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Basic Queries
• What will be the contribution of this paper
in my carrier as finance professional?
• Why do we need to study Insurance?
• What are insurance services?
WHAT IS RISK?
• Risk is defined as uncertainty concerning the
occurrence of a loss.
• Objective Risk: the relative variation of actual
loss from expected loss. Objective risk declines
as the number of exposures increases. More
specifically, objective risk varies inversely with
the square root of the number of cases under
observation.
• Subjective Risk :uncertainty based on a
person’s mental condition or state of mind.
Categories of Risk
• Pure and Speculative risks
• Types of Pure Risk
– Personal risk
• Risk of premature death or disability
• Risk of insufficient income on retirement
• Risk of unemployment
– Property risk
• Direct Loss
• Indirect or consequential loss
– Liability risk
• Fundamental and Particular Risks
Chance of loss
• Chance of loss is defined as the probability that an event will
occur.
• Objective Probability
– deductive reasoning
– inductive reasoning
• Subjective Probability
• Chance of Loss distinguished from Risk: For example,
assume that a fire insurer has 10,000 homes insured in
Mumbai and 10,000 houses insured in Delhi. Also assume
that the chance of loss in each city is 1 percent. Thus, on an
average, 100 homes should burn annually in each city.
However, if the annual variation in losses ranges from 75 to
125 in Mumbai, but only from 90 to 110 in Delhi, objective risk
is greater in Mumbai even though the chance of loss in both
cities is the same.
Insurance and society
• Risk to society
– Larger emergency fund
– Loss of certain goods and services
– Worry and fear
• Costs to society
– Cost of doing business
– Fraudulent claims
– Inflated claims
• Benefits to society
– Indemnification for loss
– Less worry and fear
– Source of investment funds
– Loss prevention
– Enhancement of credit
METHODS OF HANDLING RISK
• Risk avoidance;
• Risk retention;
– Active retention
– Passive retention
• Risk transfer;
– Transfer of risk by contracts
– Hedging
– Incorporation of a business firm
• Loss control;
– Loss prevention
– Loss reduction
• Insurance
• Choice of methods depends on the frequency and severity of loss.
Peril and Hazard
• Peril is the cause of loss.
• Hazard is a condition that creates or
increases the chance of loss.
– Physical Hazard
– Moral Hazard
– Morale Hazard
Definition of Insurance
• “Insurance is the pooling of fortuitous
losses by transfer of such risks to insurers,
who agree to indemnify insured for such
losses, to provide other pecuniary benefits
on their occurrence or to render services
connected with the risk”
Commission on Insurance Terminology
of the American Risk and Insurance
Association
Basic Characteristics of Insurance
• Pooling of losses
– Spreading losses incurred by the few over the entire group
– Risk reduction based on the Law of Large Numbers
• Payment of fortuitous losses
– Insurance pays for losses that are unforeseen, unexpected, and
occur as a result of chance
• Risk transfer
– A pure risk is transferred from the insured to the insurer, who
typically is in a stronger financial position
• Indemnification
– The insured is restored to his or her approximate financial
position prior to the occurrence of the loss
Requirements of an Insurable Risk
• Large number of exposure units
– to predict average loss
• Accidental and unintentional loss
– to control moral hazard
– to assure randomness
• Determinable and measurable loss
– to facilitate loss adjustment
• insurer must be able to determine if the loss
is covered and if so, how much should be
paid.
Requirements of an Insurable Risk
• No catastrophic loss
– to allow the pooling technique to work
– exposures to catastrophic loss can be managed
by:
• dispersing coverage over a large geographic area
• using reinsurance
• catastrophe bonds
Advantages Disadvantages