Insurance and Risk

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Insurance and risk
The possibility of happining unwanted result or outcome is called risk Risk concerns the deviation of one or more results of one or more future events from their expected value. Technically, the value of those results may be positive or negative. However, general usage tends to focus only on potential harm that may arise from a future event, which may accrue either from incurring a cost Risk is the possibility of a loss. Risk sometimes denotes an object that is a cause of risk, or a person or property that would be risky to insure. Thus, a heavy drinker would probably be a risk as a driver, or a wooden building would be a poor risk for fire insurance. There are two approaches of risk estimation. Subjective risk is what an individual perceives to be a possible unwanted event. Most people realize, for instance, that it’s possible for them to have an accident, or a heart attack or some other health problem. Or that they will lose money buying lottery tickets. How much subjective risk people experience depends on their history and their expected possibility of its occurrence. Somebody who has lost a lot of money in the stock market will probably feel more risk investing in the market than someone who has profited handsomely. Subjective risk may alter the behavior of the risk taker if it is a very undesirable risk, or one that has a good chance of occurring if something is done. Thus, someone who was in a bad auto accident might drive much more carefully than someone who has never been in one.

Objective Risk is the deviation of the actual outcome from the expected.

Types of Risk
Risk can be categorized as to why the risk exists, and to whom it affects. Pure risk is a risk in which there is only a possibility of loss or no loss—there is no possibility of gain. Pure risk can be categorized as personal, property, or legal risk. Personal risks are risks that affect someone directly, such as illness, disability, or death. Property risk affects either personal or real property. Thus, a house fire or car theft are examples of property risk. A property loss often involves both a direct loss and consequential losses. A direct loss is the loss or damage to the property itself. A consequential loss ( indirect loss) is a loss created by the direct loss. . Legal risk is a particular type of personal risk that you will be sued because of neglect, malpractice, or causing willful injury either to another person or to someone else's property. Legal risk is the possibility of financial loss if you are found liable, or the financial loss incurred just defending yourself, even if you are not found liable. Most personal, property, and legal risks are insurable. Speculative risk differs from pure risk because these is the possibility of profit or a loss. This

characterizes most financial investments. Most speculative risks are uninsurable, because they are undertaken willingly for the hope of profit. Pure risk is insurable, because the law of large numbers can be applied to forecast future losses, and, thus, insurance companies can calculate what premium to charge based on expected losses. On the other hand, speculative risks have more varied conditions that make estimating future losses difficult or impossible. Also, speculative risk will generally involve a greater frequency of loss than a pure risk. For instance, people do many things to protect their lives, or their property, but people willingly engage in speculative risks, such as investing in the stock market, to make a profit; otherwise, a person can avoid most speculative risks simply by avoiding the activity that gives rise to it. However, unlike pure risk, society benefits from speculative risks. Investments benefit society, or the risk of starting a business helps to create jobs and pay taxes for society, and can lead to economic growth, or even technological advancement. Because the only possibility of a pure risk is loss or no loss, there is no possibility of a gain. Risk can also be classified as to whether it affects many people or only a single individual. Fundamental risk is a risk, such as an earthquake or terrorism, that can affect many people at once. Economic risks, such as unemployment, are also fundamental risks because they affect many people. Particular risk is a risk that affects particular individuals, such as robbery or vandalism. Insurance companies generally insure some fundamental risks, such as hurricane or wind damage, and most particular risks. In the case of fundamental risks that are insured, insurance companies help to reduce their risk of great financial loss by limiting coverage in a specific geographic area and by the use of reinsurance, which is the purchase of insurance from other companies to cover their potential losses. However, private insurers do not insure many fundamental risks, such as unemployment. These risks are generally insured by the government, because the government has some control over economic risks through specific policies, such as monetary policy, and law. Fundamental and particular risks can be pure or speculative risks. Fundamental risks are risks that affect many members of society, but fundamental risks can also affect organizations. For instance, Enterprise risk is the set of all risks that affects a business enterprise. Speculative risks that can affect an organization are usually subdivided into strategic risk, operational risk, and financial risk. Strategic risk results from goal-oriented behavior. A business may want to try to improve efficiency by buying new equipment or trying a new technique, but may result in more losses than gains. Operational risks arise from the operation of the enterprise, such as the risk of injury to employees, or the risk that customers data can be leaked to the public because of insufficient security.

Financial risk is the risk that an investment will result in losses. Because most enterprise risk is a speculative risk, and because the enterprise itself can do much to lower its own risk, many companies are learning to manage their risk by creating departments and hiring people with the express purpose of reducing enterprise risks.

Peril and Hazard
Risk is the chance of loss, and peril is the direct cause of the loss. If a house burns down, then fire is the peril. A hazard is anything that either causes or increases the likelihood of a loss. There are different types of hazard. A physical hazard is a physical condition that increases the possibility of a loss. Thus, smoking is a physical hazard that increases the likelihood of a house fire and illness. Moral hazards are losses that results from dishonesty. Thus, insurance companies suffer losses because of fraudulent or inflated claims. In other words the possibility of occuring lossesbecause of the wrong and dishonest behavior of the insured is called maral hazard.

Distinction Between Moral Hazard and Morale Hazard
The distinction between moral and morale hazard in insurance is one of intention, but in other disciplines, such as banking, the term moral hazard is used in a more general sense that includes morale hazard. Moral hazard is often applied to a receiver of funds, such as a borrower, and means that there is a risk that the receiver of funds will not use the money as was intended or that they may take unnecessary risks or not be vigilant in reducing risk. This definition includes not only intentional dishonesty, but also a change in behavior that results from using someone else's money, which, in insurance, would be described as morale hazard.

Insurance
Insurance is the transference of financial loss due to risk to a company or other organization. The company accepts this transference for a periodic premium, and profits by collecting more in premiums and making more from the investments of those premiums than it pays out in claims, which are payments to the insured for the losses they incurred.Insurance companies can only make a profit if they understand risk and the frequency and severity of its occurrence. One way to study risk is to observe the actual number of losses to the total possible.

The Importance of Insurance :
When you hear the word insurance, the words boring and mundane probably enter your mind. It is realized that insurance is not a fun topic to discuss or think about, yet it is important and serves to protect your financial future. It is comforting to think that nothing will ever happen to you and that you are invincible. But odds are that you are likely to get into a car accident or have some type of health problem at some point in your life, and when that happens, you will want to have insurance. So when you question whether you need insurance, the answer is a resounding yes, you definitely need insurance.

It may seem like insurance is a waste of resources- spending money on something that may or may not happen. Since you cannot predict the future, it is important to protect yourself and your possessions against damage and harm. Insurance is all about protection- it protects you against an unfortunate incident such as a car accident, a robbery, or an illness. The moment an unexpected ill-fated event happens, you will be so glad you have insurance. Medical bills from a minor accident can deplete your savings and force you into bankruptcy. Insurance is not a rip off, but rather an essential financial service. Insurance can be tedious, stressful, and mind boggling-- trying to figure out what you need, what you don't need, and how much you need. Basically, there are four areas that most people are concerned about insuring: their life, their health, their possessions, and their finances. When deciding on what type of insurance you need, you must first ask yourself some basic questions. What is most valuable to you? Your health? Your car? Your material possessions? If you die what would the financial result be? Are you supporting any dependents such as a child or other family member? Most of you probably do not support dependents, so life insurance is not necessary. What type of health are you in? Would you be able to support yourself if you became sick or disabled? For most people, the answer is no, so you probably need to buy disability insurance. What would happen if you got sick? Can you afford to go to the doctor without health insurance? Health insurance is something you simply must have. Most employers offer health insurance to employees at reasonable rates, so definitely choose a health insurance plan that your employer offers.

Functions Of Insurance
In simple terms, insurance is a protection against financial loss arising on the happening of an unexpected event. In most countries especially the third world the insurance sector is still in its infancy state and it comes last on the priority list due to a number of reasons among which ignorance is out standing. All individuals have assets both tangible ;the house, car, factory, or intangible; voice of a singer, leg of a footballer the hand of an author.....etc all these can be insured because they run risk of becoming non functional through a disaster or an accident.The concept of insurance is quite advantageous and plays a number of basic roles as may be seen below. The functions of Insurance can be bifurcated into two parts: 1. Primary Functions 2. Secondary Functions 3. Other Functions The primary functions of insurance include the following: Provide Protection - The primary function of insurance is to provide protection against future risk, accidents and uncertainty. Insurance cannot check the happening of the risk, but can certainly provide for the losses of risk. Insurance is actually a protection against economic loss, by sharing the risk with others. Collective bearing of risk - Insurance is a device to share the financial loss of few among many others. Insurance is a mean by which few losses are shared among larger number of people. All

the insured contribute the premiums towards a fund and out of which the persons exposed to a particular risk is paid. Assessment of risk - Insurance determines the probable volume of risk by evaluating various factors that give rise to risk. Risk is the basis for determining the premium rate also Provide Certainty - Insurance is a device, which helps to change from uncertainty to certainty. Insurance is device whereby the uncertain risks may be made more certain. The secondary functions of insurance include the following: Prevention of Losses - Insurance cautions individuals and businessmen to adopt suitable device to prevent unfortunate consequences of risk by observing safety instructions; installation of automatic sparkler or alarm systems, etc. Prevention of losses causes lesser payment to the assured by the insurer and this will encourage for more savings by way of premium. Reduced rate of premiums stimulate for more business and better protection to the insured. Small capital to cover larger risks - Insurance relieves the businessmen from security investments, by paying small amount of premium against larger risks and uncertainty. Contributes towards the development of larger industries - Insurance provides development opportunity to those larger industries having more risks in their setting up. Even the financial institutions may be prepared to give credit to sick industrial units which have insured their assets including plant and machinery. The other functions of insurance include the following: Means of savings and investment - Insurance serves as savings and investment, insurance is a compulsory way of savings and it restricts the unnecessary expenses by the insured''s For the purpose of availing income-tax exemptions also, people invest in insurance. Source of earning foreign exchange - Insurance is an international business. The country can earn foreign exchange by way of issue of marine insurance policies and various other ways. Risk Free trade - Insurance promotes exports insurance, which makes the foreign trade risk free with the help of different types of policies under marine insurance cover.

Essentials of insurance contract
1. Offer and Acceptance: When applying for insurance, the first thing we do is to get the proposal form of a particular insurance company. After filling in the requested details, we send the form to the company. This is our offer. If the insurance company accepts our offer and agrees to insure us, this is called an acceptance. .

2. Free consent3.Legal consideration: This is the premium or the future premiums that you have pay to your insurance company. For insurers, consideration also refers to the money paid out to you should you file an insurance claim. This means that each party to the contract must provide some value to the relationship. 4. Legal Capacity: You need to be legally competent to enter into an agreement with your insurer. If you are a minor or are mentally ill, for example, then you may not be qualified to make contracts. Similarly, insurers are considered to be competent if they are licensed under the prevailing regulations that govern them. 5. Lawful objective: If the purpose of your contract is to encourage illegal activities, it is invalid.Therefore, the objective of insurance must be lawful. Insurance is a cover used for protecting a person from the financial losses. Financial losses can take many forms. There are risks to our investments, liabilities for our actions, and risks to our ability to earn income.The insurer and the insured are the main two parties involved in insurance. The insurer is the insurance company which will provide the cover to the insured against any financial losses. The insured may be an individual person or a group of people like an employer, members of a society, etc.

Basic categorization of Insurance
There are mainly two broad categories of insurance •Life insurance •Non-life insurance Life insurance products include Life term policies, which give clean risk coverage of only the death benefit, whereas endowment or money back policies have a risk as well as savings component i.e. death as well as maturity benefit. The life insurance also includes Unit - Linked Policies in which there is a risk component and a savings component, which is invested in equity, debt or gilt funds, depending on the insurance company. Non Life insurance products include property or casualty, health insurance or house, fire, marine insurance etc. This insurance category deals with all the non-life aspects of an insured like their house, health, land, office, etc which might bring financial loss. All risk are not insurable, therefore for a risk to be an insurable the following things must be presented in a particular risk. In other words, from the view point of insurer the following essentials must be presented in the insurable risk. •Definite Loss - The event that gives rise to the loss that is subject to insurance should, at least in principle, take place at a known time, in a known place, and from a known cause. The classic example is death of an insured on a life insurance policy.
•Unintentional or Accidental Loss - The event that comprises the trigger of a claim should

be accidental, or at least outside the control of the beneficiary of the insurance The loss should be 'pure,' in the sense that it results from an event for which there is only the

opportunity for cost. •Huge Loss - The size of the loss must be meaningful from the perspective of the insured. Insurance premiums need to cover both the expected cost of losses, plus the cost of issuing and administering the policy, adjusting losses, and supplying the capital needed to rationally assure that the insurer will be able to pay claims. •Affordable Premium - If the probability of an insured event is so high, or the cost of the event is so large, that the resulting premium is large relative to the amount of protection offered, it is not likely that anyone will buy insurance, even if on offer. •A large number of identical coverage units - The vast majority of insurance policies are provided for individual members of very large classes. The existence of a large number of identical coverage units allows insurers to benefit from the so-called "law of large numbers," which in effect states that as the number of coverage units increases, the actual results are increasingly likely to become close to expected results. •Measurable Loss - There are two elements that must be at least estimatable, if not formally calculable: the probability of loss, and the attendant cost. Probability of loss is generally an empirical exercise, while cost has more to do with the ability of a reasonable person in possession of a copy of the insurance policy and a proof of loss associated with a claim presented under that policy to make a reasonably definite and objective evaluation of the amount of the loss recoverable as a result of the claim.
•Limited risk of terribly large losses - If the same event can cause losses to numerous

policyholders of the same insurer, the ability of that insurer to issue policies becomes constrained, not by factors surrounding the individual characteristics of a given policyholder, but by the factors surrounding the sum of all policyholders so exposed.



priciples of insurance
1. Insurable Interest
The person getting an insurance policy must have an insurable interest in the property or life insured. A person is said to have an insurable interest in the property if he is benefited by its existence and be prejudiced by its destruction. Without insurable interest the insurance contract is void. The ownership of a property is not necessary for establishing insurable interest. A banker has an insurable interest in the property mortgaged to it against a loan. An employer can insure the lives of his employees because of his pecuniary interest in them. In the same way, a creditor can insure the life of his debtor. A person cannot insure the property of a third party, because he does not have an insurable interest in it. In case of fire insurance, insurable interest must exist both at the time of contract and at the time

of loss. In marine insurance, however, insurable interest must exist at the time of loss. It may or may not exist at the time of contract. In case of life insurance, the persons taking up a policy should have insurable interest in the life of insured person at the time of taking up the policy. It is not necessary that he should have insurable interest at the time of maturity also. Suppose a person gets an insurance policy on the life of his wife. Later on the wife is divorced. The policy will not become void because the husband ceases to have an insurable interest. Insurable interest in different polices can be explained as follows: Life Insurance Following persons have insurable interest in life insurance contract: •An employer in the life of an employee during the course of employment. •A partner is the life of other partners in case of partnership. •Husband in the life of his wife or vice-versa. •A creditor in the life of his debtor to the limit of the amount of his debt. •A son in the life of his father on whom he is dependent. •A dependent to the extent of support he is getting. •A surety in the life of his principal to the extent of his guarantee. Fire and Marine Insurance Under these contracts, following persons have insurable interest; •Mortgagee to the extent of amount of loan he has given. •Owner of the property in his property. •Wife and husband in each other’s property. •An agent in the goods of his principal.

2. Utmost Good Faith
The insurance contract is founded on the basis of utmost good faith on the part of both the parties. It is obligatory on the part of the proposer (one who wants to get an insurance policy) to disclose all material facts about the subject to be insured. If some material facts come to light later on then the contract can be avoided at the discretion of the insurer. The amount of premium is fixed on the basis of all the facts supplied to the insurance company. If some facts are withheld, then the amount of premium will not be properly settled. The insurer should also disclose the facts of the policy to the proposer. So utmost good faith on the part of

both the parties is a must.

3. Indemnity
The principle of indemnity is applicable to all types of insurance policies except life insurance. Indemnity means a promise to compensate in case of a loss. The insurer promise to help the insured in restoring the position before loss. Whenever there is a loss of property, the loss is compensated. The compensation payable and the loss suffered should be measurable in term of money. The insured will be compensated only upto the amount of loss suffered by him. He will not earn profit from the contractor. The maximum amount of compensation will be upto the value of the policy. The value of the policy undertaken is fixed at the time of contract. The actual amount of loss suffered is compensated and the value of policy is only the maximum limit. The principle of indemnity is not applicable in case of life insurance contracts, because it is not based on the principle of compensation. The loss of life cannot be compensated by any amount of money.

4. Principle of Contribution
Sometimes a property is insured with more than one company. The insured cannot claim more than total loss from all the companies put together. He cannot claim the same loss from different companies. In this case he will be benefited by the insurance which runs counter to the principle of indemnity. A person cannot be restored to a better position than before the loss occurred. The total loss suffered by the insured will be contributed by different companies in the ratio of the value of policies issued by them. So companies make a contribution to restore the previous position of the insured. For example, A has a property of one lakh rupees. He gets an insurance policy for Rs. 50,000 from R & C. and Rs. 50,000 from S & Co. Because of fire, property is destroyed to the extent of Rs. 40,000. A cannot claim a total sum of Rs. 40,000 from either of companies from both companies to the extent of Rs. 20,000 from each. In case he claims Rs. 40,000 from R & Co. then S & Co. will pay Rs. 20,000 to R & Co. So this is known as the principle of contribution.

5. Principle of Subrogation
The principle of subrogation is applicable to all insurances other than the life insurance. If the insured party gets a compensation for the loss suffered by him, he cannot claim the same amount of loss from any other party. The rights of claiming the loss are shifted to the insurer (Insurance Company), for example, a gets his house insured for Rs. 50,000 with an insurance company. The house is intentionally destroyed by B. A claims the loss from the insurance company. A cannot sue B for getting the compensation because he has already been compensated by the insurance company. Now, insurance company can sue B on behalf of A because of making good the loss suffered by A, the insurance company steps into the shoes of A. 6. Mitigation of loss When the event insured against takes place, the policy holder must do every thing to minimize the loss and to save what is left. This principle makes the insured more careful in respect of this

insured property. 7. Doctrine of proximate cause This principle is found very useful when the loss occurred due to series of events. It means that in deciding whether the loss has arisen through any of the risks insured against, the proximate or the nearest cause should be considered. To take an illustration in one case where a policy holder sustains an accident while hunting. He was unable to walk after the accident and as a result of lying on wet ground before being picked up, he suffered pneumonia. There was an unbroken change of cause between the accident and the death, and the proximate cause of the death, therefore, was the accident and not the pneumonia

Reinsurance
The practice of insurers transferring portions of risk portfolios to other parties by some form of agreement in order to reduce the likelihood of having to pay a large obligation resulting from an insurance claim. The intent of reinsurance is for an insurance company to reduce the risks associated with underwritten policies by spreading risks across alternative institutions.There are two basic types of reinsurance :-

1.Facultative Reinsurance
This is the arrangement of separate reinsurance for each risk that the insurer underwrites. This is normally part of an on-going arrangement and the insurer continually offers policies to the reinsurer, and the reinsurer decides whether to accept each or not individually. Obviously this requires a lot of work and is now generally regarded as too expensive in human resources to be practical.

2.Treaty Reinsurance
Treaty reinsurance is arranged for a block an insurer's underwritten policies. The reinsurer reinsurers a whole large chunk of the insurer's business. This means that the reinsurer does not need to scrutinise each policy individually and the insurer does not have the added workload of providing the reinsurer details of each and every risk it underwrites. In another way, reinsurance is classified as proportional and non-proportional reinsurances. Proportional Reinsurances: The two companies share the premium as well as risk. The reinsurer usually pays a ceding commission. Pro-Rata Reinsurance: It is a classification based on the way the two companies share the risk. The cedent and the reinsurer share a pre decided percentage of the premium and losses. It is used widely as it provides surplus protection. There are two types of pro-rata reinsurance, quota share and surplus share. Quota Share Pro-Rata Reinsurance: The primary insurer cedes a fixed percentage of premiums and loses for every risk accepted.

Surplus Share Pro-Rata Reinsurance: It is different in that not every risk is ceded but only those that exceed certain predetermined amounts. Non-Proportional Reinsurance: As the name suggests it is not proportional and the reinsurer only responds if the loss suffered by the insurer exceeds a certain amount. Excess of Loss: It covers a single risk or a certain type of business. Catastrophe reinsurance is a type of excess of loss reinsurance. It provides the captive with a great deal of flexibility. Stop Loss Reinsurance: It covers the whole account and is also known as excessive loss ratio reinsurance. These are the various types of reinsurances. There are firms that offer their services as well as their products to help new business start up flourish and succeed.

Life insurance
Life insurance is a contract between the policy owner and the insurer, where the insurer agrees to pay a designated beneficiary a sum of money upon the occurrence of the insured individual's or individuals' death or other event, such as terminal illness or critical illness. In return, the policy owner agrees to pay a stipulated amount at regular intervals or in lump sums. There may be designs in some countries where bills and death expenses plus catering for after funeral expenses should be included in Policy Premium. In the United States, the predominant form simply specifies a lump sum to be paid on the insured's demise The general principles discussed in element of valid contract apply to life insurance contract also with a few exceptions. The main elements of life insurancecontract are: (i) The life insurance contract must have all the essentials of a valid contract. Certain elements like offer and acceptance, free consent, capacityto enter into a contract, lawful object must be present for the contract to be valid. (ii) The contract of life insurance is a contrcat of utmost good faith. The assured should be honest and truthful in giving information to the insurance company. He must disclose all material facts about his health to the insurer. It is his duty to disclose aacurately all the material facts known to him even if the insurer does not ask him. (iii) In life insurance, the insured must have insurable interest in the life of the assured. Without interest the cotract of insurance is void. In case of life insurance, insurable interst must be present at the time the policy is affected. It is not necessary that the assured shoould have insurable

intersrt at the time of maturity also.Following persons have insurable interest in life insurance contract: •An employer in the life of an employee during the course of employment. •A partner is the life of other partners in case of partnership. •Husband in the life of his wife or vice-versa. •A creditor in the life of his debtor to the limit of the amount of his debt. •A son in the life of his father on whom he is dependent. •A dependent to the extent of support he is getting. A surety in the life of his principal to the extent of his guarantee (iv) Life insurance contract is not a contract of indemnity. The life of a human being can not be compensated and only a specified sum of money is paid. That is why the amount payable in life insurance on the ahppening of an event is fixed in advance. The sum of money payable is fixed, at the time of entering into contract

procedures of life insurance
The procedure of taking life policy is very easy. The following are the different steps involved in taking the life insurance policy. Submission of proposal form: A person desiring to take policy of life insurance will have to fill in the proposal form supplied by the insurance company. The proposal form requires information with regard to the health, the proposer, his family history, his age habits of life, the amount a kind and term of policy. Submission of agent's report: The agent prepares a report on the basis of proposal from duly filled in. the report contains the facts on the basis of proposal form and also from the enquiry made by the agent. The contract of insurance largely depends upon agent's report. Doctor's report: The doctor of insurance company also presents a report regarding the proposer to the company. The doctor certifies that the customer is free from fatal diseases and there is no risk if the company issues him a life insurance policy. The report I very important because the company evaluates the risk of life on the basis of this report. Certificate of age: The proposer will have to submit the certificate of his actual age. The certificate is the proof of age. It is very important because the rate of premium is determined on the basis of actual age. The customer must provide true information to the company. In case of concealment and wrong information, the insurance company has a right to cancel the policy.

Scrutiny of documents: The insurance company has the right to check the documents filed by the customers. The contents of the proposal form, medical report and the certificate of age are examined by the insurance company. Acceptance of the proposal: On consideration of the above facts, the insurance company decides to insure or not to insure the life of the proposer. When the proposal is accepted the insurance company informs the customer and demands the first premium. If the proposal is rejected, the letter of regret is sent to the customer. Payment of first premium: The proposer should pay the premium amount to the company on the receipt of the demand notice for the premium. The insurance contract is completed in receipt of the first premium. The company issues a receipt for the amount of premium. The receipt acts as a contract between the insurance company and the insured person. Later on, the company issues the life insurance policy.

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