Chapter 2: Defining the Insurable Event

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Chapter 2Defining the Insurable Event
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Insurable Loss Exposures

• Introduction
• Not all exposures to loss are insurable - Which
  ones are?
• What criteria is used to produce a financially
  viable and sustainable result?

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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 low 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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Large Losses

• Recently Hurricane Andrew (1992) 16.3 billion
• Hurricane Katrina (2005) - 60 billion (est.)
• Result
• Companies reconsidered exposures
• Some did not renew policies
• Some went out of business
• Catastrophic Insurance Program examples
• Beach Plans
• Federal Flood Insurance

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Terrorism Insurance and Loss estimates

• Defining Terrorism What is it? What will happen
  if courts need to interpret the definition?
• September 11, 2001 attack on the World Trade
  Center and the Pentagon
• Estimate 40 - 60 billion

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November 2002 Federal Insurance Act

• Passed as a result of 9/11, 2001
• Federal govt will share losses with insurance
  industry act ends 12/31, 2005 (under
  reconsideration)
• Sec. of the Treasury certifies an event as
  terrorism
• Mandatory participation of all policy holders
• Insurers pay first dollars equal to a percent of
  the prior years premiums
• After loss split 90/10 govt max is 100
  billion
• Premiums charged for terrorism must be explicit

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Principles of Risk Classification

• Used to
• Minimize subsidization
• Minimize adverse selection
• Goal is to have all pay a "fair" share
• Provide a structure for the evaluation of
  classification schemes

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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 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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Principles of Risk ClassificationFactors

• 2) Reliability
• Information is easily obtained and not subject to
  manipulation
• Information is verifiable

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Principles of Risk ClassificationFactors

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

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Principles of Risk ClassificationFactors

• 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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Important Social Issues and Subsidization

• Acquired Immune Deficiency Syndrome (AIDS)
• Automobile Insurance
• Pension Benefits
• Catastrophes

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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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Example Cases

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

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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 are insurable?

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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
• Workers compensation, pure no-fault

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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
  insureds legitimate claim
• Other Damages
• Hedonic damages - loss of lifes 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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Legal Liability Insurance

• Pays for a persons legal liability as outlined
  in the insurance contract up to policy limits.
• Provides a defense for persons who could be
  liable under the insurance contract (defense
  costs).