Chapter 1 ：

Introduction to
Insurance
Learning objectives

Defining insurance
Explain the importance of insurance
Elaborate on how insurance works
Explain function of insurance
Differentiate classes of insurance and
risk covered
Insurance – what is
it?
 Definition of insurance

An economic institution based on the

principle of mutuality, formed for the
purpose of establishing a common fund, the
need for which arises from chance
occurrences of nature, whose probability
can be fairly estimated.
 Essential features of
Insurance

i. It is an economic institution.
ii. It is based on the principle of mutuality or
cooperation.
iii. Its objective is to accumulate funds to pay for
claims as a result of the operation of specific
risks.
iv. Only certain risks can be insured against, viz.
those whose occurrence can be confidently
estimated with a certain degreee of accuracy.
 Importance of Insurance

1. Insurance provides security

2. Insurance reduces business risk or losses
3. Insurance provides peace of mind
4. Life insurance encourages saving
5. Insurance accelerates the economic
growth of the country
6. Insurance makes security and welfare of
employees
 Insurance provides security

 Insurance provides safety and security against the loss on

a particular event. Life insurance provides security against
death and old age sufferings. Fire insurance protects
against loss due to fire while Marine insurance provides
protection and safety against loss of ship and cargo. For
personal accident and sickness insurance financial
protection is given when the individual is unable to earn. In
other insurance too, this security is provided against the
loss at a given contingency.
Insurance reduces business risk
or losses

– In Business, commerce and industry, huge properties

are employed. Because of slight negligence, the
property may be turned in to ashes. A person may not
be sure of his life, health and cannot continue the
business up to the longer period to support his
dependents. By the help of insurance, he can be sure of
his earning, because the insurance company will pay a
fixed amount at the time of death, damage by fire, theft,
accident and other perils.
Insurance provides peace of mind

 Insurance removes the tensions, fears,

anxiety, frustrate or weaken of the human
mind associated with the future uncertainty.
By providing financial position and promise to
compensate losses arise out from various
risk, it provides peace of mind and stimulates
more and better work performance of an
individual.
Life insurance encourages saving

 The insured has an obligation to pay

premium regularly and cannot be withdrawn
easily before the expiry of the term of policy.
Life insurance encourages the habit of
regular and systematic saving through
premium and after a certain period, it would
be a part of necessary saving of the insured
person.
 Insurance accelerates the
economic growth of the country

 To develop the economic growth of the country,

insurance provides strong hand and mind, with
protection against loss of property and capital to
produce more wealth. It provides protection against
different kinds of loss caused by risk. It accumulates
the capital from the insured and utilizes for the
development of country. Thus, the insurance meets
all the requirements for the economic growth of a
country.
 Insurance makes security and
welfare of employees

 The security and welfare of employees is the

responsibility of employer. These security and welfare
are easily met by life insurance, accident and
sickness benefit and pension which are generally
provided by group insurance. The premium for group
insurance is normally paid by the employer.
Insurance is the simple method for employer to fulfill
their responsibility. Due to these benefits, employee
will devote their maximum capacities to complete
their job.
How insurance works?
 Pooling of Losses
 The Law of Large Numbers
 Premiums Have to be Adequate
in a Competitive Business
Environment
 Payment of fortuitous losses
 Pooling of losses
 Pooling or sharing losses is the heart of
insurance.

 Pooling is the spreading of losses

incurred by the few over the entire group,
so that in the process, average loss is
substituted for actual loss.
 Pooling of losses

Pooling implies:
 the grouping of a large number of
exposure units, so that the law of large
numbers can operate to provide a
substantially accurate prediction of future
losses.
 The sharing of losses by the entire group
 The Law of Large numbers
 it states that the greater the number of
exposure, the more closely will the actual
results that are expected from an infinite
number of exposures.

 The insurer can predict future losses with a

greater degree of accuracy as the number of
exposures increases.
The Law of Large numbers

It can only operate efficiently if the following

requirements are fulfilled:-
1. Large number of similar exposures
2. Loss exposures must be independent
3. Random or chance occurance of
losses
The Law of Large numbers
 There should be a large group of roughly similar,
but not necessarily identical, exposure units that
are subject to the same peril or group of perils.
(examples)

 The purpose is to enable the insurer to predict

loss based on the law of large numbers.

 The loss costs can be spread over all insureds.

 Premiums Have to be Adequate in a
Competitive Business Environment

 For most insurance lines, estimates of both

average frequency and the average severity
of loss must be based on previous loss
experiences
 The insurer must charge a premium that will
be adequate for paying all losses and
expenses during the policy period.
 Premiums Have to be Adequate in a
Competitive Business Environment

 The premium should be economically

feasible.
 The insured must be able to afford to pay the
premium;
 Low premium is attractive and competitive in
market;
 To have an economically feasible premium,
the chance of loss must be relatively low.
Payment of fortuitous losses

 A fortuitous loss is one that is unforeseen

and unexpected and occurs as a result of
chance.
 That’s the loss must be accidental.
 Insurance policies do not cover intentional
losses.
Functions of insurance

 Primary function

 Secondary function
 Primary function

The equitable distribution of financial

losses of the few who are insured
among the many insureds.
 Secondary function
1. Cost stabilization
2. Stimulates Business Enterprise
3. Removes Fear and Worries
4. Reduction of Losses
5. Means of saving
6. Sources of Capital for Investment
7. Provides Employment for Many
 Cost stabilization

Through the purchase of insurance,

business enterprises avoid the
necessity of having to freeze capital to
provide for financial protection against
losses. This provides a means of
stabilizing the costs involved in
managing risks.
 Stimulates Business Enterprise

The risk transfer mechanism provided by

insurance has made possible the present day
large scale commercial and industrial
enterprises. They would not have started if the
owners were not able to transfer their risks
through insurance.
 Removes Fear and Worries

Insurance helps to remove fears and

worries of losses of individuals and
business executives. It helps to establish
confidence and enables fordward
planning of economic activities.
 Reduction of Losses

Insurers help to reduce losses (both in

frequency and severity) through their
actions and recommendations in
rating, survey, inspection services and
salvage.
 Means of saving

 It is through the use of endowment insurance.

 It is a combination of decreasing element of
investment. The investment part of the contract
is a savings accumulation.
 The combination of the two features in a single
plan, the endowment assurance provides both
protection and savings to the insured.
Sources of Capital for Investment

 Insurers accumulate large funds which they

hold as custodians and out of which claims
and losses are met. These funds are usually
invested in the public and private sectors.
 Such investments help considerably in the
overall development of the economy.
Provides Employment for Many

The insurance industry in Malaysia has

generated numerous employment
opportunities in underwriting, claims
handling, accounts and administration,
electronic data processing, marketing
and servicing, investment and managerial
activities.
 END OF CHAPTER

 Description: End Of Chapter problems are used to reinforce

and apply some concepts and skills learned in the classroom.
For PB502 – students need to apply the concepts and skills
that they have learned in Chapter 1. In applying the concepts
and skill you are required to collect data and make a report.
You will be working in a group of 5 students. The report should
include :
 PART C : Describe what is life insurance and general insurance.
 List any TWO (2) types of risk covered under life insurance and any TWO (2) types of risk
covered under general insurance.

(8 marks)
 PART A
Insurance is one way that can avoid the losses occur as a
result of risks. Explain briefly the definition of insurance.
State FOUR (4) essential features of insurance. (8
marks)
 PART B
Describe THREE (3) importance of insurance.
 (9 marks)
 (8 marks)