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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.
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.
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
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.
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.
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.
•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:
•A creditor in the life of his debtor to the limit of the amount of his debt.
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:
•A creditor in the life of his debtor to the limit of the amount of his debt.
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.