Principles of Insurance and Risk Management
What this domain tests
The Principles of Insurance and Risk Management domain asks you to connect risk theory to the products you will sell. Expect questions on the definition of risk, insurable versus non-insurable risk, the risk management process, and the principles that govern every policy: insurable interest, indemnity, utmost good faith, subrogation, contribution and proximate cause.
Core rules
- Insurance handles pure risk (loss or no loss), not speculative risk (gain or loss).
- A risk is commercially insurable when the loss is accidental, definite and measurable, a large number of similar exposures exist, and the loss is not catastrophic to the insurer.
- Risk management steps: identify exposures, measure frequency and severity, select techniques, implement, monitor.
- Techniques: avoidance, loss prevention/reduction, retention, and transfer through insurance.
- Indemnity restores the insured to the pre-loss financial position; life insurance is a valued contract, so indemnity is not applied strictly.
Worked example
A sari-sari store owner in Cebu identifies three exposures: fire (severe, low frequency), theft (moderate), and spoilage of stock (frequent, small). She buys a fire policy with a PHP 50,000 deductible, installs a fire extinguisher, and retains spoilage risk. Reasoning: fire is transferred because severity is high; the deductible keeps a predictable small loss with her; spoilage is retained because premiums would exceed expected losses; prevention reduces both frequency and severity.
Traps that cost marks
- Treating speculative risk, such as buying shares, as insurable.
- Saying insurance removes risk; it transfers financial consequences.
- Confusing moral hazard (dishonest intent) with morale hazard (carelessness).
- Applying subrogation to life insurance; it belongs to indemnity contracts.