Chapter 1 : Basic insurance concepts

summary

Chapter 1 is your foundation chapter. The goal is to understand how insurance works before learning policies, provisions, and products. The central idea is risk: insurance allows financial risk to be transferred from an individual to an insurance company. Study Guide

Focus on being able to recognize these concepts in examples, because exam questions may describe a situation instead of simply asking for a definition. Know the difference between Pure Risk (possibility of loss only) and Speculative Risk (possibility of loss or gain). Understand that the Law of Large Numbers allows insurers to make losses more predictable by using a large number of similar exposure units, while Adverse Selection refers to the tendency of people with greater-than-average exposure to loss to seek insurance. Study Guide

Pay especially close attention to Peril vs. Hazard. A Peril is the cause of a loss, while a Hazard is a condition that increases the likelihood of a loss occurring. Your guide breaks hazards into Physical, Moral, Morale, and Legal, so learn to identify each one from a scenario. Study Guide

Another major concept is Insurable Interest. The policyowner must have the possibility of suffering a loss from the insured's death, and according to your study guide, insurable interest must exist at the time of application. When one person applies for insurance on another person's life, both signatures demonstrate consent. Also know Utmost Good Faith: the parties rely on each other's representations. Study Guide

Finally, memorize S.T.A.R.R., because it gives you the five methods of handling risk: Sharing, Transfer, Avoidance, Reduction, and Retention. Don't memorize only the letters—know what each looks like in a real situation. Buying insurance is Transfer; choosing not to participate in a risky activity is Avoidance; installing an alarm is Reduction; and accepting responsibility for your own losses is Retention. Study Guide

EXAM MINDSET: Don't ask yourself, “Do I remember seeing this word?” Ask yourself, “Can I recognize this concept when the exam gives me a scenario?” Once you can explain Risk, Indemnity, Law of Large Numbers, Adverse Selection, Loss Exposure, Peril, Hazard, Insurable Interest, Utmost Good Faith, and S.T.A.R.R. without looking at your notes, you're ready to attack the Chapter 1 practice questions