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Insurance And Risk

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The document discusses the meaning and characteristics of insurance. It outlines some key points: 1. Insurance involves pooling losses from many individuals so average losses can be substituted for actual losses of a few. It provides payment for unexpected, accidental losses. 2. Risk is transferred from the insured to the insurer, who is in a stronger position to pay losses. Indemnification means restoring the insured to their pre-loss position. 3. For a risk to be insurable, losses must be measurable, large numbers must be exposed, losses cannot be catastrophic, and the chance of loss must be calculable so premiums can be affordable.

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Insurance and Risk 2nd Session
I. Meaning of Insurance A. Definition of Insurance – There is no single definition of Insurance. B. Basic Characteristics of Insurance There are certain common elements that are typically present in any Insurance Plan:
I. Meaning of Insurance B. Basic Characteristics of Insurance: Pooling of Losses – Losses incurred by the few are spread over the entire group, so that in the process, average loss is substituted for actual loss. Payment of Fortuitous Losses – Insurance plans provide for the pooling of fortuitous losses. A fortuitous loss is one that is unforeseen and unexpected and occurs as a result of chance . In other words, the loss must be accidental!
I. Meaning of Insurance B. Basic Characteristics of Insurance: Risk Transfer – In private Insurance, a Pure Risk is transferred from the Insured to the Insurer, who typically is in a stronger financial position to pay the loss than the Insured. Indemnification – Indemnification means that the insured is restored to his or her approximate position prior to the occurrence of the loss.
II. Requirements of an Insurable Risk There are six general requirements: 1. Large number of exposure units – Ideally, 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. 2. Accidental and unintentional loss – Ideally, the loss should be fortuitous and outside the insured’s control. Thus if an individual deliberately causes a loss, he or she should not be indemnified for the loss. 3. Determinable and measureable loss – This means the loss should be definite as to cause, time, place and amount.
II. Requirements of an Insurable Risk There are six general requirements: 4. No catastrophic loss – This means that a large proportion of exposure units should not incur losses at the same time. Pooling is the essence of Insurance. 5. Calculable chance of loss – The Insurer must be able to calculate both the average frequency and the average severity of future losses with some degree of accuracy. 6. Economically feasible premium – The insured must be able to afford to pay the premium. In addition, for the Insurance to be an attractive purchase, the premiums paid must be substantially less than the face value, or amount, of the policy.
III. Description of Insurable and Uninsurable Risks A. Insurable Risks Personal Property Liability
III. Description of Insurable and Uninsurable Risks B. Generally Uninsurable Risks Market Financial Production Political
III. Description of Insurable and Uninsurable Risks These Risks are generally uninsurable for several reasons: 1. Many of these risks are speculative risks , which are very difficult to insure privately. 2. The potential for a catastrophic loss is great; this is particularly true for political risks, such as the risk of war. 3. Calculation of the proper premium may be difficult because the chance of loss cannot be accurately estimated.
IV. Insurance Distinguished from Other Transactions A. How Insurance differs from Gambling Insurance differs from gambling in two ways: Gambling creates a new Speculative Risk that did not exist before, while Insurance is a technique for handling an already existing Pure Risk . Gambling is socially unproductive , since the winner’s gain comes at the expense of the loser! However, Insurance is always socially productive, since both the insured and the insurer win if the loss does not occur!
IV. Insurance Distinguished from Other Transactions B. How Insurance Differs from Hedging Insurance differs from Hedging in two ways: An Insurance transaction usually involves the transfer of Risks that are Insurable since the requirements of an Insurable Risk generally can be met. Hedging is a technique for handling Risks that are typically uninsurable , such as protection against a substantial decline in the price of commodities e.g oil. A second difference is that Insurance may reduce Objective Risk because of the application of the law of large numbers. In contrast, hedging typically involves only Risk Transfer , not Risk Reduction!
 

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Insurance And Risk

  • 1. Insurance and Risk 2nd Session
  • 2. I. Meaning of Insurance A. Definition of Insurance – There is no single definition of Insurance. B. Basic Characteristics of Insurance There are certain common elements that are typically present in any Insurance Plan:
  • 3. I. Meaning of Insurance B. Basic Characteristics of Insurance: Pooling of Losses – Losses incurred by the few are spread over the entire group, so that in the process, average loss is substituted for actual loss. Payment of Fortuitous Losses – Insurance plans provide for the pooling of fortuitous losses. A fortuitous loss is one that is unforeseen and unexpected and occurs as a result of chance . In other words, the loss must be accidental!
  • 4. I. Meaning of Insurance B. Basic Characteristics of Insurance: Risk Transfer – In private Insurance, a Pure Risk is transferred from the Insured to the Insurer, who typically is in a stronger financial position to pay the loss than the Insured. Indemnification – Indemnification means that the insured is restored to his or her approximate position prior to the occurrence of the loss.
  • 5. II. Requirements of an Insurable Risk There are six general requirements: 1. Large number of exposure units – Ideally, 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. 2. Accidental and unintentional loss – Ideally, the loss should be fortuitous and outside the insured’s control. Thus if an individual deliberately causes a loss, he or she should not be indemnified for the loss. 3. Determinable and measureable loss – This means the loss should be definite as to cause, time, place and amount.
  • 6. II. Requirements of an Insurable Risk There are six general requirements: 4. No catastrophic loss – This means that a large proportion of exposure units should not incur losses at the same time. Pooling is the essence of Insurance. 5. Calculable chance of loss – The Insurer must be able to calculate both the average frequency and the average severity of future losses with some degree of accuracy. 6. Economically feasible premium – The insured must be able to afford to pay the premium. In addition, for the Insurance to be an attractive purchase, the premiums paid must be substantially less than the face value, or amount, of the policy.
  • 7. III. Description of Insurable and Uninsurable Risks A. Insurable Risks Personal Property Liability
  • 8. III. Description of Insurable and Uninsurable Risks B. Generally Uninsurable Risks Market Financial Production Political
  • 9. III. Description of Insurable and Uninsurable Risks These Risks are generally uninsurable for several reasons: 1. Many of these risks are speculative risks , which are very difficult to insure privately. 2. The potential for a catastrophic loss is great; this is particularly true for political risks, such as the risk of war. 3. Calculation of the proper premium may be difficult because the chance of loss cannot be accurately estimated.
  • 10. IV. Insurance Distinguished from Other Transactions A. How Insurance differs from Gambling Insurance differs from gambling in two ways: Gambling creates a new Speculative Risk that did not exist before, while Insurance is a technique for handling an already existing Pure Risk . Gambling is socially unproductive , since the winner’s gain comes at the expense of the loser! However, Insurance is always socially productive, since both the insured and the insurer win if the loss does not occur!
  • 11. IV. Insurance Distinguished from Other Transactions B. How Insurance Differs from Hedging Insurance differs from Hedging in two ways: An Insurance transaction usually involves the transfer of Risks that are Insurable since the requirements of an Insurable Risk generally can be met. Hedging is a technique for handling Risks that are typically uninsurable , such as protection against a substantial decline in the price of commodities e.g oil. A second difference is that Insurance may reduce Objective Risk because of the application of the law of large numbers. In contrast, hedging typically involves only Risk Transfer , not Risk Reduction!
  • 12.