INTRODUCTION TO RISK AND INSURANCE

RISK AND INSURANCE [INS420]CHAPTER 1

Learning Objectives At the end of this lecture, student is

expected to understanding of the followings; The concept of risk in insurance

application Probability theory application in

insurance risk forecasting Related concepts Basic category of risk in insurance Type of pure risk

What is Insurance?

Insurance, is a form of risk management primarily used to hedge against the risk of a contingent loss.

Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for a premium.

An insurer is a company selling the insurance; an insured or policyholder is the person or entity buying the insurance.

The insurance rate is a factor used to determine the amount to be charged for a certain amount of insurance coverage, called the premium.

Risk management refers to the practice of appraising and controlling risk.

CONCEPT OF RISK Risk is the variation in outcomes in a given situation Specifically, risk in insurance term refers to uncertainty about

the loss we may suffer in the future. Risk present in the lives of individuals and in the world of

commerce and industry. A peril is a cause of loss. Typical perils include the followings:-

Fire Collision Flood Sickness Premature death Negligence etc

CONCEPT OF RISK

The term probability refers to an area or study which measures the chance of occurrence of a particular event

It is possible to determine the chance of loss using probability theory provided that there is a large number of loss exposure

PROBABILITY THEORY

RELATED CONCEPT

Physical condition that increases the condition of loss

Character defect in an individual that increases the chance of loss

Indifference caused by the knowledge that insurance exist

Hazard

Perils

Loss

*Is a condition that increases the chance of loss

*Is a cause of loss

*loss is a reduction or disappearance of economic value

[1] Physical Hazard

[2] Moral Hazard

[3] Morale Hazard

Hazard – Peril - LossHAZARD PERIL LOSS

Explosive

Poor Brake

Poor Health

Carelessness

Explosion

Motor Accident

Illness

Negligence

Property damage Loss of income Additional expenses

Property damage Loss of use Loss of income

Medical expenses Loss of income Additional expenses

Court award Legal expenses Additional expenses

Basic Categories of Risk

Fundamental Risk

Particular Risk

Fundamental risk affect the entire economy or large number of persons/groups within the economy. It cannot be controlled.

Source of risk:-

[1] Flood

[2] Typhoon

[3] Inflation

[4] Mass unemployment

[5] …and ..etc

Particular risk is the consequences of individual action or choice (responsibility of individual)

For example – crossing a road

We can distinguish between the different kind of risk by looking at their EFFECTS

Pure Risk

Speculative Risk

Pure risk exists when there is both possibility of loss or no loss.

For example – The owner of an automobile faces the risk associated with a potential collision loss.

-If the collision occur, the owner will suffer financial loss

-If no collision occur, the owner does not gain, so owner financial remain unchanged

Speculative risk exists when there is possibility of profit, loss or no loss.

For example – investment in a capital project might be profitable or it might prove to be a failure

**Speculative risks are rarely insured

We can also distinguish between the different kind of risk by looking at their OUTCOMES

Pure RiskPure risk is a chance of loss with no

chance for gain. Pure risks are random (can happen to

anyone) and result in loss (not gain). Examples of pure risk include the

following: Accidents resulting in physical injury and

damage to property Illnesses that people get throughout life, as a

part of aging Acts of nature, resulting in damage to persons

and property

Speculative Risk A speculative risk may result in either gain

or loss. Because speculative risks are not “accidental”

or random, and may result in either gain or loss, you cannot protect yourself from losses in a traditional manner.

While hedging (making an investment to help offset against loss) is a technique used to help reduce losses from such risky acts, it does not reduce the risk itself.

A court of law may order you to pay substantial damage to the person whom you have injured

Risk directly affecting an individual

Risk of destruction or theft of property

Personal Risk

A personal risk is the chance of loss involving your income and standard of living.

You can protect yourself from personal risks by buying life, health, and disability insurance.

In addition, insurance against personal risks protects others who are depending on your income to provide food, clothing, shelter, and the comforts of life.

Give raise to great financial losses.

[1] Loss of human value

[2] Additional expenses inccured

The major risk associated with old age is the possibility of insufficient income during retirement

Risk of poor health is associated with the risks of

[1] Medical expenses

[2] Loss of earned income

Major risk associated with unemployment are

[1] Loss of earned income

[2] Depletion of accumulated financial assets

Property Risk The chance of loss or harm to personal or

real property is called property risk. For example, your home, car, or other

possessions could be damaged or destroyed by fire, theft, wind, rain, accident, and other hazards.

To protect against such risks, you can buy property insurance.

Damage to a property by peril

For example – loss of value of the house as a result of fire (the peril)

A loss in consequence of a direct loss i.e property damage.

For example – loss of profit as result of business interruption following damage on the business premises

Extra expenses incurred as a result of the loss.

For example – Renovation/Re-fixing of damage property

Liability Risk A liability risk is the chance of loss that

may occur when your errors or actions result in injuries to others or damages to their property. For example, you could accidentally cause

injury or damage to others or their property by your conduct while driving a car.

Or a person could fall because of your home’s crumbling front steps and break an arm.

Liability insurance will protect you when others sue you for injuring them or damaging their property.

THANK YOUANY QUESTION?DO YOU CHECKLIST

Chapter Topics ChecklistLecture Revision

CHAPTER1

The Nature of Risks Introduction Concepts relating to risks Classification of risks Measurement of risks

Check your understanding…