Different Degrees and Classes of Risk Insurance

Different Degrees and Classes of Risk Insurance

Risk is a part of living and everyone is exposed to it. Discuss risk and show how there is different degrees and classes of risk. Use examples to illustrate your answer.

What exactly is risk? It implies both doubt about the future and the fact that the outcome could leave you in a worse position then now.
The basis of risk is the lack of knowledge and uncertainty. We don’t know what could happen five minutes from now, five months from now, or even five years from now; which is why we purchase insurance for anything that is insurable. We want peace of mind for something that is beyond our control, or unintentional negligence on our part, to protect our assets, loved ones and ourselves.

Risk comes in three types for both Individuals / families and for businesses:

Personal
Individuals: unemployment, disability, old age
Business: if the owner is unable to work, co-owner dies and the surviving owner can not buy out

Property
Individuals: things you own (clothes, electronics etc)
Business: the building, its contents

Liability
Individuals: our child or pets/ animals or ourselves causing harm to others, keeping our homes safe for others (shovel sidewalk, keeping sidewalk clear of other potential hazards – extension cords, toys)
Business: faulty products, customer hurts themselves with in the store / establishment due to negligence on the owners’ part

Risk comes in different degrees; there are the Values at risk, the Severity of loss and the Cause of loss

The Values at risk looks at the “value” of the insurable interest and the chances of potential losses and to what extent. Ex. Two people buy a brand new car, one person lives in “higher class” side of the city, where the other lives in an area which is known for gang related activity. The less risky client would be the one who lives in the nicer area of the city. Where as the client who lives in the run down area would be more risky as there is more likely a chance of loss of a sort to occur to the brand new vehicle.

Severity of loss is the amount at risk for the loss. If one car is a brand new sports car worth $80,000 and another car is a beater at least 10 years old and worth just a couple grand and they get into an accident with each other. Regardless of the type of accident or amount of damage actually done to the vehicle, the high end brand new car would cost a fortune to repair. If you look at the older vehicle now, parts for that car would be cheaper and chances are you could get LKQ parts for it as well where the high end car might need brand new and depending on the type of vehicle, have it ordered in. The severity of loss would be higher for the brand new car.

Cause of loss is the last component of risk. The cause would be a peril and the hazard would influence the outcome. If a vehicle was going 120 km/hr down the highway during a storm, the cause of the loss would be the storm and the hazard would have been the insured speeding and hydroplaning.

Different classes of risk are speculative and pure risk.

Speculative risk is a chance of loss or a chance of profit and this risk is not insurable. For example, buying a lottery ticket or stealing from a store.

Pure risk is chance of loss only and this risk is insurable. For example, if you leave your house unlocked all night with the keys left in the door handle, or if you leave appliances like a stove or hair straightener on all day while out at work.

2. You have been appointed Risk Manager for a small chain of office supply stores; this is a new position. What should your responsibilities be and how will you carry them out?

My responsibilities as Rick Manager would be to determine what risks exist and what to do about them. In doing that, I would need to identify, measure and control the risks.

First I would inspect the stores in order to identify the potential risks. Possible risks might include damage to the property (perils / hazards), possible business interruption should a peril occur; which would result in loss of business and profit. I would see what liability risks there might be; faulty product (inc wiring in some of the electronic devices like a fax machine or copier), check out the risks that could be caused by negligence of the staff (leaving boxes laying out or cords or ladders if they are stocking). As an employer I would need to look at the possibility of the staff getting hurt on the job; if they are stocking, they might throw their back out if the boxes are heavy. I would consider the fact that some of the staff may be dishonest and either steal from the till or product from the store.

Now that potential risks are identified, I would need to measure the risk. By doing so I would measure the loss frequency – how many times have these sorts of accidents occurred in the past? Compare with other stores that are in the business of office supplies. I would compare the loss severity and see how much damage the incident could cause / cost.

Next I would need to control the risks. I would need to reduce them by preventative measures by having my staff take safety in the workplace courses and training. The staff would have training on the products and make them aware of their potential risks so they could share this knowledge with customers. When it comes to fidelity of my staff, I would put up cameras by the tills, through out the store and in the “stock room” also I could put up sensors by the washrooms so when people or staff go in, it would detect if they had something with a security tag on it.
After reducing the risk by preventative measures, I would have to assume / retain some of the risk as well. Considering I have done what I can to prevent the above risks, chances are that I can not stop absolutely everything that might happen. There is always a chance that someone will get injured or a theft will occur. I would also obtain enough insurance to cover the potential losses. It would include personal (in case something happens to me and I can no longer work) property (to cover losses of items stolen and money taken) and it would include liability to cover my staff and my customers should someone get hurt.

3. Compile a comprehensive definition of insurance. It should contain 1 reference to all its major elements.

Insurance is:
Sharing the losses of a few among many
Peace of mind
Indemnifying – putting the client back in the same financial position as they were just prior to the loss
Security – being able to carry on with life and knowing the loss is more of an inconvenience then a financial hardship.

Definition of insurance: is the undertaking by one person to indemnify another person against a loss or liability for loss in respect of a certain risk or peril to which the object of insurance may be exposed, or to pay the sum of money or other thing of value upon the happening of a certain event.

Insurance requires a large group of people to be successful (and profitable). These people put money into the “pot” (premiums) in order to have sufficient funds to reimburse those who suffer losses. This “pot” must include enough to cover the following
- provide payment to those who suffer losses (make claims)
- reserves for outstanding losses (ones that are not yet reported as they have a limitation period of a year)
- returns for partial premiums (policies that are cancelled before the term ends)
- and the cost to manage the pot

4. a) Explain how insurers spread risk
Volume: by insuring large number of risks
Example: multi line companies, specialty, certain class of consumers
Diversity of types of risk: write insurance on as many different kinds of risk as possible. The chance of profit is increased this way.
Example: Automobile, residential, contents etc
Diversity of location: opportunity for profit increases when there is a greater number of locations insured.
Example: should a massive hailstorm hit, you would want to insure many areas in the city since it might only be the one area that suffers from hail damage and insuring around the city would balance the loss.

4. b) Show how insurance or the lack of it affects the economy
Insurance plays a big role in the expansion of credit. You generally need insurance on a product to get credit; you buy a car or house to build your credit and you need insurance to protect those investments.
Insurance provides 2 fold protection – it protects the insured’s interest in the property and it protects the lenders interest should something happen.

Insurance stimulates the economy as it manages larges amounts of money for the year to cover the “pot” ---insurers invest heavily in all bonds and investments - - which has a positive influence on the economy having large pools of capital available - - which helps the government to finance projects and help other business’ to expand - - which creates jobs and stimulates the economy

Insurance provides jobs – in not only the insurance industry, but in government insurers, other industries that insurance deal with directly and indirectly example: chiropractor and massage therapists from accidents, jewelers, body shops, rental car companies, contractors etc

Loss prevention; insurance plays a role in loss prevention, whether it be fire, safe driving or crime and fraud. Insurers lobby for safer products and practices to reduce the cost of insurance for clients and the inconvenience that the client would suffer resulting from a loss.

5. a) Explain the difference between the following:
i) rate and premium
Rate is the price of a unit of insurance for a period of a year where Premium is multiplying the rate X the amount of insurance purchased. Determining premiums that are required come from the law of averages (law of large numbers) and the theory of probability

ii) ratemaking and rating
Ratemaking is the process of establishing rates for each class of insurance which is carried out by actuaries where rating is applied to establish rates to a specific item that is to be insured and this is carried out by underwriters or rating clerks

5. b) Out line the basic premise of:
i) the law of large numbers is the basis that the more samples used, the better the assumptions that are based on them will be. Premiums are determined from the law of large numbers and the theory of probability. The basic premise of the law of large numbers is the possibility

ii) theory of probability is the likelihood of an occurrence. This is a ratio of the number of actual occurrences to that of possible occurrences. The basic premise of the theory of the theory of probability is occurrences.

5. c) Explain how the law of large numbers and the theory of probability are used in establishing rates.

The insurer needs to obtain a proper quote for the insured yet obtain adequate income for the risk. With that they take into consideration both the law of large numbers and the theory of probability. They consider chance and the probability of a certain event. Chance is represented as a fraction. It is the number of times the event happens over the number of times the event may happen.

Accuracy is greater when predictions are based on large numbers making it more accurate. This is based on the following factors: the size of the sample, the time period in which the sample was taken and the conditions in the past relative to the future.