Basic concepts in Risk

management and
Insurance
Insurance and Risk
Lecture-2
 Explain the basic characteristics of
insurance
Explain the law of large numbers
Describe the requirements of an insurable
Learning risk from the viewpoint of private insurer.
Objectives Identify the major insurable and
uninsurable risks in our society
Describe the major types of insurance
Explain the social benefits and social
costs of insurance.
 Insurance is the pooling of fortuitous
losses by transfer of such risks to
What is insurers, who agree to indemnify insured
for such losses, to provide other
Insurance? pecuniary benefits on their occurrences,
or to render services connected with the
risk.
 An insurance plan or arrangement
typically includes the following
characteristics:
Basic
Characteristic 1) Pooling of losses
s of Insurance 2) Payment of fortuitous losses
3) Risk transfer
4) Indemnification
 Though insurers normally insure pure risk but certain
requirements must be fulfilled before a pure risk can be
privately insured. There are six requirements of an
insurable risk………..
Requirements 1) There must be a large number of exposure units.
of an Insurable 2) The loss must be accidental or unintentional.
Risk 3) The loss must be determinable and measurable.
4) The loss should not be catastrophic.
5) The chance of loss must be calculable.
6) The premium must be economically feasible.
 The risk of fire to private car, home
Two or any business organization.
Application: On the other hand,
The Risk s of The risk of unemployment does not
Fire and completely meet requirements
Unemployment
 Adverse selection is the tendency of persons with a
higher-than-average chance of loss to seek insurance at
standard (average) rates, which if not controlled by
underwriting, results in higher-than-expected loss levels.
Adverse It can be controlled by careful underwriting.
Selection and
Insurance Underwriting refers to the process of selecting and
classifying applicants for insurance. Applicants who meet
the underwriting standards are insured at standard rate
and if underwriting standards are not met, the insurance is
denied or extra premium must be paid.
 There are two important differences between
insurance and gambling which are
following………….
Insurance and
1) Gambling creates a new speculative risk while
Gambling insurance is a technique for handling an
Compared already existing pure risk.
2) Gambling is socially unproductive where
insurance is always socially productive.
 Although both technique is similar in that risk is
transferred to another party and no new risk is created but
the differences between them are….
Insurance and 1) Insurance transaction involves the transfer of
Hedging insurable risk where hedging is a technique for
handling risk that are typically uninsurable.
compared
2) Insurance can reduce the objective risk by applying
the law of large numbers where hedging involves
only risk transfer not risk reduction.
 Insurance can be classified in the following
ways………….
1) Private insurance
Life and health insurance
Types of
Property and liability insurance
Insurance
2) Government Insurance
Social Insurance
Other Government insurance
 The major social and economic benefits of
insurance to society includes the
following………..
Benefits of 1. Indemnification for loss
Insurance to 2. Reduction of worry and fear
Society 3. Source of investment funds
4. Loss prevention
5. Enhancement of credit
 The major cost of insurance include
the following…………
Costs of
Insurance to 1. Cost of doing business
Society 2. Fraudulent claims
3. Inflated claims