Which of these statements regarding insurance is false?
1) One way of insurers deal with catastrophic loss is through reinsurance.
2) As the number of insured units increases, the number of losses decreases.
3) Speculative risk cannot be insured.
4) Pure risk can be insured.
The Correct Answer and Explanation is:
The false statement regarding insurance is:
2) As the number of insured units increases, the number of losses decreases.
Explanation:
In insurance, losses are generally random and can occur independently of the number of insured units. Increasing the number of insured units doesn’t inherently reduce the number of losses, but rather spreads the risk across a larger pool. This means that while the total number of losses might remain constant or even increase with more units, the financial burden on any single insurer is lessened as the risk is distributed among more policyholders. Insurance works by pooling the risks of a large number of individuals or entities, but the occurrence of losses itself is not directly influenced by the number of insured units.
Here’s an explanation of the other statements:
- One way insurers deal with catastrophic loss is through reinsurance.
- This statement is true. Reinsurance is a practice where an insurance company transfers a portion of its risk to another insurance company (reinsurer) to limit the potential losses from catastrophic events. By doing so, the original insurer can avoid being overwhelmed by claims from large-scale disasters, such as natural calamities, and remain financially stable.
- Speculative risk cannot be insured.
- This statement is true. Speculative risk involves the possibility of either a gain or a loss (such as in gambling or investing in the stock market). Insurance companies do not cover speculative risks because they involve the potential for profit, which is not the purpose of insurance. Insurance is designed to cover pure risks, which are situations where there is only the possibility of loss or no loss.
- Pure risk can be insured.
- This statement is true. Pure risk refers to risks that involve only the possibility of loss or no change (e.g., damage to property, illness, or death). These types of risks can be insured because the insurer can predict the likelihood of occurrence based on statistical data, allowing them to assess premiums accordingly.