Download VTU (Visvesvaraya Technological University) MBA 4th Semester (Fourth Semester) 16MBAFM402-Risk Management and Insurance RMI Module 4 Important Lecture Notes (MBA Study Material Notes)
to Insurance
MODULE 4
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
Requirements of an insurable risk
? Insurers insure pure risk but not all pure risks are insurable.
Certain requirements must be fulfilled before a pure risk can
be insured. There are 6 requirements of an insurable risk:
? 1. Large number of exposure units:
There must be a large number of roughly similar but not
identical risk exposure units so that the insurer can predict
loss based on the law of large numbers. This helps predict
loss and spread premium across clients
? 2. Accidental and unintentional loss:
? Ideally the loss must be fortuitous and outside the control of
the insured. If the insured causes a deliberate loss he or she
should not be indemnified.
? If intentional losses are paid moral hazards increases
causing an increase in premium resulting in reduction in
clientele. This reduces predictability of losses.
? Secondly, the law of large numbers is based on random
occurrence of events. An intentional loss is not random and
will therefore affect predictability.
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
Requirements of an insurable risk
? Insurers insure pure risk but not all pure risks are insurable.
Certain requirements must be fulfilled before a pure risk can
be insured. There are 6 requirements of an insurable risk:
? 1. Large number of exposure units:
There must be a large number of roughly similar but not
identical risk exposure units so that the insurer can predict
loss based on the law of large numbers. This helps predict
loss and spread premium across clients
? 2. Accidental and unintentional loss:
? Ideally the loss must be fortuitous and outside the control of
the insured. If the insured causes a deliberate loss he or she
should not be indemnified.
? If intentional losses are paid moral hazards increases
causing an increase in premium resulting in reduction in
clientele. This reduces predictability of losses.
? Secondly, the law of large numbers is based on random
occurrence of events. An intentional loss is not random and
will therefore affect predictability.
? 3. Determinable and measurable loss:
? Means of the loss should be definite as to cause, time,
place and amount. Life insurance easily meets these
requirements. But there are cases like disability where it
is difficult to determine where people can fake
disability/injury. Measuring it is also not easy. It also
depends upon the will power of the client to
rehabilitate and get back to work.
? 4. No catastrophic loss:
? Catastrophe goes against the advantages of pooling
and sharing risk. Insurance technique becomes
unviable under catastrophe. Insurers wish to not cover
catastrophe but it is not possible all the time. Floods,
hurricane, tornadoes, earthquake, forest fires, and other
natural disasters happen. There are three ways an
insurer avoids catastrophe losses viz re-insurance,
dispersing coverage area and financial instruments like
catastrophe bonds
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
Requirements of an insurable risk
? Insurers insure pure risk but not all pure risks are insurable.
Certain requirements must be fulfilled before a pure risk can
be insured. There are 6 requirements of an insurable risk:
? 1. Large number of exposure units:
There must be a large number of roughly similar but not
identical risk exposure units so that the insurer can predict
loss based on the law of large numbers. This helps predict
loss and spread premium across clients
? 2. Accidental and unintentional loss:
? Ideally the loss must be fortuitous and outside the control of
the insured. If the insured causes a deliberate loss he or she
should not be indemnified.
? If intentional losses are paid moral hazards increases
causing an increase in premium resulting in reduction in
clientele. This reduces predictability of losses.
? Secondly, the law of large numbers is based on random
occurrence of events. An intentional loss is not random and
will therefore affect predictability.
? 3. Determinable and measurable loss:
? Means of the loss should be definite as to cause, time,
place and amount. Life insurance easily meets these
requirements. But there are cases like disability where it
is difficult to determine where people can fake
disability/injury. Measuring it is also not easy. It also
depends upon the will power of the client to
rehabilitate and get back to work.
? 4. No catastrophic loss:
? Catastrophe goes against the advantages of pooling
and sharing risk. Insurance technique becomes
unviable under catastrophe. Insurers wish to not cover
catastrophe but it is not possible all the time. Floods,
hurricane, tornadoes, earthquake, forest fires, and other
natural disasters happen. There are three ways an
insurer avoids catastrophe losses viz re-insurance,
dispersing coverage area and financial instruments like
catastrophe bonds
? 5. calculable chances of loss:
? An insurer must be able to calculate both the
average frequency and average severity of future
losses with some accuracy. This helps them
calculate a premium that suffices paying for losses
and maintain some profit. Certain losses like
catastrophe losses are difficult to estimate and
private insurers have difficulty in covering them
without govt support.
? 6. economically feasible premium:
? Premium must be affordable by the insured. It must
be substantially lower than the face value of the
policy. To maintain an affordable premium the
chance of occurrence must be very low. If chance
of occurrence >40% then premium >sum assured.
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
Requirements of an insurable risk
? Insurers insure pure risk but not all pure risks are insurable.
Certain requirements must be fulfilled before a pure risk can
be insured. There are 6 requirements of an insurable risk:
? 1. Large number of exposure units:
There must be a large number of roughly similar but not
identical risk exposure units so that the insurer can predict
loss based on the law of large numbers. This helps predict
loss and spread premium across clients
? 2. Accidental and unintentional loss:
? Ideally the loss must be fortuitous and outside the control of
the insured. If the insured causes a deliberate loss he or she
should not be indemnified.
? If intentional losses are paid moral hazards increases
causing an increase in premium resulting in reduction in
clientele. This reduces predictability of losses.
? Secondly, the law of large numbers is based on random
occurrence of events. An intentional loss is not random and
will therefore affect predictability.
? 3. Determinable and measurable loss:
? Means of the loss should be definite as to cause, time,
place and amount. Life insurance easily meets these
requirements. But there are cases like disability where it
is difficult to determine where people can fake
disability/injury. Measuring it is also not easy. It also
depends upon the will power of the client to
rehabilitate and get back to work.
? 4. No catastrophic loss:
? Catastrophe goes against the advantages of pooling
and sharing risk. Insurance technique becomes
unviable under catastrophe. Insurers wish to not cover
catastrophe but it is not possible all the time. Floods,
hurricane, tornadoes, earthquake, forest fires, and other
natural disasters happen. There are three ways an
insurer avoids catastrophe losses viz re-insurance,
dispersing coverage area and financial instruments like
catastrophe bonds
? 5. calculable chances of loss:
? An insurer must be able to calculate both the
average frequency and average severity of future
losses with some accuracy. This helps them
calculate a premium that suffices paying for losses
and maintain some profit. Certain losses like
catastrophe losses are difficult to estimate and
private insurers have difficulty in covering them
without govt support.
? 6. economically feasible premium:
? Premium must be affordable by the insured. It must
be substantially lower than the face value of the
policy. To maintain an affordable premium the
chance of occurrence must be very low. If chance
of occurrence >40% then premium >sum assured.
?Based on these 6 requirements it is easy
to insure most personal risks, property
risks and liability risks as requirements of
insurable risk can be met easily.
However, market risks, financial risks,
production risks, and political risks are
difficult to insure by private insurers.
These are speculative and requirements
of insurable risks are difficult to maintain.
Also, each risk is capable of producing a
catastrophe. Ex political risk turning into
a war.
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
Requirements of an insurable risk
? Insurers insure pure risk but not all pure risks are insurable.
Certain requirements must be fulfilled before a pure risk can
be insured. There are 6 requirements of an insurable risk:
? 1. Large number of exposure units:
There must be a large number of roughly similar but not
identical risk exposure units so that the insurer can predict
loss based on the law of large numbers. This helps predict
loss and spread premium across clients
? 2. Accidental and unintentional loss:
? Ideally the loss must be fortuitous and outside the control of
the insured. If the insured causes a deliberate loss he or she
should not be indemnified.
? If intentional losses are paid moral hazards increases
causing an increase in premium resulting in reduction in
clientele. This reduces predictability of losses.
? Secondly, the law of large numbers is based on random
occurrence of events. An intentional loss is not random and
will therefore affect predictability.
? 3. Determinable and measurable loss:
? Means of the loss should be definite as to cause, time,
place and amount. Life insurance easily meets these
requirements. But there are cases like disability where it
is difficult to determine where people can fake
disability/injury. Measuring it is also not easy. It also
depends upon the will power of the client to
rehabilitate and get back to work.
? 4. No catastrophic loss:
? Catastrophe goes against the advantages of pooling
and sharing risk. Insurance technique becomes
unviable under catastrophe. Insurers wish to not cover
catastrophe but it is not possible all the time. Floods,
hurricane, tornadoes, earthquake, forest fires, and other
natural disasters happen. There are three ways an
insurer avoids catastrophe losses viz re-insurance,
dispersing coverage area and financial instruments like
catastrophe bonds
? 5. calculable chances of loss:
? An insurer must be able to calculate both the
average frequency and average severity of future
losses with some accuracy. This helps them
calculate a premium that suffices paying for losses
and maintain some profit. Certain losses like
catastrophe losses are difficult to estimate and
private insurers have difficulty in covering them
without govt support.
? 6. economically feasible premium:
? Premium must be affordable by the insured. It must
be substantially lower than the face value of the
policy. To maintain an affordable premium the
chance of occurrence must be very low. If chance
of occurrence >40% then premium >sum assured.
?Based on these 6 requirements it is easy
to insure most personal risks, property
risks and liability risks as requirements of
insurable risk can be met easily.
However, market risks, financial risks,
production risks, and political risks are
difficult to insure by private insurers.
These are speculative and requirements
of insurable risks are difficult to maintain.
Also, each risk is capable of producing a
catastrophe. Ex political risk turning into
a war.
Two examples- fire and
unemployment
? Read text by Rejda page nos 23 and 24
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
Requirements of an insurable risk
? Insurers insure pure risk but not all pure risks are insurable.
Certain requirements must be fulfilled before a pure risk can
be insured. There are 6 requirements of an insurable risk:
? 1. Large number of exposure units:
There must be a large number of roughly similar but not
identical risk exposure units so that the insurer can predict
loss based on the law of large numbers. This helps predict
loss and spread premium across clients
? 2. Accidental and unintentional loss:
? Ideally the loss must be fortuitous and outside the control of
the insured. If the insured causes a deliberate loss he or she
should not be indemnified.
? If intentional losses are paid moral hazards increases
causing an increase in premium resulting in reduction in
clientele. This reduces predictability of losses.
? Secondly, the law of large numbers is based on random
occurrence of events. An intentional loss is not random and
will therefore affect predictability.
? 3. Determinable and measurable loss:
? Means of the loss should be definite as to cause, time,
place and amount. Life insurance easily meets these
requirements. But there are cases like disability where it
is difficult to determine where people can fake
disability/injury. Measuring it is also not easy. It also
depends upon the will power of the client to
rehabilitate and get back to work.
? 4. No catastrophic loss:
? Catastrophe goes against the advantages of pooling
and sharing risk. Insurance technique becomes
unviable under catastrophe. Insurers wish to not cover
catastrophe but it is not possible all the time. Floods,
hurricane, tornadoes, earthquake, forest fires, and other
natural disasters happen. There are three ways an
insurer avoids catastrophe losses viz re-insurance,
dispersing coverage area and financial instruments like
catastrophe bonds
? 5. calculable chances of loss:
? An insurer must be able to calculate both the
average frequency and average severity of future
losses with some accuracy. This helps them
calculate a premium that suffices paying for losses
and maintain some profit. Certain losses like
catastrophe losses are difficult to estimate and
private insurers have difficulty in covering them
without govt support.
? 6. economically feasible premium:
? Premium must be affordable by the insured. It must
be substantially lower than the face value of the
policy. To maintain an affordable premium the
chance of occurrence must be very low. If chance
of occurrence >40% then premium >sum assured.
?Based on these 6 requirements it is easy
to insure most personal risks, property
risks and liability risks as requirements of
insurable risk can be met easily.
However, market risks, financial risks,
production risks, and political risks are
difficult to insure by private insurers.
These are speculative and requirements
of insurable risks are difficult to maintain.
Also, each risk is capable of producing a
catastrophe. Ex political risk turning into
a war.
Two examples- fire and
unemployment
? Read text by Rejda page nos 23 and 24
Adverse selection and insurance
? Insurers have to deal with the problem of adverse selection.
Adverse selection is is the tendency of persons with a
higher than average chance of loss seeking insurance at
standard rates which if not controlled by underwriting
results in higher than expected loss levels. In such cases the
insurer is said to be ?adversely selected against? eg: high
risk drivers, low health individuals seeking insurance at
normal rates
? This can be controlled by careful underwriting. Underwriting
refers to the process of selecting and classifying applicants
for insurance. Applicants who meet the standard are
insured at standard rates and others are either denied
insurance or charged higher premiums.
? Policy provisions are also made use of to prevent adverse
selection eg suicide clause in insurance and pre-existing
clause in health insurance.
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
Requirements of an insurable risk
? Insurers insure pure risk but not all pure risks are insurable.
Certain requirements must be fulfilled before a pure risk can
be insured. There are 6 requirements of an insurable risk:
? 1. Large number of exposure units:
There must be a large number of roughly similar but not
identical risk exposure units so that the insurer can predict
loss based on the law of large numbers. This helps predict
loss and spread premium across clients
? 2. Accidental and unintentional loss:
? Ideally the loss must be fortuitous and outside the control of
the insured. If the insured causes a deliberate loss he or she
should not be indemnified.
? If intentional losses are paid moral hazards increases
causing an increase in premium resulting in reduction in
clientele. This reduces predictability of losses.
? Secondly, the law of large numbers is based on random
occurrence of events. An intentional loss is not random and
will therefore affect predictability.
? 3. Determinable and measurable loss:
? Means of the loss should be definite as to cause, time,
place and amount. Life insurance easily meets these
requirements. But there are cases like disability where it
is difficult to determine where people can fake
disability/injury. Measuring it is also not easy. It also
depends upon the will power of the client to
rehabilitate and get back to work.
? 4. No catastrophic loss:
? Catastrophe goes against the advantages of pooling
and sharing risk. Insurance technique becomes
unviable under catastrophe. Insurers wish to not cover
catastrophe but it is not possible all the time. Floods,
hurricane, tornadoes, earthquake, forest fires, and other
natural disasters happen. There are three ways an
insurer avoids catastrophe losses viz re-insurance,
dispersing coverage area and financial instruments like
catastrophe bonds
? 5. calculable chances of loss:
? An insurer must be able to calculate both the
average frequency and average severity of future
losses with some accuracy. This helps them
calculate a premium that suffices paying for losses
and maintain some profit. Certain losses like
catastrophe losses are difficult to estimate and
private insurers have difficulty in covering them
without govt support.
? 6. economically feasible premium:
? Premium must be affordable by the insured. It must
be substantially lower than the face value of the
policy. To maintain an affordable premium the
chance of occurrence must be very low. If chance
of occurrence >40% then premium >sum assured.
?Based on these 6 requirements it is easy
to insure most personal risks, property
risks and liability risks as requirements of
insurable risk can be met easily.
However, market risks, financial risks,
production risks, and political risks are
difficult to insure by private insurers.
These are speculative and requirements
of insurable risks are difficult to maintain.
Also, each risk is capable of producing a
catastrophe. Ex political risk turning into
a war.
Two examples- fire and
unemployment
? Read text by Rejda page nos 23 and 24
Adverse selection and insurance
? Insurers have to deal with the problem of adverse selection.
Adverse selection is is the tendency of persons with a
higher than average chance of loss seeking insurance at
standard rates which if not controlled by underwriting
results in higher than expected loss levels. In such cases the
insurer is said to be ?adversely selected against? eg: high
risk drivers, low health individuals seeking insurance at
normal rates
? This can be controlled by careful underwriting. Underwriting
refers to the process of selecting and classifying applicants
for insurance. Applicants who meet the standard are
insured at standard rates and others are either denied
insurance or charged higher premiums.
? Policy provisions are also made use of to prevent adverse
selection eg suicide clause in insurance and pre-existing
clause in health insurance.
Insurance v/s gambling
? Insurance is often confused with gambling but
there are 2 important differences between the
two
? 1. gambling creates a new speculative risk
while insurance is a technique for handling an
already existing pure risk. Betting 500 on a horse
creates new risk while buying a fire insurance
for 500 takes care of fire risk
? 2. gambling is socially unproductive as winner?s
gain comes at the expense of losers. Insurance
is socially productive as both the insurer and
the insured stand to gain
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
Requirements of an insurable risk
? Insurers insure pure risk but not all pure risks are insurable.
Certain requirements must be fulfilled before a pure risk can
be insured. There are 6 requirements of an insurable risk:
? 1. Large number of exposure units:
There must be a large number of roughly similar but not
identical risk exposure units so that the insurer can predict
loss based on the law of large numbers. This helps predict
loss and spread premium across clients
? 2. Accidental and unintentional loss:
? Ideally the loss must be fortuitous and outside the control of
the insured. If the insured causes a deliberate loss he or she
should not be indemnified.
? If intentional losses are paid moral hazards increases
causing an increase in premium resulting in reduction in
clientele. This reduces predictability of losses.
? Secondly, the law of large numbers is based on random
occurrence of events. An intentional loss is not random and
will therefore affect predictability.
? 3. Determinable and measurable loss:
? Means of the loss should be definite as to cause, time,
place and amount. Life insurance easily meets these
requirements. But there are cases like disability where it
is difficult to determine where people can fake
disability/injury. Measuring it is also not easy. It also
depends upon the will power of the client to
rehabilitate and get back to work.
? 4. No catastrophic loss:
? Catastrophe goes against the advantages of pooling
and sharing risk. Insurance technique becomes
unviable under catastrophe. Insurers wish to not cover
catastrophe but it is not possible all the time. Floods,
hurricane, tornadoes, earthquake, forest fires, and other
natural disasters happen. There are three ways an
insurer avoids catastrophe losses viz re-insurance,
dispersing coverage area and financial instruments like
catastrophe bonds
? 5. calculable chances of loss:
? An insurer must be able to calculate both the
average frequency and average severity of future
losses with some accuracy. This helps them
calculate a premium that suffices paying for losses
and maintain some profit. Certain losses like
catastrophe losses are difficult to estimate and
private insurers have difficulty in covering them
without govt support.
? 6. economically feasible premium:
? Premium must be affordable by the insured. It must
be substantially lower than the face value of the
policy. To maintain an affordable premium the
chance of occurrence must be very low. If chance
of occurrence >40% then premium >sum assured.
?Based on these 6 requirements it is easy
to insure most personal risks, property
risks and liability risks as requirements of
insurable risk can be met easily.
However, market risks, financial risks,
production risks, and political risks are
difficult to insure by private insurers.
These are speculative and requirements
of insurable risks are difficult to maintain.
Also, each risk is capable of producing a
catastrophe. Ex political risk turning into
a war.
Two examples- fire and
unemployment
? Read text by Rejda page nos 23 and 24
Adverse selection and insurance
? Insurers have to deal with the problem of adverse selection.
Adverse selection is is the tendency of persons with a
higher than average chance of loss seeking insurance at
standard rates which if not controlled by underwriting
results in higher than expected loss levels. In such cases the
insurer is said to be ?adversely selected against? eg: high
risk drivers, low health individuals seeking insurance at
normal rates
? This can be controlled by careful underwriting. Underwriting
refers to the process of selecting and classifying applicants
for insurance. Applicants who meet the standard are
insured at standard rates and others are either denied
insurance or charged higher premiums.
? Policy provisions are also made use of to prevent adverse
selection eg suicide clause in insurance and pre-existing
clause in health insurance.
Insurance v/s gambling
? Insurance is often confused with gambling but
there are 2 important differences between the
two
? 1. gambling creates a new speculative risk
while insurance is a technique for handling an
already existing pure risk. Betting 500 on a horse
creates new risk while buying a fire insurance
for 500 takes care of fire risk
? 2. gambling is socially unproductive as winner?s
gain comes at the expense of losers. Insurance
is socially productive as both the insurer and
the insured stand to gain
Insurance v/s hedging
? Hedging transfers risk by purchase of futures
contract. Insurance although transfers risk, is
not the same as hedging
? 1. insurance contract transfers an insurable
risk while hedging transfers an uninsurable risk
such as price risk.
? 2. insurance can reduce the objective risk of
an insurer by law of large numbers while
hedging does only risk transfer to someone
who thinks he can handle it and not risk
reduction by law of large numbers
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
Requirements of an insurable risk
? Insurers insure pure risk but not all pure risks are insurable.
Certain requirements must be fulfilled before a pure risk can
be insured. There are 6 requirements of an insurable risk:
? 1. Large number of exposure units:
There must be a large number of roughly similar but not
identical risk exposure units so that the insurer can predict
loss based on the law of large numbers. This helps predict
loss and spread premium across clients
? 2. Accidental and unintentional loss:
? Ideally the loss must be fortuitous and outside the control of
the insured. If the insured causes a deliberate loss he or she
should not be indemnified.
? If intentional losses are paid moral hazards increases
causing an increase in premium resulting in reduction in
clientele. This reduces predictability of losses.
? Secondly, the law of large numbers is based on random
occurrence of events. An intentional loss is not random and
will therefore affect predictability.
? 3. Determinable and measurable loss:
? Means of the loss should be definite as to cause, time,
place and amount. Life insurance easily meets these
requirements. But there are cases like disability where it
is difficult to determine where people can fake
disability/injury. Measuring it is also not easy. It also
depends upon the will power of the client to
rehabilitate and get back to work.
? 4. No catastrophic loss:
? Catastrophe goes against the advantages of pooling
and sharing risk. Insurance technique becomes
unviable under catastrophe. Insurers wish to not cover
catastrophe but it is not possible all the time. Floods,
hurricane, tornadoes, earthquake, forest fires, and other
natural disasters happen. There are three ways an
insurer avoids catastrophe losses viz re-insurance,
dispersing coverage area and financial instruments like
catastrophe bonds
? 5. calculable chances of loss:
? An insurer must be able to calculate both the
average frequency and average severity of future
losses with some accuracy. This helps them
calculate a premium that suffices paying for losses
and maintain some profit. Certain losses like
catastrophe losses are difficult to estimate and
private insurers have difficulty in covering them
without govt support.
? 6. economically feasible premium:
? Premium must be affordable by the insured. It must
be substantially lower than the face value of the
policy. To maintain an affordable premium the
chance of occurrence must be very low. If chance
of occurrence >40% then premium >sum assured.
?Based on these 6 requirements it is easy
to insure most personal risks, property
risks and liability risks as requirements of
insurable risk can be met easily.
However, market risks, financial risks,
production risks, and political risks are
difficult to insure by private insurers.
These are speculative and requirements
of insurable risks are difficult to maintain.
Also, each risk is capable of producing a
catastrophe. Ex political risk turning into
a war.
Two examples- fire and
unemployment
? Read text by Rejda page nos 23 and 24
Adverse selection and insurance
? Insurers have to deal with the problem of adverse selection.
Adverse selection is is the tendency of persons with a
higher than average chance of loss seeking insurance at
standard rates which if not controlled by underwriting
results in higher than expected loss levels. In such cases the
insurer is said to be ?adversely selected against? eg: high
risk drivers, low health individuals seeking insurance at
normal rates
? This can be controlled by careful underwriting. Underwriting
refers to the process of selecting and classifying applicants
for insurance. Applicants who meet the standard are
insured at standard rates and others are either denied
insurance or charged higher premiums.
? Policy provisions are also made use of to prevent adverse
selection eg suicide clause in insurance and pre-existing
clause in health insurance.
Insurance v/s gambling
? Insurance is often confused with gambling but
there are 2 important differences between the
two
? 1. gambling creates a new speculative risk
while insurance is a technique for handling an
already existing pure risk. Betting 500 on a horse
creates new risk while buying a fire insurance
for 500 takes care of fire risk
? 2. gambling is socially unproductive as winner?s
gain comes at the expense of losers. Insurance
is socially productive as both the insurer and
the insured stand to gain
Insurance v/s hedging
? Hedging transfers risk by purchase of futures
contract. Insurance although transfers risk, is
not the same as hedging
? 1. insurance contract transfers an insurable
risk while hedging transfers an uninsurable risk
such as price risk.
? 2. insurance can reduce the objective risk of
an insurer by law of large numbers while
hedging does only risk transfer to someone
who thinks he can handle it and not risk
reduction by law of large numbers
Types of insurance
Life insurance:
Without profit (term insurance) With profit
(Endowment, money back), market linked
Non-life insurance
- General insurance- Health, marine, fire,
personal accident, vehicle insurance,
- Miscellaneous insurance- fidelity guarantee,
crop insurance, burglary, flood, cattle, cash in
transit insurance
(assignment: refer and prepare a 10 marks note
on types of insurance. It is a MLQ)
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
Requirements of an insurable risk
? Insurers insure pure risk but not all pure risks are insurable.
Certain requirements must be fulfilled before a pure risk can
be insured. There are 6 requirements of an insurable risk:
? 1. Large number of exposure units:
There must be a large number of roughly similar but not
identical risk exposure units so that the insurer can predict
loss based on the law of large numbers. This helps predict
loss and spread premium across clients
? 2. Accidental and unintentional loss:
? Ideally the loss must be fortuitous and outside the control of
the insured. If the insured causes a deliberate loss he or she
should not be indemnified.
? If intentional losses are paid moral hazards increases
causing an increase in premium resulting in reduction in
clientele. This reduces predictability of losses.
? Secondly, the law of large numbers is based on random
occurrence of events. An intentional loss is not random and
will therefore affect predictability.
? 3. Determinable and measurable loss:
? Means of the loss should be definite as to cause, time,
place and amount. Life insurance easily meets these
requirements. But there are cases like disability where it
is difficult to determine where people can fake
disability/injury. Measuring it is also not easy. It also
depends upon the will power of the client to
rehabilitate and get back to work.
? 4. No catastrophic loss:
? Catastrophe goes against the advantages of pooling
and sharing risk. Insurance technique becomes
unviable under catastrophe. Insurers wish to not cover
catastrophe but it is not possible all the time. Floods,
hurricane, tornadoes, earthquake, forest fires, and other
natural disasters happen. There are three ways an
insurer avoids catastrophe losses viz re-insurance,
dispersing coverage area and financial instruments like
catastrophe bonds
? 5. calculable chances of loss:
? An insurer must be able to calculate both the
average frequency and average severity of future
losses with some accuracy. This helps them
calculate a premium that suffices paying for losses
and maintain some profit. Certain losses like
catastrophe losses are difficult to estimate and
private insurers have difficulty in covering them
without govt support.
? 6. economically feasible premium:
? Premium must be affordable by the insured. It must
be substantially lower than the face value of the
policy. To maintain an affordable premium the
chance of occurrence must be very low. If chance
of occurrence >40% then premium >sum assured.
?Based on these 6 requirements it is easy
to insure most personal risks, property
risks and liability risks as requirements of
insurable risk can be met easily.
However, market risks, financial risks,
production risks, and political risks are
difficult to insure by private insurers.
These are speculative and requirements
of insurable risks are difficult to maintain.
Also, each risk is capable of producing a
catastrophe. Ex political risk turning into
a war.
Two examples- fire and
unemployment
? Read text by Rejda page nos 23 and 24
Adverse selection and insurance
? Insurers have to deal with the problem of adverse selection.
Adverse selection is is the tendency of persons with a
higher than average chance of loss seeking insurance at
standard rates which if not controlled by underwriting
results in higher than expected loss levels. In such cases the
insurer is said to be ?adversely selected against? eg: high
risk drivers, low health individuals seeking insurance at
normal rates
? This can be controlled by careful underwriting. Underwriting
refers to the process of selecting and classifying applicants
for insurance. Applicants who meet the standard are
insured at standard rates and others are either denied
insurance or charged higher premiums.
? Policy provisions are also made use of to prevent adverse
selection eg suicide clause in insurance and pre-existing
clause in health insurance.
Insurance v/s gambling
? Insurance is often confused with gambling but
there are 2 important differences between the
two
? 1. gambling creates a new speculative risk
while insurance is a technique for handling an
already existing pure risk. Betting 500 on a horse
creates new risk while buying a fire insurance
for 500 takes care of fire risk
? 2. gambling is socially unproductive as winner?s
gain comes at the expense of losers. Insurance
is socially productive as both the insurer and
the insured stand to gain
Insurance v/s hedging
? Hedging transfers risk by purchase of futures
contract. Insurance although transfers risk, is
not the same as hedging
? 1. insurance contract transfers an insurable
risk while hedging transfers an uninsurable risk
such as price risk.
? 2. insurance can reduce the objective risk of
an insurer by law of large numbers while
hedging does only risk transfer to someone
who thinks he can handle it and not risk
reduction by law of large numbers
Types of insurance
Life insurance:
Without profit (term insurance) With profit
(Endowment, money back), market linked
Non-life insurance
- General insurance- Health, marine, fire,
personal accident, vehicle insurance,
- Miscellaneous insurance- fidelity guarantee,
crop insurance, burglary, flood, cattle, cash in
transit insurance
(assignment: refer and prepare a 10 marks note
on types of insurance. It is a MLQ)
Essentials/principles of insurance contract
? 1. Nature of contract: offer and acceptance of valid
contract, free consent, competent person- proposer,
major with sound mind, premium is the consideration,
effective policy date, Conditional receipt
? 2. Utmost good faith: uberrimae fidei, is the basis of an
insurance contract. Both parties must disclose all
material facts related to the contract. Ex: age, income,
education, health, imflammable material, fire
detection, type and condition of car
? 3. Insurable interest: reason to insure without it the
contract is void and unenforceable. fundamental
principal. Must be pecuniary interest.
? 4. Indemnity: ?make good the loss? all insurance except,
life, PA and health are indemnity contracts. Means that
full amount of loss will be paid example, marine and fire
insurance.
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
Requirements of an insurable risk
? Insurers insure pure risk but not all pure risks are insurable.
Certain requirements must be fulfilled before a pure risk can
be insured. There are 6 requirements of an insurable risk:
? 1. Large number of exposure units:
There must be a large number of roughly similar but not
identical risk exposure units so that the insurer can predict
loss based on the law of large numbers. This helps predict
loss and spread premium across clients
? 2. Accidental and unintentional loss:
? Ideally the loss must be fortuitous and outside the control of
the insured. If the insured causes a deliberate loss he or she
should not be indemnified.
? If intentional losses are paid moral hazards increases
causing an increase in premium resulting in reduction in
clientele. This reduces predictability of losses.
? Secondly, the law of large numbers is based on random
occurrence of events. An intentional loss is not random and
will therefore affect predictability.
? 3. Determinable and measurable loss:
? Means of the loss should be definite as to cause, time,
place and amount. Life insurance easily meets these
requirements. But there are cases like disability where it
is difficult to determine where people can fake
disability/injury. Measuring it is also not easy. It also
depends upon the will power of the client to
rehabilitate and get back to work.
? 4. No catastrophic loss:
? Catastrophe goes against the advantages of pooling
and sharing risk. Insurance technique becomes
unviable under catastrophe. Insurers wish to not cover
catastrophe but it is not possible all the time. Floods,
hurricane, tornadoes, earthquake, forest fires, and other
natural disasters happen. There are three ways an
insurer avoids catastrophe losses viz re-insurance,
dispersing coverage area and financial instruments like
catastrophe bonds
? 5. calculable chances of loss:
? An insurer must be able to calculate both the
average frequency and average severity of future
losses with some accuracy. This helps them
calculate a premium that suffices paying for losses
and maintain some profit. Certain losses like
catastrophe losses are difficult to estimate and
private insurers have difficulty in covering them
without govt support.
? 6. economically feasible premium:
? Premium must be affordable by the insured. It must
be substantially lower than the face value of the
policy. To maintain an affordable premium the
chance of occurrence must be very low. If chance
of occurrence >40% then premium >sum assured.
?Based on these 6 requirements it is easy
to insure most personal risks, property
risks and liability risks as requirements of
insurable risk can be met easily.
However, market risks, financial risks,
production risks, and political risks are
difficult to insure by private insurers.
These are speculative and requirements
of insurable risks are difficult to maintain.
Also, each risk is capable of producing a
catastrophe. Ex political risk turning into
a war.
Two examples- fire and
unemployment
? Read text by Rejda page nos 23 and 24
Adverse selection and insurance
? Insurers have to deal with the problem of adverse selection.
Adverse selection is is the tendency of persons with a
higher than average chance of loss seeking insurance at
standard rates which if not controlled by underwriting
results in higher than expected loss levels. In such cases the
insurer is said to be ?adversely selected against? eg: high
risk drivers, low health individuals seeking insurance at
normal rates
? This can be controlled by careful underwriting. Underwriting
refers to the process of selecting and classifying applicants
for insurance. Applicants who meet the standard are
insured at standard rates and others are either denied
insurance or charged higher premiums.
? Policy provisions are also made use of to prevent adverse
selection eg suicide clause in insurance and pre-existing
clause in health insurance.
Insurance v/s gambling
? Insurance is often confused with gambling but
there are 2 important differences between the
two
? 1. gambling creates a new speculative risk
while insurance is a technique for handling an
already existing pure risk. Betting 500 on a horse
creates new risk while buying a fire insurance
for 500 takes care of fire risk
? 2. gambling is socially unproductive as winner?s
gain comes at the expense of losers. Insurance
is socially productive as both the insurer and
the insured stand to gain
Insurance v/s hedging
? Hedging transfers risk by purchase of futures
contract. Insurance although transfers risk, is
not the same as hedging
? 1. insurance contract transfers an insurable
risk while hedging transfers an uninsurable risk
such as price risk.
? 2. insurance can reduce the objective risk of
an insurer by law of large numbers while
hedging does only risk transfer to someone
who thinks he can handle it and not risk
reduction by law of large numbers
Types of insurance
Life insurance:
Without profit (term insurance) With profit
(Endowment, money back), market linked
Non-life insurance
- General insurance- Health, marine, fire,
personal accident, vehicle insurance,
- Miscellaneous insurance- fidelity guarantee,
crop insurance, burglary, flood, cattle, cash in
transit insurance
(assignment: refer and prepare a 10 marks note
on types of insurance. It is a MLQ)
Essentials/principles of insurance contract
? 1. Nature of contract: offer and acceptance of valid
contract, free consent, competent person- proposer,
major with sound mind, premium is the consideration,
effective policy date, Conditional receipt
? 2. Utmost good faith: uberrimae fidei, is the basis of an
insurance contract. Both parties must disclose all
material facts related to the contract. Ex: age, income,
education, health, imflammable material, fire
detection, type and condition of car
? 3. Insurable interest: reason to insure without it the
contract is void and unenforceable. fundamental
principal. Must be pecuniary interest.
? 4. Indemnity: ?make good the loss? all insurance except,
life, PA and health are indemnity contracts. Means that
full amount of loss will be paid example, marine and fire
insurance.
? Causa proxima: the nearest peril is deemed
to be the cause of the loss. It is not necessary
to go into the cause of the cause. If the
closest peril is the one insured against the
insured must be compensated.
? Rat made hole in sugar bags and water
came in. sugar was insured against water.
Loss was paid
? Oranges were insured against collision.
Collission happned but oranges spoiled
because of delay and mishandling. Loss was
not paid
? Contribution: in case of more than one
insurance the insurers are to share the loss in
proportion to the amount assured by each
one of tem. A[[lies to indemnity contracts like
fire and marine insurance.
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
Requirements of an insurable risk
? Insurers insure pure risk but not all pure risks are insurable.
Certain requirements must be fulfilled before a pure risk can
be insured. There are 6 requirements of an insurable risk:
? 1. Large number of exposure units:
There must be a large number of roughly similar but not
identical risk exposure units so that the insurer can predict
loss based on the law of large numbers. This helps predict
loss and spread premium across clients
? 2. Accidental and unintentional loss:
? Ideally the loss must be fortuitous and outside the control of
the insured. If the insured causes a deliberate loss he or she
should not be indemnified.
? If intentional losses are paid moral hazards increases
causing an increase in premium resulting in reduction in
clientele. This reduces predictability of losses.
? Secondly, the law of large numbers is based on random
occurrence of events. An intentional loss is not random and
will therefore affect predictability.
? 3. Determinable and measurable loss:
? Means of the loss should be definite as to cause, time,
place and amount. Life insurance easily meets these
requirements. But there are cases like disability where it
is difficult to determine where people can fake
disability/injury. Measuring it is also not easy. It also
depends upon the will power of the client to
rehabilitate and get back to work.
? 4. No catastrophic loss:
? Catastrophe goes against the advantages of pooling
and sharing risk. Insurance technique becomes
unviable under catastrophe. Insurers wish to not cover
catastrophe but it is not possible all the time. Floods,
hurricane, tornadoes, earthquake, forest fires, and other
natural disasters happen. There are three ways an
insurer avoids catastrophe losses viz re-insurance,
dispersing coverage area and financial instruments like
catastrophe bonds
? 5. calculable chances of loss:
? An insurer must be able to calculate both the
average frequency and average severity of future
losses with some accuracy. This helps them
calculate a premium that suffices paying for losses
and maintain some profit. Certain losses like
catastrophe losses are difficult to estimate and
private insurers have difficulty in covering them
without govt support.
? 6. economically feasible premium:
? Premium must be affordable by the insured. It must
be substantially lower than the face value of the
policy. To maintain an affordable premium the
chance of occurrence must be very low. If chance
of occurrence >40% then premium >sum assured.
?Based on these 6 requirements it is easy
to insure most personal risks, property
risks and liability risks as requirements of
insurable risk can be met easily.
However, market risks, financial risks,
production risks, and political risks are
difficult to insure by private insurers.
These are speculative and requirements
of insurable risks are difficult to maintain.
Also, each risk is capable of producing a
catastrophe. Ex political risk turning into
a war.
Two examples- fire and
unemployment
? Read text by Rejda page nos 23 and 24
Adverse selection and insurance
? Insurers have to deal with the problem of adverse selection.
Adverse selection is is the tendency of persons with a
higher than average chance of loss seeking insurance at
standard rates which if not controlled by underwriting
results in higher than expected loss levels. In such cases the
insurer is said to be ?adversely selected against? eg: high
risk drivers, low health individuals seeking insurance at
normal rates
? This can be controlled by careful underwriting. Underwriting
refers to the process of selecting and classifying applicants
for insurance. Applicants who meet the standard are
insured at standard rates and others are either denied
insurance or charged higher premiums.
? Policy provisions are also made use of to prevent adverse
selection eg suicide clause in insurance and pre-existing
clause in health insurance.
Insurance v/s gambling
? Insurance is often confused with gambling but
there are 2 important differences between the
two
? 1. gambling creates a new speculative risk
while insurance is a technique for handling an
already existing pure risk. Betting 500 on a horse
creates new risk while buying a fire insurance
for 500 takes care of fire risk
? 2. gambling is socially unproductive as winner?s
gain comes at the expense of losers. Insurance
is socially productive as both the insurer and
the insured stand to gain
Insurance v/s hedging
? Hedging transfers risk by purchase of futures
contract. Insurance although transfers risk, is
not the same as hedging
? 1. insurance contract transfers an insurable
risk while hedging transfers an uninsurable risk
such as price risk.
? 2. insurance can reduce the objective risk of
an insurer by law of large numbers while
hedging does only risk transfer to someone
who thinks he can handle it and not risk
reduction by law of large numbers
Types of insurance
Life insurance:
Without profit (term insurance) With profit
(Endowment, money back), market linked
Non-life insurance
- General insurance- Health, marine, fire,
personal accident, vehicle insurance,
- Miscellaneous insurance- fidelity guarantee,
crop insurance, burglary, flood, cattle, cash in
transit insurance
(assignment: refer and prepare a 10 marks note
on types of insurance. It is a MLQ)
Essentials/principles of insurance contract
? 1. Nature of contract: offer and acceptance of valid
contract, free consent, competent person- proposer,
major with sound mind, premium is the consideration,
effective policy date, Conditional receipt
? 2. Utmost good faith: uberrimae fidei, is the basis of an
insurance contract. Both parties must disclose all
material facts related to the contract. Ex: age, income,
education, health, imflammable material, fire
detection, type and condition of car
? 3. Insurable interest: reason to insure without it the
contract is void and unenforceable. fundamental
principal. Must be pecuniary interest.
? 4. Indemnity: ?make good the loss? all insurance except,
life, PA and health are indemnity contracts. Means that
full amount of loss will be paid example, marine and fire
insurance.
? Causa proxima: the nearest peril is deemed
to be the cause of the loss. It is not necessary
to go into the cause of the cause. If the
closest peril is the one insured against the
insured must be compensated.
? Rat made hole in sugar bags and water
came in. sugar was insured against water.
Loss was paid
? Oranges were insured against collision.
Collission happned but oranges spoiled
because of delay and mishandling. Loss was
not paid
? Contribution: in case of more than one
insurance the insurers are to share the loss in
proportion to the amount assured by each
one of tem. A[[lies to indemnity contracts like
fire and marine insurance.
? Risk attached: risk must be attached to the policy for
the premium to run. If there is no risk the policy cannot
run and the premium can be claimed back e: goods
burnt, ship arrived safely.
? Mitigation of loss: in the event of mishap, the insured
must make reasonable efforts to mitigate the loss;
absence of which the insurer may refuse to pay.
? Subrogation: transfer of all the rights and remedies
available on the subject to the insurer after the
indemnity has been effected. It means substitution of
the insurer in place of the insured. If a car is damaged
by a truck the owner gets paid by insurance and the
insurer gets the right to sue the truck owner.
? Term of policy: policy covers a specified number of
years as term of the policy
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
Requirements of an insurable risk
? Insurers insure pure risk but not all pure risks are insurable.
Certain requirements must be fulfilled before a pure risk can
be insured. There are 6 requirements of an insurable risk:
? 1. Large number of exposure units:
There must be a large number of roughly similar but not
identical risk exposure units so that the insurer can predict
loss based on the law of large numbers. This helps predict
loss and spread premium across clients
? 2. Accidental and unintentional loss:
? Ideally the loss must be fortuitous and outside the control of
the insured. If the insured causes a deliberate loss he or she
should not be indemnified.
? If intentional losses are paid moral hazards increases
causing an increase in premium resulting in reduction in
clientele. This reduces predictability of losses.
? Secondly, the law of large numbers is based on random
occurrence of events. An intentional loss is not random and
will therefore affect predictability.
? 3. Determinable and measurable loss:
? Means of the loss should be definite as to cause, time,
place and amount. Life insurance easily meets these
requirements. But there are cases like disability where it
is difficult to determine where people can fake
disability/injury. Measuring it is also not easy. It also
depends upon the will power of the client to
rehabilitate and get back to work.
? 4. No catastrophic loss:
? Catastrophe goes against the advantages of pooling
and sharing risk. Insurance technique becomes
unviable under catastrophe. Insurers wish to not cover
catastrophe but it is not possible all the time. Floods,
hurricane, tornadoes, earthquake, forest fires, and other
natural disasters happen. There are three ways an
insurer avoids catastrophe losses viz re-insurance,
dispersing coverage area and financial instruments like
catastrophe bonds
? 5. calculable chances of loss:
? An insurer must be able to calculate both the
average frequency and average severity of future
losses with some accuracy. This helps them
calculate a premium that suffices paying for losses
and maintain some profit. Certain losses like
catastrophe losses are difficult to estimate and
private insurers have difficulty in covering them
without govt support.
? 6. economically feasible premium:
? Premium must be affordable by the insured. It must
be substantially lower than the face value of the
policy. To maintain an affordable premium the
chance of occurrence must be very low. If chance
of occurrence >40% then premium >sum assured.
?Based on these 6 requirements it is easy
to insure most personal risks, property
risks and liability risks as requirements of
insurable risk can be met easily.
However, market risks, financial risks,
production risks, and political risks are
difficult to insure by private insurers.
These are speculative and requirements
of insurable risks are difficult to maintain.
Also, each risk is capable of producing a
catastrophe. Ex political risk turning into
a war.
Two examples- fire and
unemployment
? Read text by Rejda page nos 23 and 24
Adverse selection and insurance
? Insurers have to deal with the problem of adverse selection.
Adverse selection is is the tendency of persons with a
higher than average chance of loss seeking insurance at
standard rates which if not controlled by underwriting
results in higher than expected loss levels. In such cases the
insurer is said to be ?adversely selected against? eg: high
risk drivers, low health individuals seeking insurance at
normal rates
? This can be controlled by careful underwriting. Underwriting
refers to the process of selecting and classifying applicants
for insurance. Applicants who meet the standard are
insured at standard rates and others are either denied
insurance or charged higher premiums.
? Policy provisions are also made use of to prevent adverse
selection eg suicide clause in insurance and pre-existing
clause in health insurance.
Insurance v/s gambling
? Insurance is often confused with gambling but
there are 2 important differences between the
two
? 1. gambling creates a new speculative risk
while insurance is a technique for handling an
already existing pure risk. Betting 500 on a horse
creates new risk while buying a fire insurance
for 500 takes care of fire risk
? 2. gambling is socially unproductive as winner?s
gain comes at the expense of losers. Insurance
is socially productive as both the insurer and
the insured stand to gain
Insurance v/s hedging
? Hedging transfers risk by purchase of futures
contract. Insurance although transfers risk, is
not the same as hedging
? 1. insurance contract transfers an insurable
risk while hedging transfers an uninsurable risk
such as price risk.
? 2. insurance can reduce the objective risk of
an insurer by law of large numbers while
hedging does only risk transfer to someone
who thinks he can handle it and not risk
reduction by law of large numbers
Types of insurance
Life insurance:
Without profit (term insurance) With profit
(Endowment, money back), market linked
Non-life insurance
- General insurance- Health, marine, fire,
personal accident, vehicle insurance,
- Miscellaneous insurance- fidelity guarantee,
crop insurance, burglary, flood, cattle, cash in
transit insurance
(assignment: refer and prepare a 10 marks note
on types of insurance. It is a MLQ)
Essentials/principles of insurance contract
? 1. Nature of contract: offer and acceptance of valid
contract, free consent, competent person- proposer,
major with sound mind, premium is the consideration,
effective policy date, Conditional receipt
? 2. Utmost good faith: uberrimae fidei, is the basis of an
insurance contract. Both parties must disclose all
material facts related to the contract. Ex: age, income,
education, health, imflammable material, fire
detection, type and condition of car
? 3. Insurable interest: reason to insure without it the
contract is void and unenforceable. fundamental
principal. Must be pecuniary interest.
? 4. Indemnity: ?make good the loss? all insurance except,
life, PA and health are indemnity contracts. Means that
full amount of loss will be paid example, marine and fire
insurance.
? Causa proxima: the nearest peril is deemed
to be the cause of the loss. It is not necessary
to go into the cause of the cause. If the
closest peril is the one insured against the
insured must be compensated.
? Rat made hole in sugar bags and water
came in. sugar was insured against water.
Loss was paid
? Oranges were insured against collision.
Collission happned but oranges spoiled
because of delay and mishandling. Loss was
not paid
? Contribution: in case of more than one
insurance the insurers are to share the loss in
proportion to the amount assured by each
one of tem. A[[lies to indemnity contracts like
fire and marine insurance.
? Risk attached: risk must be attached to the policy for
the premium to run. If there is no risk the policy cannot
run and the premium can be claimed back e: goods
burnt, ship arrived safely.
? Mitigation of loss: in the event of mishap, the insured
must make reasonable efforts to mitigate the loss;
absence of which the insurer may refuse to pay.
? Subrogation: transfer of all the rights and remedies
available on the subject to the insurer after the
indemnity has been effected. It means substitution of
the insurer in place of the insured. If a car is damaged
by a truck the owner gets paid by insurance and the
insurer gets the right to sue the truck owner.
? Term of policy: policy covers a specified number of
years as term of the policy
Elements of insurance contracts
?Application
?Binders
?Policy forms- heading, body,
back, endorsements
READ FUNDAMENTALS OF
INSURANCE CONTRACT BY P K
GUPTA (Assignment)
FirstRanker.com - FirstRanker's Choice
Introduction
to Insurance
MODULE 4
Insurance
?Insurance is the pooling of
fortuitous losses by transfer of
such risks to insurers who agree to
indemnify insureds for such losses,
to provide other pecuniary
benefits on their occurrence, or
to render services connected
with the risk.
Basic characteristics of Insurance
? Pooling of losses
? Payment of fortuitous (happening by chance) losses
? Risk transfer
? Indemnification
1. Pooling of losses:
Pooling or sharing of losses is the heart of insurance.
Pooling is the spreading of losses incurred by a few
over the entire group, so that in the process, average
loss is substituted for actual loss.
Pooling involves grouping of large number of exposure
units to provide a substantially accurate prediction of
losses by the law of large Numbers.
Basic characteristics
? Pooling offers sharing of losses by entire group and
prediction of future losses with greater accuracy by the law
of large numbers
? Assume 1000 farmers in moodabidre taluk and if on an
average 1 house burns every year the loss is 200000. in the
absence of pooling or loss sharing the loss is 200000 but by
loss sharing it comes down to 200000/1000= 200. so pooling
helps in substitution of average loss of 200 for the actual loss
of 200000
? The insurer on the other hand can more accurately predict
the average loss which results in risk reduction based on
large numbers. The law of large numbers states that the
greater the number of exposures the more closely will the
actual results approach the probable result that are
expected from an infinite number of exposures. Ex: tossing a
coin 10 times and a million times
Basic characteristics
? In another example accident chances can be more
accurately predicted during a mela than on a normal
day because of law of large numbers.
? Most insurers do not know the true probability and
severity of losses. They estimate average probability and
average severity of losses based on historical data.
Objective risk varies inversely with square root of number
of cases. Greater the number better is the prediction
and lower is the premium charged to each client.
2. Payment of fortuitous losses:
Fortuitous loss is one that is unforeseen and unexpected
and occurs as a matter of chance. Insurance
companies pay fortuitous losses and not intentional
losses.
Basic characteristics
3. Risk transfer:
A pure risk (pure loss, no gain) is transferred from the
insured to the insurer who is typically in a stronger
financial position to pay the losses than the insured.
Pure risks that are transferred are risk of premature
death, poor health, disability, destruction and theft
of property and personal liability lawsuits.
4. Indemnification:
Indemnification means that the insured is restored to
his or her approximate financial losses prior to the
occurrence of loss. Eg: fire policy, auto liability
policy, disability insurance
Requirements of an insurable risk
? Insurers insure pure risk but not all pure risks are insurable.
Certain requirements must be fulfilled before a pure risk can
be insured. There are 6 requirements of an insurable risk:
? 1. Large number of exposure units:
There must be a large number of roughly similar but not
identical risk exposure units so that the insurer can predict
loss based on the law of large numbers. This helps predict
loss and spread premium across clients
? 2. Accidental and unintentional loss:
? Ideally the loss must be fortuitous and outside the control of
the insured. If the insured causes a deliberate loss he or she
should not be indemnified.
? If intentional losses are paid moral hazards increases
causing an increase in premium resulting in reduction in
clientele. This reduces predictability of losses.
? Secondly, the law of large numbers is based on random
occurrence of events. An intentional loss is not random and
will therefore affect predictability.
? 3. Determinable and measurable loss:
? Means of the loss should be definite as to cause, time,
place and amount. Life insurance easily meets these
requirements. But there are cases like disability where it
is difficult to determine where people can fake
disability/injury. Measuring it is also not easy. It also
depends upon the will power of the client to
rehabilitate and get back to work.
? 4. No catastrophic loss:
? Catastrophe goes against the advantages of pooling
and sharing risk. Insurance technique becomes
unviable under catastrophe. Insurers wish to not cover
catastrophe but it is not possible all the time. Floods,
hurricane, tornadoes, earthquake, forest fires, and other
natural disasters happen. There are three ways an
insurer avoids catastrophe losses viz re-insurance,
dispersing coverage area and financial instruments like
catastrophe bonds
? 5. calculable chances of loss:
? An insurer must be able to calculate both the
average frequency and average severity of future
losses with some accuracy. This helps them
calculate a premium that suffices paying for losses
and maintain some profit. Certain losses like
catastrophe losses are difficult to estimate and
private insurers have difficulty in covering them
without govt support.
? 6. economically feasible premium:
? Premium must be affordable by the insured. It must
be substantially lower than the face value of the
policy. To maintain an affordable premium the
chance of occurrence must be very low. If chance
of occurrence >40% then premium >sum assured.
?Based on these 6 requirements it is easy
to insure most personal risks, property
risks and liability risks as requirements of
insurable risk can be met easily.
However, market risks, financial risks,
production risks, and political risks are
difficult to insure by private insurers.
These are speculative and requirements
of insurable risks are difficult to maintain.
Also, each risk is capable of producing a
catastrophe. Ex political risk turning into
a war.
Two examples- fire and
unemployment
? Read text by Rejda page nos 23 and 24
Adverse selection and insurance
? Insurers have to deal with the problem of adverse selection.
Adverse selection is is the tendency of persons with a
higher than average chance of loss seeking insurance at
standard rates which if not controlled by underwriting
results in higher than expected loss levels. In such cases the
insurer is said to be ?adversely selected against? eg: high
risk drivers, low health individuals seeking insurance at
normal rates
? This can be controlled by careful underwriting. Underwriting
refers to the process of selecting and classifying applicants
for insurance. Applicants who meet the standard are
insured at standard rates and others are either denied
insurance or charged higher premiums.
? Policy provisions are also made use of to prevent adverse
selection eg suicide clause in insurance and pre-existing
clause in health insurance.
Insurance v/s gambling
? Insurance is often confused with gambling but
there are 2 important differences between the
two
? 1. gambling creates a new speculative risk
while insurance is a technique for handling an
already existing pure risk. Betting 500 on a horse
creates new risk while buying a fire insurance
for 500 takes care of fire risk
? 2. gambling is socially unproductive as winner?s
gain comes at the expense of losers. Insurance
is socially productive as both the insurer and
the insured stand to gain
Insurance v/s hedging
? Hedging transfers risk by purchase of futures
contract. Insurance although transfers risk, is
not the same as hedging
? 1. insurance contract transfers an insurable
risk while hedging transfers an uninsurable risk
such as price risk.
? 2. insurance can reduce the objective risk of
an insurer by law of large numbers while
hedging does only risk transfer to someone
who thinks he can handle it and not risk
reduction by law of large numbers
Types of insurance
Life insurance:
Without profit (term insurance) With profit
(Endowment, money back), market linked
Non-life insurance
- General insurance- Health, marine, fire,
personal accident, vehicle insurance,
- Miscellaneous insurance- fidelity guarantee,
crop insurance, burglary, flood, cattle, cash in
transit insurance
(assignment: refer and prepare a 10 marks note
on types of insurance. It is a MLQ)
Essentials/principles of insurance contract
? 1. Nature of contract: offer and acceptance of valid
contract, free consent, competent person- proposer,
major with sound mind, premium is the consideration,
effective policy date, Conditional receipt
? 2. Utmost good faith: uberrimae fidei, is the basis of an
insurance contract. Both parties must disclose all
material facts related to the contract. Ex: age, income,
education, health, imflammable material, fire
detection, type and condition of car
? 3. Insurable interest: reason to insure without it the
contract is void and unenforceable. fundamental
principal. Must be pecuniary interest.
? 4. Indemnity: ?make good the loss? all insurance except,
life, PA and health are indemnity contracts. Means that
full amount of loss will be paid example, marine and fire
insurance.
? Causa proxima: the nearest peril is deemed
to be the cause of the loss. It is not necessary
to go into the cause of the cause. If the
closest peril is the one insured against the
insured must be compensated.
? Rat made hole in sugar bags and water
came in. sugar was insured against water.
Loss was paid
? Oranges were insured against collision.
Collission happned but oranges spoiled
because of delay and mishandling. Loss was
not paid
? Contribution: in case of more than one
insurance the insurers are to share the loss in
proportion to the amount assured by each
one of tem. A[[lies to indemnity contracts like
fire and marine insurance.
? Risk attached: risk must be attached to the policy for
the premium to run. If there is no risk the policy cannot
run and the premium can be claimed back e: goods
burnt, ship arrived safely.
? Mitigation of loss: in the event of mishap, the insured
must make reasonable efforts to mitigate the loss;
absence of which the insurer may refuse to pay.
? Subrogation: transfer of all the rights and remedies
available on the subject to the insurer after the
indemnity has been effected. It means substitution of
the insurer in place of the insured. If a car is damaged
by a truck the owner gets paid by insurance and the
insurer gets the right to sue the truck owner.
? Term of policy: policy covers a specified number of
years as term of the policy
Elements of insurance contracts
?Application
?Binders
?Policy forms- heading, body,
back, endorsements
READ FUNDAMENTALS OF
INSURANCE CONTRACT BY P K
GUPTA (Assignment)
Indian
insurance
industry
FirstRanker.com - FirstRanker's Choice
This post was last modified on 18 February 2020