Insurance; Chapter 2- Key Points

Chapter 2: Risk and Insurance:

Nature of Risk as it Relates to Insurance;

• Risk has many meanings in the context of insurance. It can relate to the possibility of a loss ocurring, the item that is proposed for insurance or the potential hazard. 

Categories of Risk;

Insurable risks can be grouped as;

• Financial (i.e. their impact must be capable of financial measurement)
• Pure (i.e. Not speculative) 
• Particular (i.e. Localised and personal in their impact)

Types of risk which can be insured;

• For a risk to be insurable it must be fortuitous (i.e. accidental and not inevitable), there must be insurable interest (i.e. a legally recognised relationship between the insured and the financial loss) and in keeping with public policy (i.e. not be contrary to what society is believes is right and proper)

Types of risk which cannot be insured; 

Risks cannot be insured which are;

• Non financial (i.e. not measureable in monetary terms)
• Speculative (i.e. not undertaken for profit)
• Fundamental (i.e. outside of the control of one individual and affecting large swathes of society)

Components of Risk;

• The insurer will consider the frequency with which a risk occurs, and the severity of it's impact when it does, when deciding how much of a risk can be prudently accepted. 
• A peril is that which gives rise to a loss and a hazard is that which influences the operation or effect of the peril. Hazards can be physical or moral and either can be 'good' or 'poor'. 

Basis of insurance as a risk transfer mechanism;

• The primary function of insurance is to act as a risk transfer mechanism, that is to transfer a risk from one person, the insured, to another, the insurer. The insured exchanges a large unknown financial risk for a much smaller certain premium. 

Pooling of Risks;

• Pooling of risks is the principle whereby the losses of the few are paid for by the premiums of the many who, facing the same risk, suffer no loss.
• The law of large numbers means that where there are a large number of similar situations the actual number of events occuring tends towards the expected number.
• Each person contributing to the pool must contribute a fair premium to it based on the amount of risk they bring to the pool.

Self-Insurance; Co-Insurance; Dual Insurance; Reinsurance:

• Self-insurance is where the insured decides to carry the risk themselves by setting aside funding.
• Co-insurance involves several insurers taking a specified proportion of the same risk.
• Duel insurance is the existence of two or more policies covering the same risk.
• Reinsurance is where insurers effectively insure the risk again.

Benefits of Insurance;

• Insurance brings peace of mind for the insurerd and a number of economic benefits to both businesses and society at large.