Ch10. Insurance Fundamentals — Comprehensive Review & Final Check

Core Insurance Principles — Summary

4 Risk Management Methods:
Avoidance, Reduction, Retention, Transfer (A-R-R-T)
Insurance = the risk transfer mechanism

Foundational Insurance Principles:
Law of Large Numbers: pool many similar risks → loss prediction improves
Premium-Loss Balance: total premiums collected = total claims paid
  (actuarial equivalence)
Individual Equity: each insured's premium reflects their risk level

Insurance Contract Characteristics:
Utmost Good Faith: mutual honesty and full disclosure
Bilateral, adhesion, and aleatory contract features

Duty of Disclosure:
Reveal all material facts before policy issuance.
Breach allows rescission and claim denial.
No-causation exception: if the concealed fact did not
  cause the loss, the claim must still be paid.

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Key Comparisons Across Insurance Types

Life Insurance:
Fixed (flat) benefit — indemnity principle does NOT apply
Multiple policies → each pays its full face amount (no contribution)
Whole life (permanent) · Term (limited period) · Annuity (retirement income)

Property & Casualty (P&C) Insurance:
Indemnity principle applies — recovery capped at actual loss
Multiple policies → proportional contribution; total ≤ actual loss
Homeowners · Auto · Marine · Liability

Accident & Health (A&H):
Covers accident (external/sudden/unintended) and sickness
Can blend fixed benefit AND expense reimbursement
Sold by both life/health and P&C insurers

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Social Insurance and Regulation — Summary

4 Core Social Insurance Programs (US):
Medicare, Medicaid, Social Security (OASDI), Workers' Comp
Mandatory participation; income/wage-based funding

Workers' Compensation:
100% employer-funded — employees pay nothing

Unemployment Insurance:
Eligibility: involuntary separation + active job search
Funded by employer payroll taxes (FUTA/SUTA)

Free-Look Period:
Right to cancel after policy delivery — typically 10–30 days

Rebating:
Giving clients a portion of commission as an inducement → illegal
  in most states (anti-rebate statutes)

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Adverse Selection, Moral Hazard, and Reinsurance

Adverse Selection:
Pre-contract; high-risk individuals disproportionately buy coverage
Response: underwriting, risk classification, mandatory participation

Moral Hazard:
Post-contract; insured reduces loss-prevention effort
Response: deductibles, coinsurance, fraud investigation

Reinsurance:
Primary insurer cedes risk to reinsurer
Proportional (quota share): share both premium and loss by ratio
Non-proportional (XL / catastrophe): reinsurer pays only when
  loss exceeds the retention layer

Risk-Based Capital (RBC):
Insurers must maintain capital buffers proportional to their risks.
Regulatory action levels are triggered when the RBC ratio falls.

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Key Concept Cards

3 Foundational Insurance Principles ★★★★★ : Law of Large Numbers · Premium-Loss Balance · Individual Equity. Memory hook: LLN + Balance + Equity

Life = Fixed Benefit · P&C = Indemnity ★★★★★ : The root of every multiple-policy question on the exam. Memory hook: Life = fixed, P&C = actual loss

Workers’ Comp = Employer Pays All · Social Security = Shared 50/50 ★★★★★ : Know the funding split for each program cold. Memory hook: WC = employer only; SS = employer + employee

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Practice Quiz

Q. Name and explain the three principles most frequently tested in insurance exams.

1. Indemnity Principle: the cornerstone of P&C insurance. Recovery is limited to actual financial loss — no unjust enrichment. Defines how over-insurance and coinsurance work.
2. Utmost Good Faith (Uberrimae Fidei): both the insurer and insured must deal with each other with complete transparency. The insured must disclose all material facts; the insurer must clearly explain terms and exclusions. Breach by the insured allows rescission.
3. Law of Large Numbers: actuarial foundation of premium pricing. The larger and more homogeneous the insured pool, the more accurately future losses can be predicted and priced. These three principles often conflict in exam questions — e.g., an insurer denying a claim citing a disclosure breach vs. the no-causation exception.

Q. How should someone prioritize building a comprehensive personal insurance portfolio?

Priority 1: Maximize mandatory social insurance — Workers’ Comp (employer-provided), Social Security contributions, Medicare (automatic at 65). Priority 2: Health insurance — ACA marketplace or employer-sponsored plan; covers the largest financial risk most people face. Priority 3: Life insurance — only if others depend on your income. Term life for income-replacement years; whole life only if estate planning needs justify it. Priority 4: Auto insurance — mandatory liability plus UM/UIM and collision/comprehensive. Priority 5: Supplemental coverage — disability income (most underinsured risk), critical illness, long-term care as needed. Guiding principle: insure the catastrophic risks first (the ones that could destroy your finances), then layer in additional coverage.