Key Answers of the Mid-term Paper
Principles of Insurance
Major: Finance of 2007
Instructor: Huixia Liu
April28, 2009
Ⅰ. Define the following concepts and terms(15Points, 3 points for each)
1. Fundamental risk （3）
A fundamental risk is a risk that affects the entire economy or large numbers of people or groups within the economy, such as inflation, cyclical unemployment, broadly spread communicable diseases.
2. Moral Hazard （3）
Moral hazardis dishonesty or character defects in an individual that increase the frequency or severity of loss.Moral hazard is present in all forms of insurance, and it is difficulty to control and Insurers try to control moral hazard by various policy provisions. Moral hazard leads to higher premiums for everyone.
3. Adverse selection（3）
Adverse selection is the tendency of persons with higher-than-average chance of loss to seek insurance at standard（average）premium, which if not controlled by underwriting, results in higher-than-expected loss levels. For example, adverse selection can result from persons with serious health problems seeking life or health insurance.
4. Actual cash value（3）
It is the actual cash value of the damaged property at the time of the loss. In property insurance, the basic method for indemnifying the insured is based on the actual cash value.
5. Law of large numbers （3）
The law of large numbers states that the greater the number of exposure, the more closely will the actual results that are expected from an infinite number of exposures. The insurer can predict future losses with a greater degree of accuracy with large number of exposures units.
Ⅱ. Give brief answers to the following questions(35Points)
1. Insurance contracts have distinct legal characteristics that distinguish them from other contracts. Explain these characteristics. (7)
Answers:
Insurance contracts have severaldistinct legal characteristics which distinguish them from another contracts. They are as follows(1 point):①Bilateral Contract: an insurance contract is a bilateral contract, that is both parties should make enforceable promises.The insured should pay the premiums to the insurer, the insurer should pay the loss under the contract.(some scholars think that insurance contract is a unilateral contract.(1 point)②Aleatory Contract: this means the parties to the contract know in advance the value they exchange will be unequal. The insured pays the premium, and collects a large sum if a large loss occurs or collect nothing if no loss occurs. The opposite is true to the insurer. (1 point)③Indemnity Contract: it means an insurance contract provide compensation for an insured’s losses. The insured, however, should not profit from an insurance transaction.The insured should be in the same financial condition as before the loss. (1point)④Conditional Contract:It means the contract can enforce only if all the fact meets the conditions stipulated in the contract. Common policy conditions include notifying the insurer if a loss occurs, protecting the property after a loss, filing a proof of loss with the insurer, etc.(1 point)⑤Personal Contract: it means the loss of the insured subjects is the loss for the insured himself/or herself.The insurance contract , the premium is decided on his or her conditions, no other substitute.(1point)⑥Adhesion Contract: that is the insurer list out the main contents and conditions of the contract, the insured in most case can only follow.(1point)
2. Describe the basic parts of an insurance contract. (7)
Answers:
①Generally, an insurance contract may containsix parts as: Declarations,Definitions, Insuring agreement, Exclusion, Conditions, Miscellaneous provisions.all insurance contracts do not necessarily contain all the six parts.(1point)②Declaration means providing information about the property or activity to be insured, which is used for underwriting and rating purposes. It usually includes the following information: the identification of the insurer, name of the insured, location of the property, period of protection, amount of insurance, amount of premium, size of the deductible, and other relevant information. (1point)③Definitions contain such key word as “ We”, “our”, “us”, referring to the insurer ; “you”, “your” , referring to the insured. (1point)④Insuring Agreement summarizes the major promises of the insurer. That’s the insurer agrees to do certain things under the contract. (1point) ⑤In Exclusions part, some perils or losses are excluded from the coverage. There are three major types of exclusions as follows:excluded peril, excluded losses, excluded property. (1point)⑥Conditions section impose certain duties on the insured. If the policy conditions are not met, the insurer can refuse to pay the claim. (1point) ⑦Insurance contracts also contain a number of miscellaneous provisions, such as in property and liability insurance, some miscellaneous provisions refer to cancellation, subrogation; in life and health insurance, typical provision include the grace period, reinstatement of a lapsed policy, and misstatement of age. (1point)
3. Why do deductibles appear in insurance contracts? Identify some common deductibles that are found in insurance contracts. (7)
Answers:
①A deductible is a provision of an insurance policy by which a specified amount is subtracted from the total loss payment. Deductibles typically are found in property, health, and auto insurance contracts. Deductibles are not used in life or in personal liability insurance.(2 points).②There are several important purposes for deductibles: first, a deductible eliminates small claims; second, reduce premiums paid by the insured. Third, reduce moral and morale hazard.(2 points). ③The following Deductibles in property insurance: Straight deductible and Aggregate deductible; Deductibles in health insurance, including Calendar-year deductible, corridor deductible and elimination (Waiting) period.(3 points).
4. What is an insurable interest?Why is an insurable interest required in every insurance contract?(7)
Answers:
Insurable interest states that the insured must be in a position to lose financially if a loss occurs, or to incur some other kind of harm if the loss takes place. Such as you have a insurable interest in your own car because you may lose financially if the car is damaged or stolen.(2 points) .All insurance contracts must be supported by an insurable interest.The reasons are(2 points): First, to prevent gambling. If the insurable interest were not required, the contract would be a gambling contract and would be against the public interest. (1point).Second, to reduce moral hazard. If an insurable interest were not required, a dishonest person could purchase a property insurance contract on someone else’s property and then deliberately cause a loss to receive the proceeds.(1 point).Finally, in property insurance, an insurable interest measures the amount of the insured’s loss. (1 point) .
5. What are the basic functions of insurance? How is insurance beneficial to society? (7)
Answers:
Concerning the functions of insurance, there are various argues: some claims that the unique function is Indemnification for loss. Some argues that the Fundamental functions are spreading risks and indemnification for loss. Others claims that the Multi-function, that’s besides the fundamental functions, there are more other functions as pooling funds, deposit, etc. Actually, the basic functions of insurance are: Dispersing risk, and indemnifying loss.(4points).The major social and economic benefits of insurance include: indemnification for loss, less worry and fear, source of investment funds, loss prevention, enhancement of credit.(3points).
Ⅲ. Application Questions (30 points)
1. Identify the types of financial losses likely to be incurred by each of the following parties:(15 points)
Answers:
a. If a person negligently injures another motorist in an auto accident, the likely financial losses are:①medical costs, that’s the medical expenses.②Human life value happens if the injured died in the accident. ③the loss of income. (5 points).
b. If a restaurant that is shut down for six months because of fire, the likely financial losses include: ①Direct loss that is physical damage, destruction to the building of restaurant. ②Indirect or consequential loss that result indirectly from the fire accident, including the loss of profit for 6 months, the loss of rents, the loss of using the building, and the loss of local market. (5 points) .
c. If a family whose family head dies prematurely, there are at least four costs: ①the human life value of the family head is lost forever. ②additional expenses including funeral expenses, uninsured medical bills, probate estate settlement costs and estate taxes for larger estates. ③loss of income from the head’s earning. ④certain non-economic costs, such as emotional grief, loss of model, and guidance for the children. (5 points) .
2. Briefly describe the standard of care to protect others from harm for each of the following liability situations: (15 points)
Answers:
a. Property owners
The property owners have the legal duty to protect others from harm. However, the standard of care owned to others depends upon the situation. There are three groups traditionally recognized：①Trespasser. That is the property owners cannot deliberately injure or refrain the trespasser, which is called the duty of slight care. ②Licensee. Such as door-to-door salespersons, solicitors for charitable or religious organizations, police officers and firefighters. The property owners are required to warn the licensee of any unsafe condition or activity on the premises.③Invitee. The invitee includes customers in a store, mail carriers, and garbage collectors. The property owners has an obligation to warning the invitee of any dangerous conditions, and has the obligation to eliminate any dangerous condition. (5 points) .
b. owners and operators of automobiles
Owners and operators of automobile have the legal duty to protect others from harm. They have a legal duty to stop at a red light and to drive an automobile safely within the speed limits. If they fail to do thelegal duties,such financial losses will result as medical bills or funeral expenses from the injured persons, the property loss of the autos, and some attorney fees.(4 points) .
c. governmental units and agencies
e. employers and employees
Ⅳ. Case Application (20 points)
Risk exists everywhere. Risk management is important to institutions and units both profit-making and non-profit-making. Please identify the types of risk likely to be incurred in your university, and provide a risk-handling program as a good suggestion for your university. (风险管理是现代企业经营管理中的重要组成本分。它对事业团体、非营利性组织同样非常重要。试分析你所在的学校可能面临的各种风险，并依据风险管理的主要环节，为学校制定一套风险管理方案。)
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