INSURANCE AND RISK MANAGEMENT (câu hỏi vấn đáp bảo hiểm cô Đoan Trang FTU)

Tổng hợp toàn bộ câu hỏi ôn tập vấn đáp cuối kỳ môn Bảo hiểm và quản lý rủi ro của cô Đoan Trang FTU, bộ câu hỏi bằng tiếng Anh dành cho sinh viên hệ Chất lượng cao. Tất cả các câu trả lời được dựa theo 100% slide giảng dạy và bài giảng trên lớp của cô

CHAPTER 1 RISK AND RISK MANAGEMENT

1 Risk, objective risk, subjective risk, pure risk, speculative risk (definition and example)

- Risk: is uncertainty concerning the occurrence of a loss.

Ex: risk of being killed in an auto accident is present because uncertainty is present

In economic terms: Risk = probability density/possible consequence

In insurance economic, the probability of occurrence and severity of consequence are distinguished in definition of risk

Note: loss happens after risk: whenever risk happens  loss occurs

- Subjective risk: is an uncertainty based on a person’s mental condition or state of mind

Ex: drunk driver is uncertain whether he will arrive home safely without being arrested by the police for drunk driving

- Objective risk: relative variation of actual loss from expected loss

Calculated by statistical techniques like standard deviation, coefficient of deviation

Ex: Among 10,000 houses insured, insurers expect 1% (100 houses) to burn each year But some years, 90 houses burn,some years 110 houses burn  a variation of 10 houses from expected number of 100 (a variation of 10%) is objectiverisk

- Pure risk: a situation in which there are only the possibilities of loss or no loss Nothing gain can come from an

exposure of pure risk

Ex: Factory exposure to loss by fire A factory either burns or it does not burn

Ex: premature death or job related accidents

- Speculative risk: situation in which either profit or loss is possible

Ex: risk of price change of investment in stock market or investment in real estate

Note: Possible outcomes of pure risk and speculative risk

 Usually pure risk are insured Speculative risk is not insured (with certain exceptions: some insurers insure institutional portfolio investment and municipal bonds)

 Law of large number can be applied more easily to pure risks than to speculative risks (Law of large number: exposure units increase  the more closely the actual loss experience will approach the expected loss experience for predicting future loss experience)

 Pure risk always cause harm to the society (ex: earthquake floods) on the other hand speculative risk may benefit society (ex: new technology is developed  some company go bankrupt but society still gains)

2 Fundamental risk and particular risk, enterprise risk (definition and example)

- Fundamental risk: is a risk that affects entire economy or large number of persons or groups within the economy is

called fundamental risk

Ex: the risk of natural disaster, risk of high inflation, risk of terrorist attack…

Note: Fundamental risk is always insured by social insurance and government insurance program

Ex: the risk of unemployment is insured by state unemployment compensation programs, flood insurance is subsidized

by federal government in USA

- Particular risk: a risk that affects only individuals and not the entire economy

Ex: bank robbers, car accidents, car theft

- Enterprise risk: encompasses all major risk faced by a business firm, such as pure risk, speculative risk, strategic risk

strategic risk, operational risk and financial risk  used in commercial risk management

Note: Commercial risk management is process that organizations use to identify and treat major and minor risks.

 Enterprise risk management combines into single unified treatment program all major risk faced by the firm  firmcan offset one risk against another

3 Strategic risk, operational risk and financial risk (definition and example)

- Strategic risk: refers to uncertainty regarding the firm’s financial goals and objective

Ex: a firm enters a new line of business, the line may be unprofitable

- Operational risk: results from firm’s business operations

Ex: bank offering online banking service face the risk of being hacked

- Financial risk: refers to uncertainty of loss because of adverse changes in commodity prices, interest rate, foreign

exchange rates or the value of money

Ex: food company sells cereal at the fixed price to supermarket in 6 months may lose money if grain price rise

4 Three types of pure risk

- Personal risk: directly affect the individual in the form either complete loss or reduction of earned money or extra

expenses and the depletion of financial assets

Note: 4 major personal risk are:

 Risk of premature death: death of a family head with unfulfilled financial obligations  the human life value

is lost, additional expenses, family has trouble making ends meet, certain non economic costs

Note: Financial obligations: dependents to support, children to educate

Human life value: the present value of the family’s share of the deceased breadwinner’s future earnings

Additional expenses: funeral expense, uninsured medical bills, inheritance tax Noneconomic costs: emotional grief, counseling and guidance for children

 Risk of insufficient income during retirement: majority of the workers experience substantial reduction in

their money incomes after they retire  a reduced standard of living unless they have sufficient financial assets

or have access to other sources of retirement income such as social security or a private pension Especially for retired workers having substantial additional expenses such as high uninsured medical bills or high property taxes or both spouses paying for the cost of long term care in nursing facility.

 most workers are not paying enough for comfortable retirement, these amounts are small

 Risk of poor health: includes both payment if the catastrophic medical bills and loss of earned income 

unless workers have adequate health insurance, private savings, financial assets or other sources of income to meet these expenditure, the may be financially insecure

Note:

 Cost of major medical bills has increased sharply in recent years (surgery, transplant, rehabilitation)

 Loss of earned income: the likelihood that man aged 22 will become disabled for 90 days or longer before age 65 is 21%, for female is 33%

 Risk of unemployment: unemployment can result from business cycle downswing, technological and

structural changes in the economy, the seasonal factors, and imperfections in the labor market The cause of unemployment are that corporations have downsized to save labor costs, millions of jobs have been lost to foreign nations bcs of outsourcing, the world economic crisis

 Effect : workers lose their earned income and employment benefits, may change to part-time jobs 

insufficient income if extended over long period past savings and unemployment benefits may be exhausted

- Property risk: risk of having one’s property damaged or lost from numerous causes

Ex: any real estate and personal property can be damaged by or cause loss from fire, lightening cyclone, theft numerouscauses

Note:

 Direct loss: a financial loss resulting from the physical damage, destruction or theft of property

Ex: restaurant is damaged by fire, the physical damage is direct loss

 Indirect loss: a financial loss resulting indirectly from the occurrence of a direct physical damage or theft loss

Ex: in addition to the physical damage the restaurant will lose profit for several moths while is being rebuilt

 Consequential loss: loss of profit, loss of rents, loss of the use of the building, loss of local market,

continuing expense

 Extra expense: when loss occurs bank owner must continue to operate regardless of the cost, even if he

has to set up temporary operation at other location with extra expense, otherwise he will lose customers to his competitors

- Liability risk: risk of being legally liable for any bodily injury or property damage to someone else A court law may

order to pay substantial damages to the injured person

Ex: business firm can be held legally liable for defective products that harm and injure customers

Note: important because

 There is no max upper limit with respect to the amount of the loss A person can be sued for any amount.

Unlike property risk if a person cause serous bodily injury to the other driver , he can be sued for $1mil by the person he injured

 A lien can be placed on income and financial assets to satisfy legal judgment

Ex: if a person can not pay damages to the injured according to court judgment, a lien may be placed on his income, if he declare bankruptcy to avoid payment, his credit will be impaired

 Legal defense cost can be enormous  the cost of hiring attorney to defend is high, especially if the suit goes

to trial, attorney fees and other expenses can be great

5 Analyze the 3 burdens of risks on society.

- The size of emergency fund must be increased: In the absence of insurance individuals and business firms have to

increase size of their emergency fund to pay for unexpected losses Sometimes the fund may be insufficient to pay theloss The higher the amount that must be saved, the more current consumption spending must be reduced, resulting inlower standard of living

- Loss of certain goods and services: Only a small number of firms manufacture childhood vaccines, silicone-gel breast

implants, certain birth-control devices because of fear of legal suit

- Worry and fear are present: Mental unrest and fear caused by risks are present.

Ex: parents are fearful if their son depart on skiing trip during a blinding snowstorm because the risk of being killed on

an ice road is present

6 Analyze five major methods of handling risks.

- Avoidance: Ex: avoid the risk of divorce by not getting married

 Not all risk can be avoided Ex: avoid risk of being killed by staying at home and not taking part in traffic  may diebecause of electric shock

- Loss control: certain activities reducing both frequency and severity of losses.

Note: 2 major objectives

 Loss prevention: aims at reducing the probability of loss so that the frequency is reduced  prevent the loss from occurring

Ex: the number of heart attack can be reduced if individuals can control their weight, stop smoking, eat healthy diets…

 Loss reduction: reduce the severity of a loss after it occurs

Ex: plant can be constructed with fire-resistant materials to minimize fire damage

Note: Loss control is desirable because:

 Indirect cost of losses can be large, sometimes exceed direct costs.

Ex: a worker is injured on the job Direct cost = medical expense, certain % of earnings Indirect cost = cost of training a new worker to replace the injured one or a contract may be cancelled because goods are not shipped

on time

 The social costs of losses are reduced

Ex: worker dies from the accident  society is deprived of the goods and services the worker could produce

- Retention: An individual or business firm can retain all or a part of a given risk  appropriate for high frequency, low

severity where potential losses are quite small

 Active retention: individual is consciously aware of risk and deliberately plans to retain all or part of it Two

reasons:

 Save money

 Commercial insurance is either unavailable or unaffordableEx: home owner may retain a small part of the risk of damage to the home by purchasing a homeowners policywith a substantial deductibles

 Passive retention: certain risks are unknowingly retained because of ignorance, indifference or laziness 

Dangerous if the risk retained has the potential to destroy financially

- Non-insurance transfers: the risks are transferred to a party other than an insurance company.

Note: Three methods

 By contracts: unwanted risks can be transferred by contract (risk of rent increase can be transferred to

landlord by a long-term lease)

or hold-harmless clause (manufacturer of elevators insert a hold harmless clause in the contract with retailer,

the retailer agrees to hold the manufacturer harmless in case of elevator fall

 Hedging price risks: technique for transferring the risk of unfavorable price fluctuation to a speculator by

purchasing and selling future contracts on an organized exchange (stock exchange)

Ex: manager hold US Treasury bonds If interest rate rise, the value of bonds will decline To hedge this risk,

he can sell US Treasury bonds futures Assume the interest rate rise, bond price decline The value of futures contract will decline, which helps the manager to make offsetting purchase at a lower price The profit obtained from the closing out futures position will partly offset the decline in the market value of US Treasury bonds Interest rates do not usually move as expected, so the hedge may not be perfect.

 Incorporation of business firm: If a firm is sole proprietorship, owners personal assets can be attached by

creditors for satisfaction of debts If a firm incorporates, personal assets can not be attached by creditors for payment of firm’s debts By incorporation the liability if stockholder is limited and the risk of the firm having insufficient assets to pay business debts is shifted to creditors.

- Insurance: most practical method for handling a major risk.

 Pure risk is transferred to insurer

 Pooling technique: used to spread the losses of the few over the entire group so that average loss is substituted for actual loss

 The risk may be reduced by application law of large numbers by which an insurer can predict future loss experience with greater accuracy

7 Risk management and 4 steps in the risk management process (definition, example)

- Risk management: is systematic process if identifying loss exposures faced by an org and selecting the most

appropriate techniques for treating such exposures

 Step 1: Identification of loss exposure: indentify sources of possible exposures.

Note: Loss exposures are related to following issues:

 Property loss exposures: building, plants, equipments…

 Liability loss exposures: defective products, environment pollution, liability arising from company decisions or equipments

 Business income loss exposures: continuing loss after a loss, extra expense

 Human resource loss exposures: death or disability or retirement of key employees, job related or diseases experienced by workers

 Crime loss exposures: fraud and embezzlement, Internet crime, theft…

 Employee benefit loss exposures

 Foreign loss exposures

 Reputation and public image of the company

 Historical loss data

 Step 2: Analyzing loss exposures: estimation of the frequency and severity of loss so that

 Loss exposures could be ranked according to their relative importance

 The risk manager can select the most appropriate technique, or combinations of techniques forhandling these exposures

 The risk manager could estimate max possible loss and max probable loss

Risk severity is more important than risk frequency as a single catastrophic loss could wipe out the firm

 Step 3: Selecting appropriate techniques: include two broad categories:

 Risk control: techniques that reduce the frequency and severity of loss

 Risk avoidance: certain loss exposure is never acquired or an existing loss exposure isabandoned That means the chance of loss has been eliminated  May reduce the chance ofcertain loss to zero but all loss exposure can not be avoided

Ex: not investing in a risky country, withdrawing drug from market that has significant sideeffect

 Loss prevention: measures that reduce the frequency of particular loss

Ex: Use of temper-resistant packaging, driver training and safety program

 Loss reduction: measurers that reduce the severity of a loss after it occursEx: installation of an automatic fire sprinkler system, maintaining limited amount of cash in thepremises

 Risk financing: techniques that provide for the funding of losses

 Risk retention/Assumption: firm retains/ assumes part or all of the losses that can result from given loss If loss occurs the concerned person or firm will pay it out what ever the funds areavailable at that time It may be planned retention or unplanned retention

Used when: There’s no other method of treatment or losses are highly predictable and that can be budgeted out of the firm’s income  when used: risk manager must determine the retention level

 No insurance transfers: risk transfers other than insurance by which pure risk and its potentialfinancial consequences are transferred to another party

Note: include hedging, hold-harmless agreements and contracts Note: Advantages: cost less than insurance, some potential risk can be transferred that are not insurable, sometimes loss exposures are transferred to the parties who are in better position to exercise loss control

 Insurance: especially appropriate risk management tool when the chance of loss is low and severity of loss is high  represents contractual transfer of risk

Note: 5 areas that must be decided

- Selecting of insurance coverage

- Selection of an insurer

- Negotiation of terms

- Dissemination of information abt insurance coverage

- Periodic review of the program

Note: Advantages:

- Firm will be indemnified after loss occurs

- Firm’s uncertainty is reduced

- Insurance premiums are tax deductibles

Disadvantages

- Premium payment is major cost

- Negotiating the insurance coverage take considerable time and effort Note:

 Step 4: Implement and monitor the program: risk management program must be properly implemented andadministered Including

 Preparation of a risk management police

 Close cooperation with other people and departments

 Periodic review of the entire risk management program

 The pooling of fortuitous losses by transfer of such risk to insurers, who agree to indemnify insured’s for suchlosses, to provide other pecuniary benefits on their occurrence, or to render services connected with the risks

- Insurer: the party agreeing to pay for the losses

- Insured: The party whose risk is transferred to the insurer

- Premium: the payment the insurer receives from the insured

Ex: Mr A buys a retirement insurance for himself from Dai-ichi Life Vietnam and pays 10 000.000VND per year So Mr A

is the insured, Dai-ichi life Vietnam is insurer, 10.000.000VND is annual premium, retirement insurance is insurance

9 4 basic characteristics of insurance (analyze)

- Pooling of loss or the sharing of losses: spreading of losses incurred by the few over the entire group, so that in the

process, average loss is substituted for actual loss large number of similar but not necessarily identical exposure unitsthat are subject to same perils so a substantially accurate prediction of future losses

 Involves:

 Sharing of losses by the entire group

 Prediction of future losses with accuracy based on the law of the large number

 Insurers can predict future losses with greater accuracy  reduce objective loss

 Objective risk varies inversely with the square root of the number if exposure units: No of exposure unitincreases, the relative variation of actual loss from expected loss decline

 Objective loss is low  actual premium will be enough for all claims, expenses and profit

Ex: 1000 farmers, if one’s home is damaged by fire, the other members will indemnify the actual costs of the unluckyfarmer Each home value is 200,000$ and on average 1 home burns a year No insurance: the max loss of each farmer us200,000$ if his house burns By pooling the loss, each farmer must only pay 200$  substitutions of an average loss of200$ for the actual 200,000$

Note: Law of the large number: the greater the no of exposures the more closely will the actual results approach the probable result that are expected from an infinite number of exposures

- Payment of fortuitous losses: one that is unforeseen and unexpected and occurs as a result of chance  lost must be

accidental Intentional losses not covered by insurance policy

Ex: a person may have a plane accident and can not return home

- Risk transfer: pure risk is transferred from the insured to the insurer, who typically is in stronger financial position to

pay the loss

Ex: premature death, poor health, disability, destruction and theft of property

- Indemnification for losses: insured is restored to his or her approximate financial position prior to the occurrence of

the loss

Ex: a person crushes into a third party using his motorbike, his motorbike liability insurance policy will pay the sumwhich he is legally obliged to pay for the injury or death and property damage of the third party

10 6 ideal requirements of an insurable risk?

- Large number of exposure units: there should be a large group of roughly similar but not necessarily identical

exposure units that are subject to the same peril or group of perils  enable insurers to predict loss based on the law ofthe large number with more accuracy

Ex: A large no of motorbikes in a city can be grouped together for insurers to provide property insurance

- Accidental and Unintentional

 If intentional loss were paid, increase in moral hazard would increase  premium would rise  fewer people wouldbuy insurance  insurers have not enough exposure units to predict future losses

 The loss should be accidental bcs the law of large numbers is based on the random occurrence of events If notprediction of future experience would be highly inaccurate

 Loss should be fortuitous and outside the insured’s control If an individual deliberately causes a loss he will not beindemnified

- Determinable and measurable loss:

 The loss must be definite as to cause, time, place and amount

Ex: Life insurance

 Some losses are difficult to determine and measure

Ex: Sickness and disability

 To enable insurer to determine if the loss is covered under policy and how much should be paid

- No catastrophic loss

 Large portion of exposure units should incur losses at the same time Otherwise, premium must be increased tounplayable levels  the pooling technique is not applicable as the losses of the few can not spread over theentire group

 Catastrophic losses (hurricane, tornadoes, floods, earthquake…) are impossible to void some approaches areavailable:

 Reinsurance: arrangement by which the primary insurer initially writing the insurance contracttransfers to another insurer part or all potential losses associated with such insurance contract.Reinsurer is then responsible for paying its share of catastrophic loss

 Insurer avoids concentration of risks by dispersing their coverage over a large geographical area

 Financial instruments are used are used to deal with catastrophic losses such as catastrophe bondswhich are designed to pay for a catastrophic loss

- Calculable chance of loss:

 The insurer muss be able to calculate both the average frequency and average severity of future lossesaccurately  insurers can charge a proper premium to cover all claims, expenses, and profit during policyperiod

 Certain losses, such as floods, wars, cyclical unemployment , which occur on an irregular basis, and prediction

of average frequency and severity of loss is difficult  not insured

- Economically feasible premium

 Affordable premium: the premium paid must be substantially less than the face value of the policy to make theinsurance more attractive

 Low chance of loss: if chance of loss > 40%, the cost of policy will exceed the total value the insurer must payunder the contract

Ex: premium for a 1000$ life insurance policy on 99 aged man is 980$ +additional amount for expenses

11 Social insurance (definition, characteristics)

- Social insurance: government insurance programs financed entirely or in large part by mandatory contributions from

employers, employees, or both, and not primarily by the general revenues of government The contributions are usuallyearmarked for special trust funds The benefits are paid from these funds The right to receive benefits is ordinarilyderived from or linked to the recipient’s past contributions or coverage under the program

 Old age, survivors, disability insurance: known as Social security, massive income maintenance program

providing benefits to eligible individuals and family

 Medicare-part of total Social security program: covers medical expenses of most people aged 65 and older

and certain disabled people younger than 65

 Unemployment insurance program: weekly cash benefits to eligible workers, experiencing short term

involuntary unemployment Paid up to 26 weeks

 Worker compensation insurance: covers workers against a job-related accident and disease

 Compulsory temporary disability insurance: provides partial replacement of wages lost because of a

temporary nonoccupational disability in the railroad industry

12 5 main benefits of insurance to society (analyze)

- Indemnification of loss:

 Allows individuals and families to be restored to their former financial position in part or in whole after loss

occur  can maintain their financial security  less likely to apply for public assistance from relatives orfriends

 To business firms: allows to remain business and employees to keep job  the community cost as tax base is

not eroded

- Reduction of worry and fear: reduced both before and after a loss

Ex: Family heads have suitable amount of life insurance  worry less abt financial security of dependents in the vent ofpremature death and have peace of mind bcs they know if loss occurs, they are covered

- Source of investment fund:

 Insurers have substantial source of funds for capital investment and accumulation Premiums are collected inadvance of loss, funds not needed to pay immediate losses and expenses can be loaned to firms and invested inhospitals, shopping centers…  increase economic growth and full employment

 Cost of capital to firms borrowing from insurers is less than from banks and credit org as the capital of insurerscomes from advance payment of insurance premiums with no interest

- Loss prevention:

 Insurers are actively involve in numerous loss prevention programs:

 Highway safety and reduction of automobile deaths

 Fire prevention

 Reduction of work-related injuries and diseases

 Prevention of auto thefts

 Prevention and defection of arson losses

 Prevention of defective products that could injure the user

 Prevention of boiler explosions

 Educational programs or loss prevention

 Insurers employ lot of loss prevention personnel, occupational safety engineers and specialists in fireprevention, occupational safety and health, product liability

 Loss prevention activities reduce both direct and consequential losses  society benefits

- Enhancement of credit: guarantees the value of the borrower’s collateral or gives greater assurance that the loan will

be repaid

Ex: house is purchased, landing institution requires property insurance on the house before the mortge loan is grantedbcs property insurance protect lender’s financial interest if the property is damaged or destroyed

13 3 main costs of insurance to society

- Social costs of insurance can be viewed as the sacrifice that the society must make to obtain true benefits of insurancesociety

- Cost of doing business:

 Insurers consume scarce economic resources to provide insurance to society The premium must includeexpense loading - the amount needed to pay all expenses, state premium taxes, acquisition expense, allowancefor contingencies and profit - to cover the expenses incurred in their daily operations

 Cost of doing business can be justified because

 Uncertainty concerning the payment of a covered loss is reduce because of insurance

 The cost of doing business are not necessarily wasteful as insurers engage in a lot of loss preventionactivities

 Insurance industry provides jobs to millions of people in each country

- Fraudulent claims:

 Auto accidents are faked or staged to collect benefits

 Dishonest claimants fake slip-and-fall accidents

 Phony burglaries, thefts and acts of vandalism are reported to insurers

 False health insurance claims are submitted to collect benefits

 Dishonest policy owners take out life insurance policies on insured who are later reported as having died

 Payment of such claims results in higher premium to all insured Existence of insurance prompts some insured todeliberately cause a loss so as to profit from insurance

 Insureds inflate the amount of damage in auto collision claims so that the insurance payments willcover the collision deductibles

 Inflated claims are social cost of insurance as premiums must be increased to pay for additional losses

Note: Cost of fraudulent and inflated claims:

 The cost of fraudulent and inflated claims is huge (80mil$ annually in USA)

 Lax public attitude toward insurance fraud

 2/3 Americans tolerate insurance fraud to varying degree

 2/5 Americans want little or no punishment for insurance cheats

 They blame the insurance industry for its fraud problems as they believe insurance is unfair

 Many ordinary Americans often engage in variety of actions linked with insurance fraud

14 Distinguish property insurance, liability insurance and person insurance

- Property insurance: All types of property insurance that includes risk under marine, fire, motor, engineering…

 Insurance value can be and must be calculated = value of goods at the time of buying insurance = the value ofgoods at the time of buying - depreciation

Note:

 Insurance value (V) - gia tri bao hiem: actual value

 Insurance amount (A) - so tien bao hiem: agreed amount of money btw insurance buyer and insurer

 A is smaller or equal to V

Ex: buy insurance with A=1000 (V=2000)

 Loss of 500  compensate: 500*A/V=250

- Liability insurance: All types of liability insurance like employer’s liability, public liability, product liability, liability

portion of motor and hull insurance and professional liability

- Person insurance: Include life insurance and personal accident insurance

 Life insurance

 Personal accident insurance

 Insurance of person and liability only identify limit of liability = amount of money buyer of insurance negotiate and

is agreed upon by the insurer

15 Time Policy, Voyage Policy and Mixed Policy in Maritime insurance

- Time policy: covers the subject matter only for specific duration Normally the policy is made for 1 year and whatever

the number of voyage made within this time is covered under this policy For valid claim the loss must be happenedwithin specified period Usually the ship/hull insured by this policy

- Voyage policy covers the subject matter only for specific voyage not for time duration For valid claim the loss must be

happened during the specified voyage Usually cargo is insured by the policy

- Mixed policy: resolves drawbacks of time and voyage policies by covering a voyage and additional time after

completion of the voyage

Note: there’s also

 Floating policy: issued for a number of estimated shipments of cargo to avoid formalities for each individual

shipment At the time each shipment, the insured just declares shipment and obtain a certificate of insurance

 Building risk policy

16 Analyze 3 standard perils in standard fire insurance policy: fire, lightening, explosion of boilers or of gas

- Fire: resulting from explosion or otherwise, but not happened by

 Its own spontaneous fermentation of heating or its undergoing any process involving the application of heat

 Earthquake, riot, civil war, rebellion, revolution, military power

- Lightning: whether or not there is any fire involved

- Explosion of boilers or of gas: used for domestic purpose only, even though there is no fire involved

However, this policy does not cover:

 Consequential loss

 Goods held in trust or on commission, money, stamp, pictures, designs,… unless are specially insured

 Loss caused by radioactive contamination or irradiated nuclear fuel

CHAPTER 3 ANALYSIS OF INSURANCE CONTRACTS

17 Insurance contract (definition) and 6 basic parts of an insurance contract

- Insurance contract is a contract (generally a standard form contract) between the insurer and insured, known as the

policyholder, which determines the claims which the insurer is legally required to pay

- 6 basic parts:

 Declarations: question 18

 Definitions:

 key words or phrases have quotation marks or are in boldface type

 clearly define meaning of key words or phrases

Note: insurer usually referred to as we, our, us Insured usually referred to as you, your

 Insuring agreement: question 19

 Exclusions: question 20+21

 Conditions: question 22

 Miscellaneous provisions: question 23

18 Declarations (definition) and Clarify declarations in property insurance contract and life insurance contract

- Declarations: statements that provide information about the particular property or activity to be insured Information in

the declarations section is used for underwriting and rating purposes and identification of the property or activityinsured Declarations on the 1st page of the policy or policy insert

- In property insurance: contains

 Identification of insurer

 Name of the insured

 Location of the property

 Period of protection

 Amount of insurance/premium

 Period of protection

 Size of the deductibles

- In life insurance contains

 Insured’s name, age

 Premium amount

 Issue date

 Policy number

19 Differences between named-perils policy and all-risks policy?

- Insuring agreement: summarizes the major promises of insurers (pay losses from covered perils, provide loss

prevention service, defend the insured in a liability lawsuit) 2 forms of insuring agreement in property insurance are:

 Named-perils policy: only those perils specifically named in the policy are covered

 All-risks policy/open perils policy/special coverage policy: all loses are covered except those losses specifically

excluded

 All risk policy is preferred to named-perils policy as the protection is broader with fewer gaps in coverage To denypayment, insurer must prove that the loss is excluded while in named-perils policy, the insured must show that the losswas caused by a named peril

20 3 major types of exclusions?

- Excluded perils: certain perils of causes of loss Ex: in homeowners policy flood, earth movement, nuclear radiation,

radioactive contamination are excluded

- Excluded losses: certain types of losses Ex: failure of the insured to protect the property from further damage after a

loss occurs is excluded

- Excluded property: contract may exclude or place limitations on the coverage of certain property Ex: in homeowners

policy, certain properties are excluded such as cars, planes, animals, birds and fish

21 6 reasons for exclusions?

- Certain perils considered uninsurable by insurers: A given peril may depart substantially from the ideal

requirements of an insurable risk

Ex: inherent vice, latent defect = destruction or damage of property without any tangible external force

- Presence of extraordinary hazard: condition increasing the chance of loss or severity of loss Because of an

extraordinary increase in hazard, a loss may be excluded

Ex: the premium for liability insurance under the personal auto policy is based on the assumption that the car is used forpersonal and reactional use and not as a taxi

- Coverage provided by other contracts: avoid duplication of coverage and limit coverage to policy best designed to

provide it

Ex: a car is excluded under a homeowners policy bcs it is covered under personal auto policy and other auto insurancecontracts

- Moral hazard problems: certain property is excluded because of moral hazard or difficulty in determination and

measurement of the amount of loss

Ex: homeowners insurance policy drafted by Insurance service Office limits the coverage of money to 200$ Ifunlimited amount of money were covered, fraudmental claims would rise

- Attitudinal hazard problems: is carelessness or indifference to a loss, which increase frequency and severity of loss

 exclusions force individuals to bear losses that result from their own carelessness

- Coverage not needed by typical insureds

Ex: most homeowners don’t own private planes to cover aircrafts as personal property under homeowners policy would

be unfair to most insureds who do not own private plane because premium would be substantially higher

22 Conditions in insurance contract?

- Conditions are provisions in policy that qualify or place limitations on the insurer’s promise to perform  imposes certain duties on insured If the policy conditions are not met, the insurer can refuse to pay the claim Common policy conditions include:

 Notifying the insurer if a loss occurs

 Protecting the property after the loss

 Preparing and inventory of damaged personal property

 Cooperating with the insurer in the event of a liability suit

23 Miscellaneous provisions in insurance contract?

- In property and casualty insurance, include

 Cancellation

 Subrogation

 Requirements if a loss occurs

 Assignment of the policy

 Other insurance provisions

- In life and health insurance, include

 Grace period

 Reinstatement of a lapsed policy

 Misstatement of age

24 Deductibles in insurance contract? 3 purposes of deductibles

- Deductible is a common policy provision requiring the insured to pay part of the loss or a provision by which specified

amount is subtracted from the total loss payment that otherwise would be payable by the insured

 Typically in: property, health, auto insurance contract

 The premium reduction resulting from a small deductible in personal types of third party liabilitycoverage is small

- 3 purposes:

 Eliminate small claims too expensive to handle and process Ex: insurer may incur 100$ or more in processing a

100$ claim With deductible, the insurer’s loss adjustment expenses are reduced

 Reduce premiums paid by the insured Small losses can be better budgeted with personal or business income.

Insurance should be used to cover large catastrophic events and can be purchased more economically if deductiblesare used  large deductibles are preferred to small one

Note: Large loss principle = concept of using insurance premiums to pay for large losses rather for small losses

Ex: collision insurance of a car: 250$ deductible with annual premium 900$

policy with 500$ deductible has annual premium 800$

 Pay 100$ for an additional 250$ compensation of insurance  relatively expensive

 Reduce both moral and morale hazards: some dishonest policyholders may deliberately cause a loss in order to

profit from insurance

 Deductible encourage people to be more careful with respect to the protection of their property and prevention of aloss because the insured must bear part of the loss

CHAPTER 4 FUNDAMENTAL LEGAL PRINCIPLES

25 principle of indemnity?

 The principle of indemnity states that the insurer agrees to pay no more than the actual amount of the loss; stateddifferently, the insured should not profit from a loss Most property and casualty insurance contracts are contracts ofindemnity If a covered loss occurs, the insurer never pay more than the actual amount of the loss Not all coveredlosses are always paid in full because of deductibles, $ limits on the amount paid, and other contractual provisions,the amount paid is often less than the actual loss

 The principle of indemnity has 2 fundamental purposes:

 To prevent the insured from profiting from a loss

Ex: If Kristin’s home is insured for $200,000 and a partial loss of $50,000 occurs, she will be compensated $50,000 at

most

 To reduce moral hazard

Ex: If dishonest policyholders could profit from a loss, they might deliberately cause losses with the intention of

collecting the indemnification

 Actual cash value: The concept of actual cash value supports the principle of indemnity In property insurance, thebasic method for indemnifying the insured is based on the actual cash value of the damaged property at the time ofloss

 3 main methods to determine actual cash value:

 Replacement cost less depreciation

 Fair market value

 Broad evidence rule

a Replacement cost less depreciation

- Under this rule, actual cash value is defined as replacement cost less depreciation used traditionally to determine theactual cash value of property in property insurance It takes into consideration both inflation and depreciation ofproperty values over time

- Replacement cost is the current cost of restoring the damaged property with new materials of like kind and quality.Depreciation is a deduction for physical wear and tear, age, and economic obsolescence

Ex: Sarah has a favorite couch burnt in a fire Assume she bought the couch 5 years ago and it is 50% depreciated, asimilar couch today would cost $1000 Under the actual cash value rule, Sarah will collect $500 for the loss because thereplacement cost is $1000, and the depreciation is $500, or 50%

b Fair market value (giá trị thị trường)

- Fair market value is the price a willing buyer would pay a willing seller in a free market The fair market value isbelow actual cash value based on replacement cost less depreciation If a loss occurs, the fair market value mayreflect more accurately the value of the loss

Ex: According to the court, a building valued at $170,000 based on the actual cash value rule had a market value of only

$65,000 when a loss occurred The court ruled that the actual cash value of the property should be based on the fairmarket value of $65,000 rather than on $170,000

c Broad evidence rule

- Broad evidence rule used by many USA states means that the determination of actual cash value should include allrelevant factors an expert would use to determine the value of the property Relevant factors include replacementcost less depreciation, fair market value, present value of expected income from the property, comparison sales ofsimilar property, opinions of appraisers (người thẩm định) and numerous other factors

- The actual cash value rule is used in property insurance

+ In liability insurance, the insurer pays up to the policy limit the amount of damages that the insured is legally obligated

to pay because of bodily injury or property damages to the 3rd party + In business income insurance, the amount paid isusually based on the loss of profits plus continuing expenses when the business is shut down because of a loss from acovered peril

+ In life insurance, the amount paid when the insured dies is generally the face value of the policy

 Exceptions to the principle of indemnity

 Valued policy: A valued policy is a policy that pays the face amount of insurance if a total loss occurs Valued

policies typically are used to insure antiques, fine arts, rare paintings, and family heirlooms Because of difficulty indetermining the actual value of the property at the time of loss, the insured and insurer both agree on the value of theproperty when the policy is first issued

 Valued policy laws: is a law that exists in some states requiring payment of the face amount of insurance to the

insured if a total loss to real property occurs from a peril specified in the law

- The specified perils vary among the states

Laws in some states cover only fire; other states cover fire, lightning, windstorm and tornado; and some states includeall insured perils

- In addition, the laws generally apply only to real property, and the loss must be total

Because the insured would be paid more than the actual cash value, the principle of indemnity would be violated

- The original purpose of a valued policy law was to protect the insured from a dispute with the insurer if an agent haddeliberately overinsured property for a higher commission

- The importance of a valued policy law has declined over time because inflation in property values has madeoverinsurance less of a problem

- Underinsurance is now the greater problem, because it results in both inadequate premiums for the insurer andinadequate protection for the insured

- Valued policy law can lead to overinsurance and an increase in moral hazard The insured may not be concernedabout loss prevention, or may even deliberately cause a loss to collect the insurance proceeds

- Although valued policy laws provide a defense for the insurer when fraud is suspected, the burden of proof is on theinsurer to prove fraudulent intent Proving fraud is often difficult

 Replacement cost insurance: means there is no deduction for physical depreciation in determining the amount paid

for a loss Because the insured receive the value of a brand-new item instead of one that has depreciated, theprinciple of indemnity is technically violated Replacement cost insurance is based on the recognition that payment

of the actual cash value can still result in a substantial loss to the insured, because few persons budget fordepreciation To deal with this problem, replacement cost insurance can be purchased to insure homes, buildings,and business and personal property

 Life insurance: A life insurance contract is not a contract of indemnity but a valued policy paying a stated amount to

the beneficiary upon the insured’s death as the indemnity principle is difficult to apply to life insurance because theactual cash value rule (replacement cost less depreciation) is meaningless in determining the value of a human life

26 principle of insurable interest?

 The principle of insurable interest states that the insured must be in a position to lose financially if a covered lossoccurs

Ex: you have an insurable interest in your car because you may lose financially if the car is damaged or stolen.

 Purposes of an insurable interest: to be legally enforceable, all insurance contracts must be supported by an insurableinterest for following reasons:

 To prevent gambling: If an insurable interest were not required, the contract would be a gambling contract and would

be against the public interest

Ex: You could similarly insure the life of another person and hope for an early death and the contract is clearly a

gambling contract and would be against the public interest

 To reduce moral hazard: If an insurable interest were not required, a dishonest person could purchase property

insurance on someone else’s property and then deliberately cause a loss to receive the proceeds In life insurance, aninsurable interest requirement reduces the incentive to murder the insured for the purpose of collecting the proceeds

 To measure the amount of the insured’s loss in property insurance: Most property insurance contracts are contracts

of indemnity, and one measure of recovery is the insurable interest of the insured If the loss payment cannot exceedthe amount of one’s insurable interest, the principle of indemnity is supported

 Example of an insurable interest

 Property and casualty insurance: Ownership of property can support an insurable interest because owners of

property will lose financially if their property is damaged or destroyed

- Potential legal liability can also support an insurable interest

Ex: A dry-cleaning firm has an insurable interest in the property of the customers, they may be legally liable for damage

to the customers’ goods caused by its negligence (Một công ty giặt khô có lợi ích không thể bảo hiểm trong tài sản củakhách hàng, họ có thể chịu trách nhiệm pháp lý về thiệt hại cho hàng hóa của khách hàng do sơ suất của nó.)

- Secured creditors have an insurable interest A commercial bank or mortgage company lending money to buy ahouse has an insurable interest in the property The property serves as collateral for the mortgage, if the building isdamaged, the collateral behind the loan is impaired But the courts have ruled that unsecured or general creditorsnormally do not have an insurable interest in the debtor’s property (Chủ nợ được bảo đảm có quyền lợi bảo hiểm.Một ngân hàng thương mại hoặc công ty thế chấp cho vay tiền để mua một căn nhà có quyền lợi bảo hiểm trong tàisản Tài sản là tài sản thế chấp để thế chấp, nếu tòa nhà bị hư hỏng, tài sản thế chấp đằng sau khoản vay bị suy giảm.Nhưng các tòa án đã phán quyết rằng các chủ nợ không có bảo đảm hoặc chung chung thường không có quyền lợibảo hiểm trong tài sản của con nợ.)

- A contractual right can support an insurable interest Thus, a business firm that contracts to purchase goods fromabroad on the condition that they arrive safely in the USA has an insurable interest in the goods because of the loss ofprofits if the merchandise does not arrive (Quyền hợp đồng có thể hỗ trợ quyền lợi bảo hiểm Vì vậy, một công tykinh doanh có hợp đồng mua hàng hóa từ nước ngoài với điều kiện họ đến một cách an toàn tại Hoa Kỳ có lợi ích bảohiểm trong hàng hóa vì mất lợi nhuận nếu hàng hóa không đến.)

 Life insurance: The law considers the insurable interest requirement to be met whenever a person voluntarily

purchases life insurance on his/her life Thus, you can purchase as much life insurance as you can afford, subject tothe insurer’s underwriting rules concerning the maximum amount of insurance that can be written on any single life.You can name anyone as beneficiary who is not required to have an insurable interest in your life

- If you wish to purchase a life insurance policy on the life of another person, you must have an insurable interest inthat person’s life Close family ties or marriage will satisfy the insurable interest requirement in life insurance

Ex: A husband can purchase a life insurance policy on his wife and be named as beneficiary Remote family

relationships will not support an insurable interest

Ex: Cousins can not insure each other unless a pecuniary/financial relationship is present One person without any

relationship by blood or marriage may be financially harmed by the death of another One business partner can insurethe life of the other partner and use the life insurance proceeds to purchase the deceased partner’s interest if he/she dies

 When must an insurable interest exist?

In property insurance, the insurable interest must exist at the time of the loss because:

- Most property insurance contracts are contracts of indemnity If an insurable interest does not exist at the time ofloss, the insured would not incur any financial loss Hence, the principle of indemnity would be violated if paymentwere made

- You may not have an insurable interest in the property when the contract is first written but may expect to have aninsurable interest in the future, at the time of possible loss, especially in marine insurance

Ex: For Incoterms 2010’s FOB condition, it is common to insure a cargo by a contract entered into prior to the ship’s

departure The policy may not cover the goods until they are on board the ship as the insured’s property