Chapter 2:

Defining 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 gov’t 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 – gov’t 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 Classification
Factors

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 Classification
Factors

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

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 Principles of Risk Classification
Factors

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

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 Principles of Risk Classification
Factors

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
• Worker’s 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 insured’s legitimate claim
• Other Damages
• Hedonic damages - loss of life’s 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 person’s 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).

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