General Principles of Risk & Insurance

1. General Principles of Risk & Insurance Chapter 1 Risk Management For Financial Planners • Definitions and concepts • What is insurance? • Purchase of a contract that on behalf of purchaser pledges the payment of a sum-certain amount (the “premium”) in exchange for a promise on behalf of the other party (the insurance company) to provide restitution or indemnity arising from the occurrence of a loss • A device for reducing risk by combining a sufficient number of exposure units to make individual losses collectively predictable • The losses of the few are shared among the many

2. General Principles of Risk & Insurance Chapter 1 Risk Management For Financial Planners • Definitions and concepts (cont'd) • The law of large numbers • Primary underpinning to the insurance mechanism • The more exposure units in the mix, the easier it become to predict the groups losses • Fortuitousness • Non-fortuitous loss (those losses that are certain to occur may not be insurable)

3. General Principles of Risk & Insurance Chapter 1 Risk Management For Financial Planners • Peril, Hazard and Risk • Although terms may be used synonymously by practitioners, they do have differing technical meaning • Risk • Refers to the uncertainty as to the the outcome of am event • Possible outcomes are Loss or No-Loss • Peril • The cause of a possible loss • Fire, water damage, mold, etc. • Peril may be a covered peril (included under the coverage) or a peril that is specifically excluded under the policy

4. General Principles of Risk & Insurance Chapter 1 Risk Management For Financial Planners • Peril, Hazard and Risk (cont'd) • Hazard • A specific situation that increases the probability of the occurrence of a loss arising from a peril or that may influence the extent of a loss • Concept of Indemnity • Indemnity means to make whole again • Insurance puts the person back in the same position he or she was in prior to the loss – no better, no worse

5. General Principles of Risk & Insurance Chapter 1 Risk Management For Financial Planners • Insurance Versus Gambling • Insurance is not wagering • Three outcomes with gambling • Loss • No loss • Gain • Two possible outcomes with insurance • Loss • No loss

6. General Principles of Risk & Insurance Chapter 1 Risk Management For Financial Planners • Other Non-insurance Responses To Risk • Retention • One assumes the risk on his or her own • Example – Not to purchase collision on an older car • Requires careful consideration of the possible losses • Corporations use large retention as a financial risk management strategy • Avoidance • Either not doing something or getting rid of the risk • Example – Use of public transportation avoids the risks of physical damage and liability of car ownership

7. General Principles of Risk & Insurance Chapter 1 Risk Management For Financial Planners • Other Non-insurance Responses To Risk • Control • Minimizing hazards • Example – Installing a burglar alarm • Non-insurance transfer • Transfer of risk to someone other than an insurer • Rental agreement for tools where the customer agrees to bring them back in the same condition. • Failure to do so could result in customers being charged for the price of those tools

8. General Principles of Risk & Insurance Chapter 1 Risk Management For Financial Planners • Voluntary and Social Insurance • Social Insurance • Government agencies that provide social insurance, against loss from • Unemployment, injuries, sickness, old age, premature death • Major types of social insurance • Old Age, Survivors, and Disability (Social Security) • Workers Compensation • Unemployment Compensation • Participation is mandatory • Premiums collected via payroll deduction • Employees and Employers pay into the social security fund • Employers must purchase both workers compensation insurance and unemployment compensation insurance