Insurance Fundamentals
Part 2
Types of risk:

1. Risk - the uncertainty of injury or loss
2. Pure risk - type of risk that has a threat of loss without the possibility of gain
3. Speculative risk - type of risk that has a possibility of gain as well as loss

Requirements of insurable risk:

1. The loss must be common to a large number of people (it isn't predictable for a single individual but if the group is large enough, it is predictable for the group; this enables the insurer to predict loss based on the law of large numbers)
2. The loss must be fortuitous - accidental and unintentional (it should be outside of the insured's control; if a person deliberately causes a loss, they would not be covered)
3. The loss must the determinable and measurable (it must be definite as to cause, time, place, and amount)
4. The loss can not be catastrophic (can't cover war because nearly everyone suffers a loss...and there isn't enough money to pay them all)
5. The loss must have an economically feasible premium (one view is that if the chance of loss exceeds 40% the cost of the policy will exceed the amount that the insurer must pay if the loss occurs)
6. The chance of loss must be calculable (the insurer must be able to calculate both the average frequency and the average severity of future losses with some accuracy)

Basic elements of insurance:

1. Premium - cost of insurance; payments the insured makes for protection
2. Underwriting - the process of determining who to insure and what to charge
3. Insurance policy - legally binding contract between policy holder and insurance company
4. Declarations - part of policy that lists what is being insured, for how long, and for how much
5. Exclusions - list of items in the insurance policy for which the insurance company makes no promise to pay
6. Conditions - a set of obligations imposed on both the insurance company and the insured; ground rules; violation of conditions may lead to denial of coverage if loss occurs
7. Endorsements (also called riders) - amendments or additions to the basic policy that tailor the policy to the specific needs of the insured

Principles of buying insurance:

1. Insure against big losses, not little ones.
2. Buy insurance with broad coverage, not narrow.
3. Shop around before buying insurance.
4. Contact companies that sell insurance directly to consumers (avoid sales commissions to agents).
5. Buy insurance only from financially strong companies.

Insurance you don't need:

1. Life insurance on a child.
2. Dread disease insurance (insurance on a specific disease).
3. Hospital indemnity insurance (pays specific amount per day, week, or month you are in hospital).
4. Accidental death and dismemberment insurance.
5. Flight insurance.
6. Credit life insurance (pays off debts if you die).
7. Rental car insurance.
8. Vacation policies.

There are two important difference between insurance and gambling:

1. Gambling creates new speculative risk that did not exist before, while insurance is a technique for managing a pre-existing pure risk.
2. Gambling is socially unproductive, since the winner's gains come at the expense of the losers.

Standard & Poor's Ratings:

1. AAA - Reserved for the few companies that have distinguished themselves over a long period of time on being truly outstanding companies, generally in almost every way, and have extremely strong financial security.
2. AA - Differ only slightly from AAA rated companies and have very strong security although such companies may not have always demonstrated such high performance as those rated AAA.
3. A - Have strong security because they have typically performed at or slightly above the average level in the industry in most categories and can be relied on to meet their financial obligations.
4. BBB - Offer good security for most risks, although insurers in this category may have demonstrated some weaknesses in one or more areas and may be susceptible to some adverse financial performance. In Standard & Poor's opinion, they offer "acceptable" financial security.
5. BB - Marginal financial security.
6. B - Weak financial security.
7. CCC - Very weak financial security.
8. CC - Extremely weak financial security.
9. R - Regulatory action has been taken regarding solvency.
10. NR - Not rated.

Notes:

Any rating below BBB (from #5 and below on list above) is in the "vulnerable" range.

+/- These signs following ratings from 'AA' to 'CCC' show relative standing within the major rating categories.


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