Introduction to Insurance

Pooja Garg
Definition of Insurance
From the viewpoint of an Individual: Insurance is an
economic device whereby an individual substitutes a
certain cost (the premium) in consideration of the
insurer incurring the risk of paying a large sum upon a
given contingency
Features:
Economic device
Premium
Large sum paid by Insurer (Sum Assured)
Payment made only upon a contingency
Definition of Insurance
From the viewpoint of Society: Insurance is an economic
device for reducing and eliminating risk through the
process of spreading the loss among a group of people
who are exposed to it and who agree to insure
themselves against the risk.
Nature of Insurance
Security: It does not decrease the uncertainty for the
individual as to whether the event will occur, nor does
it alter the probability of occurrence but it does
reduce the probability of financial loss connected with
the event.
Sharing/Pooling of risk
Co-operative device
Evaluation of Risk
Payment at Contingency
Insurance is not Gambling
Insurance is not charity
Purpose and Need of Insurance
Uses to an Individual
Provide safety and security
Affords peace of mind
Eliminates dependency
Life Insurance encourages saving
Life Insurance provides profitable investment
Life Insurance fulfills the needs of a person
Old-age needs
Early Death
Disability
Sickness
Readjustment needs
Special Needs e.g Education, Marriage
Tax Savings
Purpose and Need of Insurance
Uses to Business
Uncertainty of Business Losses reduced
Business efficiency increased
Welfare of employees
Enhancement of Credit
Covers consequential losses
Key man identification
Group insurance
Uses to Society
Economic Growth
Protection of Wealth
Increases the savings to GDP ratio
Deep Insurance penetration makes an economy
stable.
How Insurance Works ?
Sharing and Pooling of risk by combining a sufficient
number of homogenous exposures into a group to
make the losses predictable for the group as a whole
and likely big impact on one is reduced to smaller
manageable impacts on all.
How Insurance Works ?
Homogenous exposures compose a set of group of
people
Losses are predicted for the group as a whole
Sharing of proportional risk among each person in a
group
Big impact on one reduced to smaller manageable
impact on all
Examples
1. 400 Houses
Value of each house=Rs. 20,000
Probability of risk=4 houses burn in a year (Degree
of Risk=1%)
Total Loss=Rs. 80,000/400
=Rs.200/person (1% of Value of House)
Examples (Contd.)
Loss Shared in Proportion
A=(1,50,000*2)/400=Rs.750 (3.75% of value of House)
B=(1,50,000*4)/400=Rs.1500
C=(150,000*1)/400=Rs.375
D=(1,50,000*8)/400=Rs.3000
Probability of Risk does not always depend on the value of
house
Application of Probability Theory and
Law of Large Numbers
Measures of Dispersion i.e. Variance and Standard
Deviation are used to calculate the average losses to
be born by the insurer.
The inertia of large numbers is applied while
calculating the probability. The larger the sample, the
smaller the margin of error.
Case Study: Probability Theory
Year
Actual Losses
(Houses that Burn)
Average
Losses
Difference
Difference
Squared
1 7 10 3 9
2 11 10 1 1
3 10 10 0 0
4 9 10 1 1
5 13 10 3 9
20
Variance (s
2
) = 20/5=4
Standard Deviation (s)=2


Estimation of Probability of Number of
Houses Burning Next Year
10 12 14 16 8 6 4
68.27%
95.45%
99.73%
No.of Houses
Burning between Probability
8-12 68.27%
6-14 95.45%
4-16 99.73%
The Role of Insurance in
Economic Development
Pooja Garg
Promote financial stability
By indemnifying those who suffer or harm,
insurance helps stabilize the financial situation of
individuals, families and organizations.
It encourages individuals and firms to invest and
create wealth.
Peach of mind and financial carelessness
Substitutes for and complements
government security programs
Private insurance can relieve pressure on
social insurance system, preserving
government resources for essential social
security.
Pension fund and life insurance
Natural disaster indemnity plan
Facilitates trade and
commerce
Many products and services are produced and
sold only if adequate liability insurance is
available to cover any claims for negligence.
Innovation
Credit enhancement
Helps mobilize savings
Insurance and financial intermediation
Insurance enhance financial system efficiency in
three ways
Reduce transaction costs associated with bringing
together savers and borrowers
Create liquidity
Facilitate economies of scale in investment
Enables risk to be managed
more efficiently
Risk pricing greater the expected loss, higher the
price
Risk transformation risk exposures can be
transferred to an insurer for a price
Risk pooling and reduction
(1) insurers make reasonably accurate estimates as to
the pools overall losses.
(2) insurers diversify their portfolios.
Fosters a more efficient
capital allocation
Insurers will monitor the companies to reduce
risk-increasing behavior and act in the best
interests of their various stakeholders.
A watch-dog role.
Thank You