Insurance and Risk Management Fundamentals
Risk and how insurance responds
Start with the definition of risk (uncertainty of outcome) and the categories: pure versus speculative, fundamental versus particular, and static versus dynamic. Insurance addresses pure risk - chance of loss or no loss, never gain. Know the requisites of insurable risk: large number of similar exposure units, accidental and measurable loss, definite in time/place/amount, not catastrophic to the pool, and affordable premium.
Risk management process
Candidates must know the steps: identify exposures, measure/analyze frequency and severity, select techniques (avoidance, retention, transfer, loss control/reduction), implement, and monitor. Understand risk transfer versus risk sharing, and where insurance sits relative to retention and hedging. Grasp hazards (moral, morale, physical) and how they differ from perils (cause of loss).
Pooling, law of large numbers, insurable interest
Explain how pooling spreads risk, why the law of large numbers stabilizes predicted losses, and the roles of adverse selection and moral hazard. Insurable interest, indemnity, subrogation, and utmost good faith are foundational principles.
Traps to watch
Questions blur peril (fire, theft) with hazard (conditions increasing chance/severity). Another classic: treating speculative risk as insurable - it is not. Watch for confusion between avoidance (eliminating exposure) and loss reduction (lessening severity). Also, retention is not always a failure; planned retention is a legitimate strategy.
Rule of thumb
For any exposure, ask: is the loss accidental and measurable, and can the pool absorb it? If yes, insurance fits; if not, retention or avoidance usually applies.
Worked example: A firm installs sprinklers. That is loss reduction (lowers severity), not avoidance, and not transfer - the exposure remains but is mitigated.