment is therefore limited to the actual amount of the covered loss, not a larger sum.

Question 5

Why must a policyholder have an insurable interest before buying a policy?

Accepted Answer

An insurable interest is a financial stake in the insured item or life, meaning the policyholder would suffer a real monetary loss if the insured event occurred. You may insure your own home or car, but you cannot insure a stranger's house, because you would gain from its destruction rather than lose from it.

Question 6

What is adverse selection, and why do insurers work to limit it?

Accepted Answer

Adverse selection occurs when people who expect to file claims are more eager to buy coverage than people who expect few losses, which can leave an insurer with a pool more costly than the premiums anticipated. Insurers limit it through underwriting, careful applications, waiting periods, and pricing that reflects measurable risk factors.

Question 7

What exactly is a premium, and how does it relate to the insurer's expected losses?

Accepted Answer

A premium is the amount a policyholder pays to the insurer for coverage, usually billed monthly, quarterly, or annually. Premiums are set so that collected funds cover expected claims, administrative costs, and a margin for profit and reserves. Insurers therefore calculate premiums carefully before offering any policy.

Question 8

What is the difference between a loss and a claim?

Accepted Answer

A loss is the actual reduction in value that occurs when an insured event happens, such as a damaged roof. A claim is the formal request the policyholder submits to the insurer asking for payment under the policy. A loss can exist without a claim if the amount is small or uninsured.

Question 9

What is the law of large numbers, and why does it matter to insurers?

Accepted Answer

The law of large numbers states that as the number of independent exposures grows, the actual results tend to move closer to the expected average. Insurers rely on this because a large group produces more predictable total losses than a small one, which makes premium calculations more reliable.

Question 10

What is expected loss, and how is it calculated?

Accepted Answer

Expected loss is the average cost of claims an insurer anticipates for a given group of policyholders over a set period. It is estimated by multiplying the probability of a loss by the typical size of that loss, then summing across all possible outcomes. Actuaries refine these estimates using historical data.

Question 11

What is an actuary's role in setting insurance prices?

Accepted Answer

An actuary is a professional trained in probability, statistics, and financial mathematics who estimates future losses and the costs needed to cover them. Actuaries build rating models that connect measurable factors, such as age, location, or driving history, to expected claim costs. Their work helps insurers set premiums that are adequate and financially sound.

Question 12

What is a rating factor, and can you give a simple example?

Accepted Answer

A rating factor is a measurable characteristic used to estimate how likely a policyholder is to file a claim and how large that claim might be. For auto insurance, examples include the driver's age, the vehicle type, annual mileage, and the area where the car is parked overnight.

Question 13

How does moral hazard change the way an insured person might behave?

Accepted Answer

Moral hazard is the tendency of a person to take greater risks or exercise less care after becoming insured, because someone else will bear part of the cost. A driver with full collision coverage might park less carefully, for example. Insurers reduce moral hazard through deductibles, copayments, policy limits, and inspection requirements.

Question 14

What is reinsurance, and why would a primary insurer buy it?

Accepted Answer

Reinsurance is insurance purchased by an insurance company to transfer part of its own risk to another insurer, called the reinsurer. A primary insurer might buy it to protect its finances against a catastrophe, such as a major hurricane, or to accept larger policies than its capital would otherwise allow.

Question 15

How is an insurer's loss ratio calculated, and what does it indicate?

Accepted Answer

An insurer's loss ratio is the total claims incurred during a period divided by the premiums earned in that same period, usually expressed as a percentage. A high ratio suggests the insurer is paying out most of its premium income in claims, which can threaten profitability. Exact definitions can vary, so read carefully.

Question 16

What does the term exposure mean in insurance pricing?

Accepted Answer

In insurance, exposure is the unit of measurement that represents the amount of risk being insured during a period, such as one car-year or one home-year. Pricing starts by estimating how many exposures a company holds, then multiplies that count by the expected loss per exposure.

Question 17

What is the declarations page of an insurance policy, and what information does it contain?

Accepted Answer

The declarations page, often called the dec page, is the summary at the front of a policy that lists the named insureds, the covered property or persons, policy period, coverage limits, deductibles, and premium. It identifies the specific terms that apply to this policyholder, while the rest of the policy holds standard wording.

Question 18

What is a policy limit, and how does it differ from a deductible?

Accepted Answer

A policy limit is the maximum amount an insurer will pay for a covered loss, either per occurrence or over the policy period. A deductible is the portion of a covered loss the policyholder pays first before the insurer pays anything. The limit caps payment, while the deductible sets where payment begins.

Question 19

What is an exclusion in an insurance policy, and why does it matter?

Accepted Answer

An exclusion is a provision that removes a specific type of loss, property, or circumstance from coverage, even when a covered peril is involved. Flood damage is a common example under many homeowners policies. Exclusions matter because policyholders who overlook them may assume they are protected when a claim would be denied.

Question 20

How does a named perils policy differ from an open perils policy?

Accepted Answer

A named perils policy covers only the specific events listed in the policy wording, such as fire, lightning, or theft, so anything not named is not covered. An open perils policy, sometimes called all-risk, covers any cause of loss unless the policy excludes it. Open perils policies offer broader protection but may cost more.

Question 21

What is subrogation, and how does it affect a policyholder's claim?

Accepted Answer

Subrogation is the insurer's right to pursue the party responsible for a loss after paying the claim, seeking to recover the money it spent. For example, after paying for damage caused by a negligent driver, the insurer may seek reimbursement from that driver or the driver's insurer. Policyholders should avoid waiving such rights.

Question 22

What is an endorsement, and how does it change an existing policy?

Accepted Answer

An endorsement is a written amendment attached to a policy that adds, removes, or changes coverage from the original form. A common example adds coverage for valuable jewelry to a homeowners policy. Once attached, the endorsement becomes part of the contract and is read together with the base policy.

Question 23

What does the duty to mitigate loss require of a policyholder?

Accepted Answer

The duty to mitigate loss requires a policyholder to take reasonable steps to prevent further damage after an insured event, such as covering a broken window or shutting off a leaking pipe. Reasonable protective costs are usually covered, but ignoring the duty may reduce a claim.

Question 24

What is a waiting period, and which policies commonly include one?

Accepted Answer

A waiting period is the time after a policy begins during which certain coverage is not yet available, meant to prevent people from buying coverage only after a loss has already occurred. Waiting periods appear in several insurance types, including some health policies, disability coverage, and flood insurance.

Question 25

What is health insurance, and what does it commonly cover?

Accepted Answer

Health insurance pays some or all of the costs of medical care, such as doctor visits, hospital stays, prescription drugs, and preventive services, according to the terms of the plan. Many plans use shared costs, including premiums, deductibles, and copayments, so policyholders often pay part of each service.

Question 26

What is life insurance, and what are its two basic forms?

Accepted Answer

Life insurance pays a death benefit to named beneficiaries when the insured person dies during the coverage period. Term life insurance covers a set number of years, while permanent life insurance, such as whole life or universal life, lasts for the insured's lifetime and may build cash value.

Question 27

What coverages are typically included in an auto insurance policy?

Accepted Answer

Auto insurance commonly includes liability coverage, which pays for injury or property damage the insured driver causes to others, and collision coverage, which pays for damage to the insured vehicle from a crash. Comprehensive coverage handles losses such as theft, hail, or fire, while medical payments coverage can help the driver and passengers.

Question 28

What does a standard homeowners policy generally protect?

Accepted Answer

A standard homeowners policy generally protects the dwelling, other structures on the property, personal belongings, and additional living expenses if the home becomes uninhabitable after a covered loss. It also includes personal liability protection for injuries or property damage the policyholder causes to others. Flood and earthquake damage are excluded and require separate coverage.

Question 29

What does disability income insurance replace, and when does it pay?

Accepted Answer

Disability income insurance replaces part of a worker's earned income when an illness or injury prevents them from working. Policies define disability differently, sometimes as being unable to perform one's own occupation, and they usually begin payments after an elimination period of several weeks or months. Reading these definitions before buying is wise.

Question 30

What does commercial general liability insurance protect a business against?

Accepted Answer

Commercial general liability insurance protects a business against claims alleging bodily injury or property damage to third parties, along with the legal defense costs of those claims. It covers situations such as a customer slipping in a store, though it excludes the business's own property and employee injuries, which are handled by other coverages.

Question 31

How does professional liability insurance differ from general liability coverage?

Accepted Answer

Professional liability insurance, also called errors and omissions coverage, protects professionals such as accountants, consultants, and physicians against claims that their advice, services, or mistakes caused a client financial harm. General liability focuses on physical injury or property damage, while professional liability focuses on negligent acts, errors, or omissions in the work itself.

Question 32

What does workers' compensation insurance provide, and who is generally covered?

Accepted Answer

Workers' compensation insurance provides medical care and partial wage replacement for employees who are injured or become ill because of their job, and in many systems it limits the employee's right to sue the employer. Coverage is generally required of employers by law, and benefits are paid regardless of who was at fault.

Question 33

What does underwriting mean, and what is an underwriter responsible for?

Accepted Answer

Underwriting is the process of evaluating an application to decide whether to accept the risk, on what terms, and at what premium. An underwriter reviews information such as loss history, property condition, and applicant characteristics, then may approve, decline, add conditions, or charge a higher rate.

Question 34

What are the typical steps in handling an insurance claim, from first report to payment?

Accepted Answer

A typical claim begins when the policyholder reports the loss to the insurer. The insurer assigns a claim number, and an adjuster investigates the cause and extent of the loss, often inspecting property or reviewing medical records. After verifying coverage and the amount owed, the insurer issues payment, minus any deductible, or explains why the claim is denied or limited.

Question 35

What is the difference between an independent adjuster and a staff adjuster?

Accepted Answer

A staff adjuster is a salaried employee of one insurance company who handles that insurer's claims. An independent adjuster is a professional hired on a contract basis by insurers, sometimes to handle surges after a disaster, and may serve several companies. Both investigate losses, estimate damages, and recommend how much the insurer should pay.

Question 36

What is a proof of loss, and when might an insurer ask for one?

Accepted Answer

A proof of loss is a sworn written statement that describes the loss, including its date, cause, and estimated value. Insurers may request one after a claim is filed, and failure to provide it within the time the policy allows can delay or reduce payment. Keep copies of all documents you submit.

Question 37

How does actual cash value differ from replacement cost?

Accepted Answer

Actual cash value is the replacement cost of damaged property minus depreciation for age and wear, so it reflects the item's current worth. Replacement cost pays the amount needed to buy a comparable new item without deducting depreciation, although policies often pay the depreciated amount first until the replacement is actually made.

Question 38

What does the principle of utmost good faith require of applicants and insurers?

Accepted Answer

The principle of utmost good faith requires honest disclosure of all material facts, because the insurer relies on the applicant's information when deciding whether to insure and at what price. A material fact is one that would affect an underwriter's decision. Misrepresentation or concealment can allow an insurer to void a policy.

Question 39

How would a $1,000 deductible affect a covered $5,000 kitchen fire claim?

Accepted Answer

The insurer would pay $4,000, because the policyholder first absorbs the $1,000 deductible from the covered $5,000 loss. This assumes the fire is a covered peril and the loss falls within the dwelling limit. Without the deductible, the insurer would have paid the full $5,000.

Question 40

Why might a policyholder choose a higher deductible, and what trade-off comes with it?

Accepted Answer

A higher deductible usually lowers the premium because the policyholder agrees to absorb more of each small loss, which reduces the insurer's expected claim costs. The trade-off is that the policyholder must pay more out of pocket when a claim occurs, so the choice suits people who can afford that risk.

Insurance Fundamentals Flashcards

1Core concepts and terminology

2Measuring risk and setting prices

3Policy components and coverage terms

4Major types of insurance

5Claims, underwriting, and applied decisions

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