Risk Management & Insurance Guide

Understanding Risk

Risk is a concept that denotes a potential negative impact to an asset or some characteristic of value that may arise from some present process or future event. In everyday usage, "risk" is often used synonymously with the probability of a known loss. Paradoxically, a probable loss can be uncertain and relative in an individual event while having a certainty in the aggregate of multiple events.  Means of assessing risk vary widely between professions. Indeed, they may define these professions; for example, a doctor manages medical risk, while a civil engineer manages risk of structural failure.  A professional code of ethics is usually focused on risk assessment and mitigation (by the professional on behalf of client, public, society or life in general).  In the workplace exist incidental and inherent risks. Incidental risks are those which occur naturally in the business, but are not part of the core of the business. Inherent risks have a negative effect on the operating profit of the business.

Risk Management

Risk management integrates recognition of risk, risk assessment, developing strategies to manage it, and mitigation of risk using managerial resources.  The strategies include transferring the risk to another party, avoiding the risk, reducing the negative effect of the risk, and accepting some or all of the consequences of a particular risk.  Some traditional risk managements are focused on risks stemming from physical or legal causes (e.g. natural disasters or fires, accidents, death and lawsuits).

Insurance

Insurance is a form of risk management primarily used to hedge against the risk of a contingent loss. Insurance is defined as the equitable transfer of the risk of a potential loss, from one entity to another, in exchange for a premium. Insurer, in economics, is the company that sells the insurance. Insurance rate is a factor used to determine the amount, called the premium, to be charged for a certain amount of insurance coverage. Risk management, the practice of appraising and controlling risk, has evolved as a discrete field of study and practice.

Underwriting

Underwriting refers to the process that a large financial service provider (bank, insurer, investment house) uses to assess the process of providing access to their product like providing equity capital, insurance or credit to a customer. The name derives from the Lloyd's of London insurance market. Financial bankers, who would accept some of the risk on a given venture (historically a sea voyage with associated risks of shipwreck) in exchange for a premium, would literally write their names under the risk information which was written on a Lloyd's slip created for this purpose.

Insurance underwriters evaluate the risk and exposures of the prospective clients. They decide how much coverage the client should receive, how much they should pay for it, or whether to even accept the risk and insure them. Underwriting involves measuring risk exposure and determining the premium that needs to be charged to insure that risk. The function of the underwriter is to acquire—or to "write"—business that will make the insurance company money, and to protect the company's book of business from risks that they feel will make a loss.  In simple terms, it is the process of issuing insurance policies.

Each insurance company has its own set of underwriting guidelines to help the underwriter determine whether or not the company should accept the risk. The underwriters can either decline the risk, or may decide to provide a quotation in which the premiums have been loaded, or in which various exclusions have been stipulated, which restrict the circumstances under which a claim would be paid. Depending on the type of insurance product (line of business) insurance companies use automated underwriting systems to encode these rules, and reduce the amount of manual work in processing quotations and policy issuance. This is especially the case for certain simpler life or personal lines (auto, homeowners) insurance.

Insurance Broker vs. Agent

An insurance broker sources contracts of insurance with multiple insurance carriers on behalf of their customers. Unlike an insurance agent who represents one insurance carrier, brokers are independent agents who represents the buyer, rather than the insurance company, and tries to find the buyer the best policy by comparison shopping. Insurance brokerage in the United States is a regulated industry, with almost all states individually issuing brokerage licenses. Most states have reciprocity agreements whereby brokers from one state can become easily licensed in another. There are exceptions to this, most notably in the case of Hawaii, where all licensed brokers must live on the island.  Because of industry regulation, smaller brokerage firms can easily compete with larger ones, who are forbidden by law from providing their customers with rebates or other discounts on the policy prices of insurance companies.

Insurance Policy

An insurance policy is a contract that determines the legal framework under which the features of an insurance are enforced. Insurance policies are designed to meet very specific needs and thus have many features not found in many other types of contracts. Many features are similar across a wide variety of different types of insurance policies.

The insurance contract is a contract whereby the insurer will pay the insured (the person whom benefits would be paid to, or on the behalf of), if certain defined events occur. Subject to the "fortuity principle", the event must be uncertain. The uncertainty can be either as to when the event will happen (i.e. in a life insurance policy, the time of the insured's death is uncertain) or as to if it will happen at all (i.e. a fire insurance policy).

General Pricicples

1. Insurance contracts are generally considered contracts of adhesion because the insurer draws up the contract and the insured has little or no ability to make material changes to it. This is interpreted to mean that the insurer bears the burden if there is any ambiguity in any terms of the contract.
2. Insurance contracts are aleatory in that the amounts exchanged by the insured and insurer are unequal and depend upon uncertain future events.
3. Insurance contracts are unilateral, meaning that only the insurer makes legally enforceable promises in the contract. The insured is not required to pay the premiums, but the insurer is required to pay the benefits under the contract if the insured has paid the premiums and met certain other basic provisions.
4. Insurance contracts are governed by the principle of utmost good faith which requires both parties of the insurance contact to deal in good faith and in particular it imparts on the insured a duty to disclose all material facts which relate to the risk to be covered. This contrasts with the legal doctrine that covers most other types of contracts, caveat emptor (let the buyer beware).

Parts of an Insurance Policy

1. Definitions - define important terms used in the policy language.
2. Insuring Agreement - describes the covered perils, or risks assumed, or nature of coverage, or makes some reference to the contractual agreement between insurer and insured. It summarizes the major promises of the insurance company, as well as stating what is covered.
3. Declarations - identifies who is an insured, the insured's address, the insuring company, what risks or property are covered, the policy limits (amount of insurance), any applicable deductibles, the policy period and premium amount.
   Exclusions - take coverage away from the Insuring Agreement by describing property, perils, hazards or losses arising from specific causes which are not covered by the policy.
4. Conditions - provisions, rules of conduct, duties and obligations required for coverage. If policy conditions are not met, the insurer can deny the claim.