Insurance Basics in Detail

The word Insurance, derives it Origination from the term RISK.

Risk is the chance or uncertainty of loss and it is not the loss itself, but the uncertainty or not knowing.

Concept of Risk

Risk exists when there is Uncertainty about the future.
Individuals & Business experience two kinds of risks –Speculative Risk and Pure Risk

Speculative Risk –Possibility of 3 outcomes
Loss
Gain
No Change

Pure Risk –Only 2 outcomes are possible
Loss
No Change

Speculative Risk Example :  Investment in Stocks.

Stock value may Increase or Decrease or remain same.

Pure Risk Example :  Possibility of being disabled.

An earning member may become disabled and suffer Income loss. Also he may not get completely disabled at all, but partially disable.

Pure Risk is the only kind of risk that can be Insured.

Growth and Role of Insurance

Sharing, or pooling, of risk is the central concept of the business of Insurance. The idea has the beauty of simplicity combined with practicality.

If risks—chances of loss—can be divided among many members of a group, then they need fall but lightly on any single member of the group. Thus, misfortunes that could be crushing to one can be made bearable for all. Viewed as a form of mutual aid, risk-sharing can be seen not only as sound business practice, but as enlightened social behavior rooted in accepted principles of ethics.

Beginning:

The idea, and the practice, of risk-sharing originated in antiquity. Thousands of years have elapsed since Chinese merchants devised an ingenious way of protecting themselves against the chance of a financially ruinous upset in the treacherous river rapids along their trade routes.

They simply divided their cargoes among several boats.

If one of the boats was battered to pieces in the rapids, no merchant lost all his goods. Each stood to lose only a small portion. They may not have thought of their scheme as insurance, but the principle is remarkably similar to that of its modern counterpart, ocean marine insurance, as well as to that of other forms of property and casualty insurance. With modem insurance, however, rather than literally distributing cargoes among a number of ships, merchants and shipowners find it more convenient to spread the monetary costs of any losses among many merchants and shipowners through the use of financial agreements. Again for the sake of convenience, these agreements usually take the form of an insurance policy, with insurance underwriters or an insurance company acting as financial intermediary. In return for a payment called a premium, the insurer assumes the risks—that is, obligates itself to pay the losses—of all the policyholders.

Functions of Property/Casualty Insurance
Our society could hardly function without insurance. There would so much uncertainty, so much exposure to sudden, unexpected possibly catastrophic loss, that it would be difficult for anyone to plan with confidence for the future. Most importantly, it would be difficult to obtain credit or financing since few lenders or investors would be willing to risk funds without a guarantee of safety for their investments.

Purpose of Insurance
Technically, the basic function of Property/Casualty insurance is the transfer of risk. Its aim is to reduce financial uncertainty and make accidental loss manageable. It does this substituting payment of a small, known fee—an Insurance Premium—to a professional insurer in exchange for the assumption of the risk a large loss, and a promise to pay in the event of such a loss.

Spreading the Risk
Transfer of risk also is referred to as “Spreading the risk:’ because the large losses of a few are distributed through an insurer to a large number of premium payers, each of whom pays a relatively small amount. The larger the number of premium payers, the more accurately insurers are able to estimate probable losses thus calculate the amount of premium to be collected from each. Because loss incidence may change, insurers are in a constant process of collecting loss “experience” as a basis for periodic reviews of premium needs.

How Insurance Benefits Society
As an additional benefit of to society, insurers themselves, the trustees of policyholder and stockholder funds, become major investors and suppliers of capital to the economy. In this respect, insurers perform a capital formation function similar to that of banks. Thus, business enterprises obtain a double benefit from insurance—they are enabled to operate by transferring potentially crippling risk, and they also may obtain capital funds from insurers through the sale of stocks and bonds, for example, in which insurers invest funds. Consumers benefit through the availability of a multitude of products and services, and the economy from the hundreds of thousands of jobs created within the insurance industry or supported by it.

What is Insurance?
It is a Contract or device for transferring risk from a person, business or organization to an insurance company that agrees, in exchange for a premium, to pay for losses through an accumulation of premium.
Hence, it is an agreement or insurance contract, by which policyholders pay a stipulated amount called premium to the Insurer, in return for which, the insurer agrees to pay a defined amount of money or provide a defined service if a covered event occurs during the policy term.
Insurance is a financial function by which individuals exposed to a specified risk each contribute to a pool from which covered events suffered by participating individuals are paid.

Exposure to Risks:    Examples

Property (Home,Car) losses from fire
Personal losses from incapacity, death

Individuals with a probability of facing the similar kind of risk, pay an individual premium, collectively to the Insurer’s Pool, out of which, Loss experienced Individual, gets the benefit, in case of any unforeseen or unexpected event or risk occurring. Risk Substitution of a certain small loss called Premium for an uncertain large loss

The purpose of Insurance is to spread risk amongst others and is intended to provide a practical solution to economic uncertainties and unexpected losses. Hence the purpose of insurance is to compensate for financial loss.

Characteristics of an Insurance Contract

Indemnity
After loss, individual should be restored to approximate financial condition prior to loss.

Personal
Insurance contracts are entered with people, not with their property.

Aleatory
Not equal values (Potential loss is significant compared to the cost of the policy.)

Adhesion
Setting up a contract is usually one-sided.

Unilateral
Contract requires an act (payment) to be exchanged.

What can be covered in an Insurance Contract?

Insurance of Persons –These are risks associated with human life. E.gs., personal accident, health, life.

Insurance of Property –These are tangible properties having a physical shape and consistency like buildings, apartments, vehicles, personal effects, household goods etc. These are subject to many risks ranging from fire, allied perils to theft and robbery.

Insurance of Interest –Owing to an error or omission committed by employees or a third-party, our clients or customers might suffer a loss. In turn we might have to pay them damages or compensation out of our own personal resources

Parts of The Insurance Contract (D -I -C -E)

Part I -Declarations

Name and address of insured/owner
Subject of insurance (i.e. Individual life insurance)
Policy period dates
Premiums and rates
List of coverage

Part II -Insuring Clause

Describes the obligations of the insurance company.
Package policies provide individual insuring agreements for each covered form
Described are the perils covered and risks assumed

Part III -Conditions

Describes what both the insured and insurer must do in regard to their rights and duties.

Part IV -Exclusions

If the insurance company is going to exclude any type of coverage it must be specifically listed in the exclusion part of the insurance policy contract or it cannot be excluded.

Types of Insurance : 1. P & C Insurance  -> It covers all types of

Property
Casualty or accidents
Liability –arising out of contract or common law

Examples  of P & C products
Automobile
Homeowners
Liability
Commercial Liability
Multi-risk

2.  Life Insurance:  It covers

Death
Living a certain length of time-called endowment ,annuities, and pensions
Incapacity-called disability or long term-care insurance

Examples of Life products

Term Insurance
Whole Life Insurance
Variable Life Insurance
Universal life Insurance

3. Health Insurance : It protects against financial loss due to injury, illness or medical bills; extends coverage provided by Govt. plan, Medicare. Disability insurance pays for income loss arising from a disability

Examples of Health Products
Govt. Plans-Medicare/Medicaid
Group plans
Individual plans

Who is Who?

Insurer : Person that assumes the economic consequences of the claim.
Insured : Person that is exposed to the risk (or his goods)
Policy Holder : Person who holds/owns the policy
Payer : Person in charge of the payment of the premium
Beneficiary : Person who receives the indemnity rights. Or in other words, The person to whom, life Insurance Policy proceeds are paid, on the occurrence of the event giving rise to a claim.
Actuary :  It is a business professional, who analyses the financial consequences of risk & Designs & prices products based on mathematical/statistical models
Adjuster : A professional who investigates and settles claims; could be an employee of the Insurance Company or and independent person
Claims Handler/Examiner : An employee who handles claims right from its notification

 Recap: What is an Insurance Product?

Represents a promise to protect policyholders against certain “perils” –or causes of loss –for a given period of time, (usually a year in P&C Insurance and longer in Life insurance).

Covers serious and unforeseen losses.

The promise is renewed mostly annually.

Is based on a number of legal principles.

Premiums go into one large pool which Insurance companies manage to earn interest/dividends.

Losses of a few are paid from these funds.

Because only a few need to draw from the pool in any given year, there is enough money in it to pay major losses like those incurred as a result of a catastrophic occurrence.

This concept is called Spreading the risk, or Risk Sharing.

Premiums do not “build up” for policyholders to draw upon when needed (except in the case of certain life insurance products –whole life, for example –that are designed with an investment component)

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