CHAPTER II

DEFINING THE INSURABLE EVENT

DEFINING THE INSURABLE EVENT
After studying this chapter you should be able to :
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Describe the characteristics of an ideally insurable loss exposure Discuss the problem catastrophic loss potential creates for property insurers Explain subsidization in insurance and why the government promotes in some instances Define the term adverse selection Identify the main branches of the private insurance market Describe the peril of negligence and understand why it is insurable.

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IDEALLY INSURABLE LOSS EXPOSURES
What kinds of loss exposures are ideal for insurance coverage The criteria are as follows : 1- A large group of similar items exposed to the same peril 2- Accidental losses 3- Definite losses capable of causing economic hardship. 4- Extremely low probability of a catastrophic loss to the insurance pool

A LARGE GROUP OF SIMILAR ITEMS EXPOSED TO THE SAME PERIL
l needs s s st nti l number f indi idual An ins r nc units t btain predicti e accurac , ic is t e statistical benefit f t e law of lar e numbers. To be successful, an insurance s stem must reduce risk by predicting wit in an acceptable range bot t e mean frequency and t e mean severity of losses

(Ex. we can't add brick houses & wooden houses to the same fire insurance pool because it would be unfair for the brick house owners...They would be paying a premium higher than they should)

LOSSES MUST BE ACCIDENTAL AND BEYOND THE INSUREDS' CONTROL
Non accidental or expected reductions of economic value, such as depreciation or wear and tear, are not an insurable event. These are situations in which the insurance premium would have to include the costs of the losses plus the costs of operating the insurance pool. The result would be uneconomical premium, higher than the original expenses.
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A death of a person by suicide is not considered accidental. An insured's bad driving resulting a car-accident is considered accidental.

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CATASTROPHIC LOSSES
Loss exposures with catastrophic potential are not insurable events. Because we define a catastrophic loss exposure as a potential loss that is unpredictable and capable of producing an extraordinarily large amount of damage relative to the assets held in the insurance pool, the definition is open to interpretation.

CATASTROPHIC INSURANCE PROGRAMS
Since Loss exposures with catastrophic potential are not insurable events. People whom are under risk & can¶t get insurance have legislatively mandated insurance pools providing property insurance covering personal and business property in areas where private insurance companies would not voluntarily accept the exposures. Example : Beach plans in Florida, Louisiana, Mississippi, North Carolina, South Carolina & Texas.

WHEN ONLY THE PEOPLE MOST EXPOSED TO A PARTICULAR LOSS WANT COVERA GE, THIS LOSS IS NOT AN INSURABLE EVENT. People whom are exposed to a risk are willing to pay a premium for the insurance company, however people whom are not exposed to that certain risk are not willing to. That¶s why they will drop down of that particular insurance pool & therefore the premium will increase because the numerator (exposed terrain) did not change, while the denominator (number of available insured) did increase. At this point an insurance system will break down completely because instead of transferring the cost from the few who experience it to a large pool of insureds, the pool must attempt to make the transfer among only those likely to experience loss.

GAMBLI G LOSSES ARE EVENTS

OT I SURABLE

Gambling and insurance are opposites. Gambling creates risk (uncertainty) where none previously existed. Insurance reduces risk through pooling and the operation of the law of large numbers. Insurance against gambling losses is not economically possible. If gambling events were insurable, the gambler would be put in the enviable position of being unable to lose: Heads, I win; Tails: I collect my insurance.

The more I bet, the more I stand to gain.

SOME SPECULATIVE RISKS MIGHT BE INSURABLE EVENTS
An example of a speculative risk is investments in common stocks & operating a business for profit. Most losses from such exposures are uninsurable because insurance would put the owner in a position of being indifferent to operating results. ³ If losses on the stock market were reimbursed, why would the investor exercise judgment to select a good portfolio of stocks ? However, a credit insurance arrangement that guaranteed an aircraft manufacturer it would receive an amount in lease payments it had contracted for when it leased airplanes for 15 years to several airline companies throughout the world. ( this is an insurable event)

RISK CLASSIFICATION AND INSURABLE EVENTS

Generally accepted principle of insurance is that each insured, and each class of insured, should bear a mathematically fair share of the insurance pool¶s losses and expenses for an event to be insurable in the private market .Simply put, the mathematically fair price for insurance is found by multiplying the probability of loss for a given class of loss exposure times the dollar value exposed to loss, then adding a fair share of the insurance¶s expenses.

SUBSIDIZATION
In theory, each insured¶s mathematically fair share of losses and expenses is based on the expected probability of loss for the risk class in which the exposure is placed. SUBSIDIZATION occurs if each insured does not pay the mathematically fair price for insurance. If the insured is paying more than the mathematically fair price, the insured provides the subsidy. If the insured is paying less than the mathematically fair price, the insured receives a subsidy.

ADVERSE SELECTION
When one party to a transaction has more relevant information or more control of outcomes than another party to the transaction, the party with superior information or control can take advantage of the situation .Insurance scholars call taking advantage of the possession of asymmetric information ADVERSE SELECTION. Example: A man who knows his health is deteriorating; he would go & get a life insurance. PRINCIPLES OF RISK CLASSIFICATION Insurers use risk classification to minimize subsidization and adverse selection. In general, rate classification factors can be evaluated on the following four points : Separation and class homogeneity  Reliability  Incentive Value  Social Acceptability

SEPARATION AND CLASS HOMOGENEITY
If the insurer has constructed its risk classes carefully, each class will have a significantly different expected loss (separation). Moreover, each member of a given class will have approximately the same chance of lass (class homogeneity). This rule prevents combining males ages 20 and 40 in the same insurance pool and causes a mathematically fair insurance exchange.

RELIABILITY
If insurers decide to use a particular factor for classifying insured's, information about the factor should be easily obtained and not subject to manipulation by the insured. The variables of age and sex would meet this standard, but asking an applicant how many miles are driven each year or whether drugs or alcohol are used would not do as well because insureds can provide false information. When less than ideal criteria are used, insurers often seek independent verification of information provided by applicants.
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INCENTIVE VALUE
If risk classes are crafted in a way designed to promote using society¶s resources carefully, insureds should be rewarded for maintaining clean driving records or for applying successful lossprevention measures .Thus , factors used for risk classification

SOCIAL ACCEPTABILITY
This is the underwriting criterion that is the most difficult to handle .Who is to define social acceptability ? The courts? Congress? Insurance commissioners? You and I? Moreover, this measure has the possibility of being at odds with the preceding risk classification criteria. How are such conflicting outcomes to be resolved? What do we do when the desirability of a mathematically fair insurance exchange conflicts with a socially desired outcome? Among the many controversial questions that continue to receive attention in this area is the issue of genetic testing of insurance applicants .Genetic testing has the potential for certain diseases.

BRANCHES OF INSURANCE

LIABILITY IN SURANCE
Legal liability insurance provides protection against the financial impact of lawsuits .Student studying this material; however, often do not grasp liability losses as easily as property losses .You cannot see the loss a lawsuit represents in the same sense as you can see a burned home or a damaged car . Yet a $100 million loss resulting from a negligent act is a very substantial direct loss of property

LEGAL BACKGROUND
The peril of LEGAL LIABILITY arises out of the general rule of (English common) law that people are responsible for any loss (injury) they cause another to suffer .The law creates three categories for describing situations in which one person injures another : ‡ Breaches of contracts ‡ criminal acts ‡ torts or civil wrongs

NEGLIGENCE
Put simply, negligence involves doing something a reasonable person would not do, or not doing something a reasonable person would do, which results directly in some injury to another person. Violating the reasonable person standard can result in a court imposing legal liability for a person¶s direct acts or omissions of actions.
Vicarious liability Courts can also impose liability for the negligent acts of other parties. VICARIOUS LIABILITY means a person is liable because of another person¶s acts. Likewise, vicarious liability can arise for people or organizations when parties hired as contractors (or subcontractors) injure others. JOINT-AND-SEVERAL LIABILITY The rule of joint-and-several liability means if a party is one among several responsible for loss, even if its contribution was the slightest of all, it is fully responsible for making restitution to the injured party if the other defendants are financially unable to do so.

NEGLIGENCE LAWSUITS
When a case goes to court, often the purpose is to determine the facts. Once a judge or jury determine the facts, the judge applies the appropriate legal remedy. Two different juries may view the same evidence and reach different conclusions about the facts. There are two parties to a negligence lawsuit. The plaintiff is the party claiming injury. The defendant is the party from whom recovery is sought.

ESTABLISHING NEGLIGENCE AND DAMAGES
To establish a case of negligence, the law requires the plaintiff to prove all of the following:
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the defendant had a legal duty to protect the plaintiff the defendant failed to perform that duty the plaintiff suffered an injury as a result of the defendant¶s failure to perform that duty

The doctrine of ATTRACTIVE NUISANCE places a very high standard of care on property owners whose property may prove attractive to children. The property owner has the burden of proving that every reasonable step was taken to protect children from injury. If each of the three elements of a negligent act is established to the satisfaction of the judge and jury, the plaintiff is entitled to a favorable judgment, usually a specific sum of money. A JUDGMENT is the official decision of the court as to the rights of the parties to a suit. In some cases, a court will allow a plaintiff recovery for two different types of damage: compensatory damages for personal injuries and punitive damages.

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Compensatory Damages Courts allow compensatory damages to put the victim in the same financial condition after an injury as he or she was in before the occurrence. Insurance policies may cover the following three categories of loss: bodily injury, personal injury, and property damage. Bodily injuries include medical (or funeral) expenses resulting from a loss. Personal injuries include damages suffered when a person is deprived of his or her rights. Property damage, such as destroying an automobile in an accident or putting a toxic (poisonous) substance on another¶s property, includes destruction and loss of use of tangible personal property.

Punitive Damages They are a means of punishing defendants for outrageously offensive acts. Punitive damages usually imply gross negligence, something for which the insurer may not have contemplated making payment. Also, punishing an insurance company (and thereby its pool of insureds) may not satisfy the court¶s purpose of punishing wrongdoers.

Res Ipsa Loquitur
In some cases, the plaintiff¶s injury is the obvious result of the defendant¶s activity. In such cases, the court may apply the doctrine of res ipsa loquitur, which is a legal doctrine of evidence allowing the jury to infer negligence on the part of the defendant. The translation of this Latin phrase is ³the thing speaks for itself´. It means the plaintiff is relieved of the duty of establishing the three required elements of the defendant¶s negligence, as the court is presuming the defendant was negligent. The doctrine does not mean defendants cannot defend themselves, as would be the case with strict liability. It means the plaintiff is relieved of the initial burden of identifying which negligent act of the defendant caused the injury

The court applies the doctrine of res ipsa loquitor only when the following circumstances exist:
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the plaintiff¶s injury could not happen in the absence of negligence something exclusively in the control of the defendant caused the injury it was impossible for the plaintiff\¶s negligence to cause the injury

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For instance, this doctrine is applied in the following situations, commercial airplane crashes, and sponges left inside surgery patients«

DEFENSES IN A NEGLIGENCE SUIT
A defendant has two main lines of defense against a charge of negligence: contributory negligence and assumption of the risk. The jury also will find in favor of the defendant if the plaintiff fails to prove any of the three elements of a negligence act.
CONTRIBUTORY NEGLIGENCE Assuming the plaintiff establishes the defendant¶s negligence, the defendant may counter with a defense of contributory negligence. If it can be shown the plaintiff¶s own negligence contributed to or led to the injury sustained, the court will not allow recovery of damages from the defendant under the contributory negligence rule. This is not to say the existence of some measure of negligence on the plaintiff¶s part relieves defendants of their duties. It means because both parties are at fault, neither will be allowed recovery from the other.

DEFENSES IN A NEGLIGENCE SUIT
COMPARATIVE NEGLIGENCE The contributory negligence rule is harsh; even slight negligence on a plaintiff¶s part can relieve a grossly negligent defendant of responsibility for an accident. Today, most states apply a modification of the contributory negligence rule called the doctrine of comparative negligence. The comparative negligence doctrine allows plaintiffs some recovery despite contributing to their own injuries. LAST CLEAR CHANCE The doctrine of last clear chance is another modification of the contributory negligence rule. In general, when a plaintiff¶s negligence contributes to the loss, nothing may be collected if the court applies the contributory negligence rule. Assume that, despite the plaintiff¶s negligence, the defendant had a clear chance to avoid the injury.

DEFENSES IN A NEGLIGENCE SUIT
ASSUMPTION OF THE RISK A second line of defense involves that the plaintiff knowingly assumed the risk of injury. If the defendant establishes assumption of the risk, the plaintiff will not be awarded a judgment. For example, if the plaintiff challenged the defendant to a wrestling match, the plaintiff may not collect damages when his arm is broken during the contest.

THE RELATIONSHIP BETWEEN NEGLIGENCE & LEGAL LIABILITY INSURANCE QUESTIONS OF FACT One point is always certain: Until the jury determines the facts, questions based on the circumstances cannot be resolved

LEGAL JUDGMENTS

ETHICS, LIABILITY INSURANCE, AND THE INSURABLE EVENT
The alert reader may question whether or not liability insurances, which relieves insureds from paying for the damage they cause others, violates the ethic of individual responsibility for one¶s own actions. Some say that the answer is that it does to some extent. The primary goal of the tort liability system is not punishment, but victim compensation, in which case liability insurance is an efficient remedy. If, however, liability insurance causes people to behave more recklessly than they would otherwise, society¶s welfare is lowered. Insurance payments generally are not made for intentional injuries inflicted on another person. From this perspective, (unintentional) negligence is the same as an accidental fire. It is well-known that drivers with frequent accidents pay more for their automobile liability insurance than good drivers. This knowledge probably works to restrain some people from risky behavior.

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