Chapter 2: Defining the Insurable Event

Instructor’s Manual with Transparency Mastersto Accompany Introduction to Risk Management and Insurance, 7E - Dorfman

© 2002 by Prentice Hall, Inc.A Simon & Schuster CompanyUpper Saddle, NJ 07458

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Chapter 2:Defining the Insurable Event



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Insurable Loss Exposures

• Introduction - Not all exposures to loss are insurable - Which ones are?

• Gambling versus Insurance• They are opposites• Gambling increases risk (speculative)• Insurance reduces risk (pure)



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Characteristics of Ideal Insurable Loss Exposures

• Point of view of the insurance company• Large number of homogeneous units• Accidental and unintentional losses (from

the point of view of the insured)• Definite in time and in place, measurable

and of sufficient severity to cause economic hardship

• Non-catastrophic



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Characteristics of Ideal Insurable Loss Exposures

• Point of view of the insured• Does the exposure warrant protection?• Is the probability of loss low? (How much is

the premium for loss probability exposures?)



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Insurance Works Well When.....

The industry adheres to the above guidelines resulting in:

A balance that is maintained between the number of insured exposures and the number and severity of the losses in the pool.



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Insurance Will Have Difficulties Or Fail To Function When....• More and more people collect• Frequency and/or severity increases• Price must rise• Fewer people buy• Risk premiums increase• Pool shrinks in size and cycle starts again !

• Results in small pools, many collecting and unaffordable premiums



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Adverse Selection and Subsidization• Adverse selection - undisclosed

information caused people to pay less than their ‘fair’ share

• Causes subsidization - because included with people paying more than their ‘fair’ share

• Self-selection



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When Subsidization Is Caused By Government

• Setting or eliminating classification schemes prevents competition

• Called mandated subsidization• Example:• Males vs. females• Annuity• Life insurance• Group employee pension benefits



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Principles of Risk Classification

• Used to:• Minimize subsidization• Minimize adverse selection

• Goal is to have all pay a "fair" share• Evaluation of classification schemes



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Principles of Risk ClassificationFactors

1) Separation and Class Homogeneity• Each classification will have a significantly

different chance of loss• Each member (in a classification) will have

approximately the same chance of loss



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2) Reliability• Information is easily obtained and not

subject to manipulation• Information is verifiable



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3) Incentive Value• Provides incentive to act in socially and

economically positive ways



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4) Social Acceptability• Mathematically fair outcome conflicts with

social goals• Some rating criteria is socially or legally

unacceptable because it is beyond the insured's control



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Branches of Insurance - Successful transactions

• Private Insurance• Non-life - fire, marine, casualty, bonding • Life - life health, annuities• Other - weather, municipal bond, boiler and

machine, motion picture completion



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Liability Insurance

• The (English Common Law) American legal system is based on the notion that a person should be responsible for the damage caused to others

• Types of Damages• Bodily Injury• Personal Injury• Property Damage



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Legal Liability

• Legal liability arises out of:• Torts - civil wrong done to another• Breaches of contracts• Criminal wrongs

• Which of these is insurable?



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Torts - An Insurance Categorization

• Negligence• Failing to use reasonable care according to a

“reasonable man” standard• A reasonable person thinks before speaking or

acting, and is honest and moderate in all activities• Question of fact• Other parties can be held liable

• Vicarious liability• Joint-and-several liability



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Establishing Negligence

• Plaintiff must show:• Legal duty• Failure of the duty• Injury• Causal connection between the injury and the

failure

• Jury must weigh the facts based upon “the preponderance of evidence” not “beyond all or reasonable doubt”



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Types of Damages

• Compensation for Personal Injuries• Includes medical, lost wages, future wage

loss, and pain and suffering• Punitive Damages• Compensation to punish a defendant for

outrageous acts• Punitive damages against insurers• When insurers act in bad faith in resisting

an insured’s legitimate claim• Other Damages• Hedonic damages - loss of life’s pleasures• Mental anguish



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“Res Ipsa Loquitur”

• Tactic used in court to shift a legal burden to the defendant

• Requires:• The defendant has exclusive use of the

instrument or process that caused the loss and the plaintiff did not

• Use of the instrument or process does not normally cause injury unless there was negligence



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Defenses in a Negligence Suit

• Show there was no injury, duty, or failure• Contributory negligence - common law• Comparative negligence - statutory

modification• Last clear chance rule - statutory

modification• Assumption of the risk - common law



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Torts - An Insurance Categorization

• Deliberate or Intentional Interference• Assault, battery, liable, false arrest• Can result in civil as well as criminal actions

• Liability Without Fault (Strict and Absolute Liability)• Laws or court precedent mandate liability in

some circumstances: explosives, dangerous animals

• Worker’s compensation, pure no-fault



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Important Social Issues and Subsidization

• Acquired Immune Deficiency Syndrome (AIDS)

• Automobile Insurance• Pension Benefits• Catastrophes



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Example Cases:

• Girlfriend infected with herpes• BB Gun shot into crowd• Molestation of relative• Home day care operator injures child

Documents

Chapter 2: Defining the Insurable Event