Introduction to Insurance

Insurance
Insurance is the transfer of the risk of a loss, from one entity to
another in exchange for payment. It is a form of risk management
primarily used to hedge against the risk of a uncertain loss.

An insurer is a company selling the insurance.

The insured, or policyholder, is the person or entity buying the

insurance policy.

The amount of money to be charged for a certain amount of

insurance coverage is called the premium.
The insured receives a contract, called the Insurance Policy, which
details the conditions and circumstances under which the insured
will be financially compensated in exchange for agreed upon
premium payments.
 Insurance
 Meaning of Insurance : Insurance provides financial
protection against a loss arising out of happening of an
uncertain event. A person can avail this protection by
paying premium to an insurance company.

 The concept behind insurance is that a group of people

exposed to similar risk come together and make
contributions towards formation of a pool of funds.

 Contribution to the pool is made by a group of people

sharing common risks and collected by the insurance
companies in the form of premiums.

 In case a person actually suffers a loss on account of such

risk, he is compensated out of the same pool of funds.
Insurance works on the basic principle of risk-sharing. A great
advantage of insurance is that it spreads the risk of a few people
over a large group of people exposed to risk of similar type.
 How Insurance Works
The payments (or premiums) of the many pay for the
losses of a few.
The claims of the few are paid from pool of
funds. Because there are more people
contributing to the pool than there are
making claims, there is always enough to pay
the claims.
 Insurance for insurance companies

When the pool comes close to emptying because of Large

Claims, there is another pool from which insurance companies
can draw to pay claims.

Some of your premiums are used by your insurance company

to buy reinsurance – insurance for insurance companies.

Sometimes losses are so big – like those resulting from an

earthquake – that there is no way that an insurance company
can cover the costs. Reinsurance is an extra layer of
protection against large losses.
 Insurance Regulatory and Development
Authority of India (IRDA)
• IRDA is an autonomous statutory body which
regulates and develops the insurance industry in India.
• It was constituted by a Parliament of India act
called Insurance Regulatory and Development Authority
Act, 1999 and duly passed by the Government of
India.
• The agency operates from its headquarters
at Hyderabad, Telanagana where it shifted
from Delhi in 2001.
 Mission Statement (Objectives) of IRDA
 To protect the interest of and secure fair treatment to
policyholders.
 To bring about speedy and orderly growth of the insurance
industry, for the benefit of the common man.
 To ensure speedy settlement of genuine claims,
 To prevent insurance frauds and other malpractices.
 To promote fairness, transparency in the Insurance Industry.
 To take action where such standards are inadequate or
ineffectively enforced.
 Functions/Duties of IRDA
 To issue to the applicant a certificate of registration, renew,
modify, suspend or cancel such registration.

 Specifying requisite qualifications, code of conduct and

practical training for insurance intermediaries and agents.

 Specifying the code of conduct for surveyors and loss

assessors.

 Protection of the interests of the policy holders in matters

concerning settlement of insurance claim, surrender value of
policy and other terms and conditions of contracts of
insurance.
 Contd.

 Promoting efficiency in the conduct of insurance

business.

 Levying fees and other charges for carrying out the

purposes of this Act.

 Regulating investment of funds by insurance

companies;

 Regulating maintenance of margin of solvency;

 Risk
A probability or threat of damage, injury, liability, loss, or
any other negative occurrence that is caused by
external or internal factors, and that may be avoided
through pre-emptive action.

Risk is the possibility or chance of loss, danger or

injury.
 Classification of Risks
With regards insurability, there are basically two categories
of risks.

Speculative or dynamic risk

Pure or static risk
Speculative Risk:
Speculative (dynamic) risk is a situation in which either
profit or loss is possible.

Examples of speculative risks are betting on a horse

race, investing in stocks/bonds and real estate.

The outcome of the speculative risk is either beneficial

(profitable) or loss. Speculative risk is uninsurable.
 Classification of Risks
Pure Risk:

A category of Risk where there is a chance of either loss or no loss, but no chance of gain, as

oppose to loss or profit with speculative risk. The only outcome of pure risks are adverse (in a

loss) or neutral (with no loss), never beneficial.

They are pure in the sense that they do not mix both profits and losses.

Examples of pure risks include occupational disability, damage to property due to fire, lightning,

or flood.

Insuring an automobile is another example of Pure Risk.

If the insured auto is involved in an auto accident, there is most definitely going to be some

sort of damage (loss). On the other hand if no accident occurs, there is no possibility of gain.
Pure risks involve the possibility of LOSS only.
Types of Pure (Static) Risk:

1. Personal risks
2. Property risks
3. Liability risks
1.Personal Risks:

Personal risks are risks that directly affect an individual. They

involve the possibility of death, permanent physical disability, loss or
reduction of income, possibility of extra(huge) expenses etc.

There are four major personal risks:

Premature death
Old age
Poor health
Physical Disability
Premature death
Premature death risk is defined as the risk of the death of the
head of a family with unfulfilled financial obligations.

Old age
Old age is a risk of insufficient income during
retirement. When older workers retire, they lose their
regular earnings.

Poor Health
Risk of poor health includes both catastrophic medical bills
and the loss of earned income.
2. Property Risk
Property risk is the risk of having property damaged or
loss from numerous perils. Property loss can occur as a
result of fire, lightning, windstorms and a number of other
causes.

3. Liability Risk
Risk arising out of claims from third parties due to
third party bodily injuries or third party property
damages.
Liability insurance is very important for those who may be held
legally liable for the injuries of others.

A product manufacturer may purchase product liability insurance

to cover them if a product is faulty and causes damage to the
purchasers or any other third party.

Business owners may purchase liability insurance that covers

them if an employee is injured during business operations.
Fundamental Risks and Particular Risks

Fundamental risks affect the entire economy or large

numbers of people or groups within the economy.

Examples of fundamental risks are high inflation,

unemployment, war, and natural disasters such
as earthquakes, floods etc.
 Particular risks are risks that affect only individuals and
not the entire community. Examples of particular
risks are burglary, theft, auto accident, dwelling
fires. With particular risks, only individuals
experience losses, and the rest of the community are
left unaffected.
 Risk Management

Risk management refers to the practice of identifying potential

risks in advance, analysing them and taking precautionary steps to
reduce/curb the risk.

When an entity makes an investment decision, it exposes

itself to a number of financial risks.

These financial risks might be in the form of high inflation,

volatility in capital markets, recession, bankruptcy, etc.

So, in order to minimize and control the exposure of

investment to such risks, fund managers and investors
practice risk management
Stages of Risk Management
 Stages of Risk Management

1- Risk Identification:-
Risk identification starts from where the problem originates.
Determining what risks exist or are anticipated, their characteristics,
duration and possible outcomes.

2- Risk Analysis:-
Risk analysis includes analysing the risk and measuring its
impact, frequency and severity.
Quantitative Analysis - Numerically determining the probabilities of
various adverse events and expected extent of losses if any unexpected event
occurs

Qualitative Risk Analysis - Defining the various threats, planning

counter measures and determining the extent of impact.
Contd.

3- Risk Control:-
After analysing the risk then decided that how can the risk be
controlled. If the risk can be controlled by in house then well and
good, if not then decide on how to transfer that risk.

4- Risk Transfer:-
If the risk is not manageable and one cannot retain that risk,
then we have to transfer that risk to a third party. This is the
stage where insurance comes in action. Insurance will be
willing to take on those risks which the organization can’t
handle.
Contd.

5- Risk Review:-
It should be monitored that the desired results of the risk
management are being achieved or not and if not then identifying
that where the problem occurred and then reviewing all the steps
and making the change in risk management according to scenario.