RISK AND RISK AND INSURANCEINSURANCE

NATURE OF INSURANCE

DEFINITION

Insurance is an agreement whereby a group of individuals facing similar risks can share the fortuitous losses of the unlucky few by the transfer of such risks to the insurer who agrees to compensate the losses

HOW DOES INSURANCE WORK?

Insurer can collect premiums from a group of people in similar circumstances not all of whom will suffer losses in any one year.

These premiums are then pooled together and used by the insurer to pay losses.

Losses are thus shared out among all the policyholders rather than borne solely by the unlucky few.

COMMON POOL

An insurance company sets itself up to operate the pool.

It takes contributions, in the form of insurance premiums from many insureds and pay for the losses of a few.

The operation of the common pool is very much based on the successful application of the Law of Large Numbers.

LAW OF LARGE NUMBERS Law of large numbers states that the

larger the group of similar risks, the closer the actual losses experienced by the group will approach the expected losses

This law implies that the greater the number of similar risk, the more accurate the insurer can be in predicting the future losses.

Allows the insurer to fix premium in advance

Insurer can assess the risk and fix a premium which reflects the hazard and value of the risk which an insured brings to the pool.

INSURANCE PREMIUM

Contribution = premium which is the consideration an insured pays to the insure for an insurance coverage of a specified nature for a specified policy period

BREAKDOWN OF THE PREMIUM

PURE PREMIUM RISK

EXPENSE LOADING

CONTINGENCY LOADING

PROFIT LOADING

PREMIUM CALCULATION

SUM INSURED x PREMIUM RATE = PREMIUM PAYABLE.

Premium Rate =

Average Total Claims / Average Total Value Insured X 100%

Expense Loading – to cover the expenses occurred in maintaining the insureds contribution.

Contingency Loading – to cover the possible variability of claims costs.

Profit Loading – to cover expected dividend payments to the insurer’s shareholders.

CXTS OF INSURABLE RISKS

Financial Value Large number of similar

risks Pure risks only No catastrophic loss Fortuitous Loss Insurable Interest Legal and not against

public policy Reasonable premium

FUNCTION OF INSURANCE

PRIMARY FUNCTION– Risk transfer

mechanism

FUNCTION OF INSURANCE

SECONDARY FUNCTIONS– Releasing funds otherwise

tied up in reserves.– Stimulate business

enterprise– Insurance also stimulates

business– Remove fear and worry– Reduction of losses– Savings– Social benefits

FUNCTION OF INSURANCE

INDIRECT FUNCTION– Investments of funds– Invisible exports

OTHERS Sources of Employment

– Insurance industry has generated numerous employment opportunities

Classes of Insurance– Life Assurance– General Insurance

Risks Covered by Life Assurance– Premature Death– Continuous Stream of Income during retirement– Sickness or Disability

Risks Covered by General Insurance– Motor Vehicles– Marine and Aviation– Products or goods sold

DIFFERENCES BETWEEN LIFE AND OTHER FORMS OF

INSURANCE Life – Certain event, the only uncertainty

is when the time it will occur General – term of contract is only one year

and it is cancelable by both parties Life longer term and can only be cancel by

insured General is subject to principle of indemnity