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RATHNAVEL SUBRAMANIAM COLLEGE OF ARTS AND SCIENCE

(AUTONOMOUS) SULUR
SCHOOL OF BUSINESS MANAGEMENT
INSURANCE PRINCIPLES AND PRACTICE
UNIT I
Insurance -meaning
Insurance is the equitable transfer of the risk of a loss, from one entity to another in
exchange for payment. It is a form of risk management primarily used to hedge against the risk
of a contingent, uncertain loss. An insurer, or insurance carrier, is a company selling the
insurance; the insured, or policyholder, is the person or entity buying the insurance policy. The
amount of money to be charged for a certain amount of insurance coverage is called the
premium. Risk management, the practice of appraising and controlling risk, has evolved as a
discrete field of study and practice.
The transaction involves the insured assuming a guaranteed and known relatively small loss in
the form of payment to the insurer in exchange for the insurer's promise to compensate
(indemnify) the insured in the case of a financial (personal) loss. The insured receives a contract,
called the insurance policy, which details the conditions and circumstances under which the
insured will be financially compensated.
Insurance- Definition
Insurance is a cooperative form of distributing a certain risk over a group of persons who
are exposed to it. Ghosh and Agarwal
Characteristics of Insurance

It is a contract for compensating losses.

Premium is charged for Insurance Contract.

The payment of Insured as per terms of agreement in the event of loss.

It is a contract of good faith.

It is a contract for mutual benefit.

It is a future contract for compensating losses.


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It is an instrument of distributing the loss of few among many.

The occurrence of the loss must be accidental.

Insurance must be consistent with public policy.

Nature of Insurance

Sharing of Risks

C0-operative Device

Valuation of Risk

Payment made on contingency

Amount of Payment

Large Number of Insured Persons

Insurance is not gambling

Insurance is not charity

Functions Of insurance
Primary Functions:
(i) Insurance provides certainty: insurance Provides certainty of payment at the uncertainty of
loss. The uncertainty of loss can be reduced by better planning and administration. But, the
insurance relieves the person from such difficult task. Moreover, if the subject matters are not
adequate, the self- provision may prove costlier. There are different types of uncertainty in a risk.
The risk will occur or not, when will occur, how much loss will be there. In other words, there
are uncertainty of happening of time and amount of loss. Insurance removes all these uncertainty
and the assured is given certainty of payment of loss. The insurer charges premium for providing
the said certainty.
(ii) Insurance provides protection:
The main function of the insurance is to provide protection against the probable chances of loss.
The time and amount of loss are uncertain and at the happening of risk, the person will suffer
loss in absence of insurance. The insurance guarantees the payment of loss and thus protects the
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assured from sufferings. The insurance cannot cheek the happening of risk but can provide for
losses at the happening of the risk.
(iii) Risk-Sharing: The risk is uncertain, and therefore, the loss arising from the risk is also
uncertain. When risk takes place, the loss is shared by all the persons who are exposed to the
risk. The risk sharing in ancient time was done only at time of damage or death, but today, on the
basis of probability of risk, the share is obtained from each and every insured in the shape of
premium without which protection is not guaranteed by the insurer.
Secondary Functions:
(i) Prevention of loss: The insurance joins hands with those institutions which are engaged in
preventing the losses of the assured and so more saving is possible which will assist in reducing
the premium. Lesser premium invites more business and more business causes lesser share to the
assured. So again premium is reduced to, which will stimulate more business and more
protection to the masses. Therefore, the insurance assist financially to the health organization,
fire brigade, educational institution and other organizations which are engaged in preventing the
losses of the masses from death or damage.
(ii) It provides Capital: The insurance provides capital to the society. The accumulated funds
are invested in productive channel. The dearth of capital of the society is minimized to a greater
extent with the help of investment of insurance. The industry, the business & the individual are
benefited by the investment & loans of the insurers.
(iii) It improves Efficiency: The insurance eliminates worries and miseries of losses at death
and destruction of property. The care-free person can devote his body & soul together for better
achievement. It improves not only his efficiency, but the efficiencies of the masses are also
advanced.
(iv) It helps Economic Progress: The insurance by protecting the society from huge losses of
damage, destruction and death. Provides an initiative to work hard for the betterment of the
masses. The next factor of economic progress, the capital, is also immensely provided by the
masses. The property, the valuable assets, the man the machine & the society cannot lose much at
the disaster.
Principle of insurance
1. Nature of contract:
Nature of contract is a fundamental principle of insurance contract. An insurance contract comes
into existence when one party makes an offer or proposal of a contract and the other party
accepts the proposal.

A contract should be simple to be a valid contract. The person entering into a contract should
enter with his free consent.
2. Principal of utmost good faith:
Under this insurance contract both the parties should have faith over each other. As a client it is
the duty of the insured to disclose all the facts to the insurance company. Any fraud or
misrepresentation of facts can result into cancellation of the contract.
3. Principle of Insurable interest:
Under this principle of insurance, the insured must have interest in the subject matter of the
insurance. Absence of insurance makes the contract null and void. If there is no insurable
interest, an insurance company will not issue a policy.
An insurable interest must exist at the time of the purchase of the insurance. For example, a
creditor has an insurable interest in the life of a debtor, A person is considered to have an
unlimited interest in the life of their spouse etc.
4. Principle of indemnity:
Indemnity means security or compensation against loss or damage. The principle of indemnity is
such principle of insurance stating that an insured may not be compensated by the insurance
company in an amount exceeding the insureds economic loss.
In type of insurance the insured would be compensation with the amount equivalent to the actual
loss and not the amount exceeding the loss.
This is a regulatory principal. This principle is observed more strictly in property insurance than
in life insurance.
The purpose of this principle is to set back the insured to the same financial position that existed
before the loss or damage occurred.
5. Principal of subrogation:
The principle of subrogation enables the insured to claim the amount from the third party
responsible for the loss. It allows the insurer to pursue legal methods to recover the amount of
loss, For example, if you get injured in a road accident, due to reckless driving of a third party,
the insurance company will compensate your loss and will also sue the third party to recover the
money paid as claim.
6. Double insurance:

Double insurance denotes insurance of same subject matter with two different companies or with
the same company under two different policies. Insurance is possible in case of indemnity
contract like fire, marine and property insurance.
Double insurance policy is adopted where the financial position of the insurer is doubtful. The
insured cannot recover more than the actual loss and cannot claim the whole amount from both
the insurers.
7. Principle of proximate cause:
Proximate cause literally means the nearest cause or direct cause. This principle is applicable
when the loss is the result of two or more causes. The proximate cause means; the most dominant
and most effective cause of loss is considered. This principle is applicable when there are series
of causes of damage or loss.

Kinds of insurance
Life insurance (or commonly life assurance, especially in the Commonwealth) is a contract
between an insured (insurance policy holder) and an insurer or assurer, where the insurer
promises to pay a designated beneficiary a sum of money (the "benefits") in exchange for a
premium, upon the death of the insured person. Depending on the contract, other events such as
terminal illnessor critical illness may also trigger payment. The policy holder typically pays a
premium, either regularly or as a lump sum. Other expenses (such as funeral expenses) are also
sometimes included in the benefits.
Life policies are legal contracts and the terms of the contract describe the limitations of the
insured events. Specific exclusions are often written into the contract to limit the liability of the
insurer; common examples are claims relating to suicide, fraud, war, riot, and civil commotion.
Life-based contracts tend to fall into two major categories:

Protection policies designed to provide a benefit in the event of specified event,


typically a lump sum payment. A common form of this design is term insurance.

Investment policies where the main objective is to facilitate the growth of capi

tal by regular or single premiums. Common forms (in the US) are whole life, universal
life, and variable life policies.

General insurance
General insurance or non-life insurance policies, including automobile and homeowners policies,
provide payments depending on the loss from a particular financial event. General insurance is
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typically defined as any insurance that is not determined to be life insurance. It is called property
and casualty insurance in the U.S. and Canada and Non-Life Insurance in Continental Europe.
General insurance seeks to cover protection against different areas of hazards including
property, enterprise, vehicle, money lending and various other forms of professional casualties,
except the casualty of death.
Social insurance is any government-sponsored program with the following four characteristics:
the benefits, eligibility requirements and other aspects of the program are defined by statute;
explicit provision is made to account for the income and expenses (often through a trust fund).
Form of compensation provided and controlled by a government for elderly, disable, or
unemployed people.
Social insurance, Publicinsuranceprogram that provides protection against various economic
risks (e.g., loss of income due to sickness, old age, or unemployment) and in which participation
is compulsory. Social insurance is considered to be a type of social security, and in fact the two
terms are sometimes used interchangeably.

Risk-Meaning
Risk implies future uncertainty about deviation from expected earnings or expected
outcome.Risk as:(Exposure to) the possibility of loss, injury, or other adverse or
unwelcome circumstance; a chance or situation involving such a possibility.
Definition: Risk implies future uncertainty about deviation from expected earnings or
expected outcome. Risk measures the uncertainty that an investor is willing to take to realize a
gain from an investment.
A probability or threat of damage, injury, liability, loss, or any other negative occurrence
that is caused by external or internal vulnerabilities, and that may be avoided through preemptive
action.
Risk is the potential of losing something of value. Values (such as physical health,
social status, emotional well being or financial wealth) can be gained or lost when taking risk
resulting from a given action, activity and/or inaction, foreseen or unforeseen. Risk can also be
defined as the intentional interaction with uncertainty. Any human endeavor carries some risk,
but some are much riskier than others.
Risk Classification

Risks are classified in various ways. One classified is based on the extent of the damage
likely to be caused. Critical or Catastrophic risks are those which may lead to the bankruptcy
of the owner. It would happen if the loss is total, like in a tsunami, wiping out everything. It can
also happen if the deceased person was heavily in debt. Important risks may not spell doom, but
may upset family or business finances badly, requiring a lot of time to cover. The adverse effects
of an economic recession are one such. Less damaging are unimportant risks, like temporary
illness
or
accidents.
Another classification is between financial and Non-financial risks, referred to in an earlier
paragraph.
Insurance
are
concerned
with
only
financial
risks.
A third classification is between Dynamic and Static risks.Dynamic risks are caused by perils
which have national consequence, like inflation, calamities, technology, political upheavals,
etc.Static risks are caused by perils which have no consequence on the national economy, like a
fire or theft or misappropriation. Dynamic risks are less likely to occur than static risks, but are
also less predictable. Static risks are more suited to management through insurance.

Fundamental risks are those that affect large populations while Particular risks affect only
specific persons. A train crash is a fundamental risk while a theft is a particular risk. Insurance
business deals with personal risks, but fundamental risks affect the life insurance companys
experience, as many people will be affected at the same time, when there is an earthquake, flood
or
riot.
Another classification is between Pure risks and Speculative risks. The latter are in the nature
of being or gambling where the risk is, to some extent, under the control of the person concerned,
while a pure risk is not so. It is more in the nature of an Act of God. Insurance deals with only
pure risks and not speculative risks.
Methods of handling risks:
Because risk is the possibility of a loss, people, organizations, and society usually try to avoid
risk, or, if not avoidable, then to manage it somehow. There are 5 major methods of handling
risk:
1. Avoidance
2. Loss control
3. Retention
4. Noninsurance transfers
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5. Insurance.
Avoidance is the elimination of risk. You can avoid the risk of a loss in the stock market by not
buying or shorting stocks; the risk of a venereal disease can be avoided by not having sex, or the
risk of divorce, by not marrying; the risk of having car trouble, by not having a car. Many
manufacturers avoid legal risk by not manufacturing particular products.
Of course, not all risks can be avoided. Notable in this category is the risk of death. But even
where it can be avoided, it is often not desirable. By avoiding risk, you may be avoiding many
pleasures of life, or the potential profits that result from taking risks. Those who minimize risks
by avoiding activities are usually bored with their life and don't make much money. Virtually any
activity involves some risk. Where avoidance is not possible or desirable, loss control is the next
best thing.
Loss control can either be effected through loss prevention, which is reducing the probability of
risk, or loss reduction, which minimizes the loss.
Loss prevention requires identifying the factors that increase the likelihood of a loss, then either
eliminating the factors or minimizing their effect. For instance, speeding and driving drunk
greatly increase auto accidents. Not driving after drinking alcohol is a method of loss prevention
that reduces the probability of an accident. Driving slower is an example of both loss prevention
and loss reduction, since it both reduces the probability of an accident and, if an accident does
occur, it reduces the magnitude of the losses, since accidents at slower speeds generally cause
less damage.
Most businesses actively control losses because it is a cost-effective way to prevent losses from
accidents and damage to property, and generally becomes more effective the longer the business
has been operating, since it can learn from its mistakes.
Risk retention, is handling the unavoidable or unavoided risk internally, either because
insurance cannot be purchased or it is too expensive for the risk, or because it is much more costeffective to handle the risk internally. Usually, retained risks occur with greater frequency, but
have a lower severity. An insurance deductible is a common example of risk retention to save
money, since a deductible is a limited risk that can save money on insurance premiums for larger
risks. Businesses actively retain many risks what is commonly called self-insurance
because of the cost or unavailability of commercial insurance.
Risk can also be managed by noninsurance transfers of risk. The 3 major forms of
noninsurance risk transfer is by contract, hedging, and, for business risks, by incorporating. A
common way to transfer risk by contract is by purchasing the warranty extension that many
retailers sell for the items that they sell. The warranty itself transfers the risk of manufacturing
defects from the buyer to the manufacturer. Transfers of risk through contract is often

accomplished or prevented by a hold-harmless clause, which may limit liability for the party to
which the clause applies.
Insurance is another major method that most people, businesses, and other organizations
can use to transfer pure risks, by paying a premium to an insurance company in exchange for a
payment of a possible large loss. By using the law of large numbers, an insurance company can
estimate fairly reliably the amount of loss for a given number of customers within a specific
time. An insurance company can pay for losses because it pools and invests the premiums of
many subscribers to pay the few who will have significant losses. Not every pure risk is
insurable by private insurance companies. Events which are unpredictable and that could cause
extensive damage, such as earthquakes, are not insured by private insurers, although reinsurers
may cover these types of risks by relying on statistical models to estimate the probabilities of
disaster. Speculative risks risks taken in the hope of making a profit are also not insurable,
since these risks are taken voluntarily, and, hence, are not pure risks.
Risk Management
Risk management is the identification, assessment, and prioritization of risksfollowed by
coordinated and economical application of resources to minimize, monitor, and control the
probability and/or impact of unfortunate events or to maximize the realization of opportunities.

Risks can come from uncertainty in financial markets, threats from project failures (at any phase
in design, development, production, or sustainment life-cycles), legal liabilities, credit risk,
accidents, natural causes and disasters as well as deliberate attack from an adversary, or events of
uncertain or unpredictable root-cause. Several risk management standards have been developed
including the Project Management Institute, the National Institute of Standards and Technology,
actuarial societies, and ISO standards. Methods, definitions and goals vary widely according to
whether the risk management method is in the context of project management, security,
engineering, industrial processes, financial portfolios, actuarial assessments, or public health and
safety.
Risk Management Definition
Risk management is defined as identification, assessment and economic control of those
risks that endanger the assets and earning capacity of a business.
Importance of Risk Management
Risk management is an important part of planning for businesses. The process of risk
management is designed to reduce or eliminate the risk of certain kinds of events happening or
having an impact on the business.

Some risk-taking is inevitable if an organization is to achieve its objectives. Those


organizations that are more risk aware appreciate that actively managing not only potential
problems (threats) but also potential opportunities provides them with a competitive advantage.
Taking and managing risk is the very essence of business survival and growth.
Effective risk management is likely to improve performance against objectives by contributing
to:

Fewer sudden shocks and unwelcome surprises

More efficient use of resources

Reduced waste

Reduced fraud

Better service delivery

Reduction in management time spent fire-fighting

Better management of contingent and maintenance activities

Lower cost of capital

Improved innovation

Increased likelihood of change initiatives being achieved

More focus internally on doing the right things properly

More focus externally to shape effective strategies.

Principles of risk management


The International Organization for Standardization (ISO) identifies the following principles of
risk management:
Risk management should:

create value resources expended to mitigate risk should be less than the consequence of
inaction, or (as in value engineering), the gain should exceed the pain

be an integral part of organizational processes

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be part of decision making process

explicitly address uncertainty and assumptions

be systematic and structured process

be based on the best available information

be tailorable

take human factors into account

be transparent and inclusive

be dynamic, iterative and responsive to change

be capable of continual improvement and enhancement

be continually or periodically re-assessed

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