Risk Management & Insurance Flashcards

What is the primary purpose of risk management in financial planning?

Answer: To identify, assess, and mitigate potential financial losses

Risk management in financial planning is a systematic process designed to protect an individual's or entity's financial well-being. It involves pinpointing potential threats to financial goals, evaluating their likelihood and impact, and then implementing strategies to reduce or control these risks. The goal is not to eliminate all risks, but to manage them effectively to achieve financial stability.

Which type of risk is typically uninsurable?

Answer: Speculative risk

Speculative risk involves the possibility of either gain or loss, such as investing in the stock market or starting a new business. Unlike pure risks (which only involve the possibility of loss or no loss and are generally insurable), speculative risks are typically uninsurable. Insurance is designed to protect against pure risks, not to guarantee investment returns or cover voluntary ventures for profit.

What is the principle of indemnity in insurance?

Answer: Restoring the insured to their pre-loss financial position

The principle of indemnity states that an insurance policy should restore the insured to the financial condition they were in immediately before the loss occurred, without allowing them to profit from the loss. This principle prevents moral hazard and ensures that insurance serves as a protective mechanism rather than a source of unjust enrichment. It aims for financial neutrality after a covered event.

Which insurance rider would provide coverage for a serious illness?

Answer: Critical illness rider

A critical illness rider is an optional addition to a life insurance policy that provides a lump-sum payment if the insured is diagnosed with a specified serious illness, such as cancer, heart attack, or stroke. This payout can help cover medical expenses, lost income, or other costs associated with the illness. It provides crucial financial relief during a challenging time.

What is the purpose of a deductible in an insurance policy?

Answer: To share risk between insurer and policyholder

A deductible is the amount of money the policyholder must pay out-of-pocket before the insurance company begins to pay for a covered loss. Its purpose is to share a portion of the risk with the insured, which helps reduce the number of small claims, lowers administrative costs for the insurer, and encourages policyholders to be more careful to avoid losses.

Which risk management technique involves accepting potential losses?

Answer: Risk retention

Risk retention is a risk management technique where an individual or organization chooses to accept the financial responsibility for potential losses rather than transferring it (e.g., through insurance) or avoiding it. This strategy is often used for small, predictable risks or when the cost of insuring against a risk outweighs the potential loss. Self-insurance is a common form of risk retention.

What does 'subrogation' mean in insurance terms?

Answer: An insurer's right to recover costs from at-fault parties

Subrogation is a legal right held by most insurance carriers to legally pursue a third party that caused an insurance loss to the insured. When an insurer pays a claim to its policyholder, it steps into the shoes of the insured and can then seek to recover the amount paid from the party responsible for the damage. This prevents the insured from collecting twice for the same loss.

Which factor most affects life insurance premium calculations?

Answer: Policyholder's age

A policyholder's age is the most significant factor affecting life insurance premium calculations because it directly correlates with life expectancy and the probability of death. Younger individuals generally have lower premiums because they represent a lower immediate risk to the insurer, while older individuals face higher premiums due to their increased mortality risk. While health and lifestyle also play a role, age is primary.

What is the key difference between term and whole life insurance?

Answer: Whole life combines death benefit with cash value accumulation

Whole life insurance is a type of permanent life insurance that provides coverage for the insured's entire life. Its key distinguishing feature is that it combines a death benefit with a cash value component that grows over time on a tax-deferred basis. This cash value can be accessed by the policyholder through loans or withdrawals, unlike term insurance which provides coverage for a specific period and typically does not accumulate cash value.