Commissioner's Opinion #1

The 2023 Revised Modoc Insurance Code provides a list of definitions. In Chapter 1, Section 1, 1.2.  In 1.2 (9) the Code defines insurance as follows:

“Insurance” means a contract by which one party (the insurer), for a consideration that is usually paid in money either in lump sum or at different times during the continuance of the risk, promises to make a certain payment, usually of money, upon the destruction or injury of “something” in which the other party (the insured) has an interest; any risk transfer contract recognized as insurance within any jurisdiction located within the United States or anywhere in the world or recognized as insurance under the United States Internal Revenue Code, or as otherwise determined by the insurance Authority.”

The definition uses terms like risk, risk transfer, risk distribution and begs the question of what adequate risk exposure is.  This opinion seeks to provide clarification of these terms. Each term finds support in a US Tax Court case. Those cases and memoranda cited below are accessible in the website library.

Insurance Risk: Insurance risk is the possibility (fortuitist) that a particular event for which an insured will be held liable will occur. From the standpoint of the insured there can be no profit from the risk. The only possible outcomes are loss or no loss. It is this risk which must be transferred to the insurer if true insurance is to be involved. [Amerco, Inc.]

Risk Transfer (shifting): Risk transfer means one party shifts his risk of loss (Insurance risk) to another. Risk shifting occurs if a person facing the possibility of an economic loss transfers some or all the financial consequences of the potential loss to the insurer, such that a loss by the insured does not affect the insured because the loss is offset by a premium payment to the insurer. The key is that the premium or consideration transferred by the insured to the insured does not provide enough money to cover the entire loss or substantially all of the loss. Such an arrangement will defeat risk transfer. [Amerco, Inc., Allied Fidelity Corp, IRS 200125009 Release Date: 6/22/2001, Le Griese]

Risk Distribution: Risk Distribution looks at the transaction from the standpoint of the insurer. Risk distribution allows the insurer to reduce the possibility that a single costly claim will exceed the amount insurer has taken in as premiums and set aside for the payment of such a claim. By assuming numerous relatively small, independent risks that occur over time smoothes out losses to match more closely its receipts of premiums. Risk distribution necessarily entails a “pooling” of premiums from individual risk exposures, so that premiums set aside for a potential loss on an individual risk exposure is not in significant part paying for a claim attributable to that individual risk exposure. [Americo, Inc.]

Risk Exposures: The exposure of insurer to statistically independent risks in which a claim occurrence on one unit of risk exposure is distinctly independent from a claim event on any other unit of risk exposure distinguishable by event, time, location, contract, asset base (tangible or intangible) or otherwise. A claim occurrence may or may not affect multiple units of risk exposure simultaneously. [See Avrahami]