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Principles of Insurance - Revised 1
Principles of Insurance - Revised 1
SUPPOSE
∙Houses in a village = 1000
∙Value of 1 House = Rs. 40,000/-
∙Houses burning in a yr = 5
∙Total annual loss due to fire = Rs. 200,000/-
∙Contribution of each house owner = Rs. 300/-
UNDERLYING ASSUMPTION
All 1000 house owners are exposed to a common risk, i.e. fire
SUPPOSE
∙Number of Persons = 5000
∙Age and Physical condition = 50 years & Healthy
∙Number of persons dying in a yr = 50
∙Economic value of loss suffered by family of each dying
person = Rs. 1,00,000/-
∙Total annual loss due to deaths = Rs. 50,00,000/-
∙Contribution per person = Rs. 1,200/-
UNDERLYING ASSUMPTION
All 5000 persons are exposed to common risk, i.e. death
Pham Thanh Ha (MA) 7
PROCEDURE
Everybody contributes Rs. 1200/- each as premium to the
pool of funds
Total value of the fund = Rs. 60,00,000 (i.e. 5000 persons *
Rs. 1,200)
50 persons die in a year on an average
Insurance company pays Rs. 1,00,000/- out of the pool to
the family members of all 50 persons dying in a year
EFFECT OF INSURANCE
Risk of 50 persons is spread over 5000 people, thus
reducing the burden on any one person.
– Avoidance:
• You can avoid the risk of being mugged in a high-
crime rate area by staying out of the area
• A business firm can avoid the risk of being sued for
a defective product by not producing the product
=> However, not all risks should be avoided
MARINE INSURANCE
Reasonably
abandoned
(if NOA would have
Any possibility of
Insurer accepts:
benefit to insurer) admitted
interest and deal with
subject matter
insured
as its rejects:
Insurer own
partial
Loss or ACT
Partial Loss
• Particular Average: losses of each insured
interest individually due to acts of God or
Perils of the sea
• Insurer’s liability: compensate for both of
the losses and reasonable costs caused
by particular average.
– Goods: Reasonable costs are the cost used
for saving cargo or reducing its damaged
measurement.
Pham Thanh Ha (MA) 82
General Average
• General Average: the losses/ damages caused by
special expenses and sacrifices that intentionally and
reasonably conducted to save the vessel, cargo and
freight from a threat in the common ocean voyage.
TA TB TA TB
HA HB
Collision and liabilities of different parties
TA TB TA TB
HA HB
• “This insurance is extended to indemnify the
Assured against such proportion of liability under
the contract of affreightment “Both to Blame
Collision” Clause as is in respect of a loss
recoverable hereunder. In the event of any claim
by shipowners under the said Clause the
Assured agree to notify the Underwriters who
shall have the right, at their own cost and
expense, to defend the Assured against such
claim”.
Pham Thanh Ha (MA) 132
Liability of marine cargo
insurers
– If cargo owner has not received
compensation:
• Loss/ damage in collide accident
• proportion of liability under the contract of
affreightment “Both to Blame Collision” Clause
– If cargo owner has already received a portion
of compensation:
• The rest part of Loss/ damage in collide accident
• proportion of liability under the contract of
affreightment “Both to Blame Collision” Clause
INTRODUCTION TO RISK
MANAGEMENT
Meaning of risk management
• Risk management is a process that
identifies loss exposures faced by an
organization and selects the most
appropriate techniques for treating such
exposures
• Risk – loss exposure: is any situation or
circumstance in which a loss is possible,
regardless of whether a loss occurs
• Risk control:
• Avoidance: a certain loss exposure is never
acquired, or an existing loss exposure is
abandoned => the firm may not be able to avoid
all losses, it may not feasible or practical to avoid
the exposure
• Loss prevention: refers to measures that reduce
the frequency of a particular loss
• Loss reduction: refers to measures that reduce
the severity of a loss after is occurs
• Risk control:
– Duplication: refers to having back-up or
copies of important documents or property
available in case a loss occurs.
– Separation: dividing the assets exposed to
loss to minimize the harm from single event.
– Diversification: refers to reducing the chance
of loss by spreading the loss exposure across
different parties (customers and suppliers),
securities (stock and bonds), or transactions.
Pham Thanh Ha (MA) 166
Select the appropriate technique for
treating loss exposure
• Risk financing:
– Retention: the firm retains part or all of the losses that can result
from a given loss, provided that:
• No other method of treatment is available
• The worst possible loss is not serious
• Loss are fairly predictable
– Retention levels: the dollar amount of losses that a firm will
retain:
• The maximum retention can be set at 5% of the company’s
earnings before taxes from current operations
• The maximum retention level can be set as percentage of
the firm’s networking capital (between 1 and 5%)-
Networking capital is the difference between a company’s
current assets and current liabilities.
Pham Thanh Ha (MA) 167
=> Measure the firm’s ability to fund a loss
Select the appropriate technique for
treating loss exposure
• Advantages of Retention:
– Save on lost costs
– Save on expenses
– Encourage loss prevention
– Increase cash flow
• Disadvantages of retention:
– Possible higher loss
– Possible higher expenses
– Possible higher taxes
Pham Thanh Ha (MA) 168
Select the appropriate technique for
treating loss exposure
• Non-insurance transfer: is a method other than insurance by which a pure
risk and its potential financial consequences are transferred to another
party.
• Advantages:
– The risk management can transfer some potential losses that are not
commercially insurable
– Noninsurance transfers often cost less than insurance
– The potential loss may be shifted to someone whose is in a better
position to exercise loss control
• Disadvantages:
– The transfer of potential loss may fail because the contract language is
ambiguous. There may be no court precedents for the interpretation of a
contract tailor- made to fit the situation
– If the party to whom potential loss is transferred is unable to pay the
loss, the firm is still responsible for the claim.
– An insurer may not give credit for the transfers, and insurance costs
may not be reduced.
Pham Thanh Ha (MA) 169
Select the appropriate technique for
treating loss exposure
• Commercial Insurance: appropriate for loss exposures
that have a low probability of loss but the severity of loss
is high.
– Selection of insurance coverage
– Selection of insurer
– Negotiation of terms
– Dissemination of information concerning insurance
coverage
– Periodic review of the program