Insurance and Risk

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Insurance and Risk
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Meaning of Insurance
Requirements of an Insurable Risk
Description of Insurable and Uninsurable Risks
Insurance Distinguished from Other Transactions
Types of Insurance
Social Benefits and Costs of Insurance
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Meaning of Insurance
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Insurance is a technique for handling an already
existing pure risk.
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Basic Characteristics of Insurance
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1- Pooling of losses
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Losses incurred by the few are spread over the
entire group, so that in the process, average
loss is substituted for actual loss.
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• Pooling is essential for two reasons
• losses of the few are spread over the entire
  group, so that average loss is substituted for
  actual loss. Thus, the financial burden of the
  loss is shared by the entire group.
• pooling involves the grouping of a large number
  of exposure units so that the law of large
  numbers can operate to provide a substantially
  accurate prediction of future losses.

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2- Payment of fortuitous losses
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Insurance plans provide for the pooling of
fortuitous losses. A fortuitous loss is one that
is unforeseen and unexpected and occurs as a
result of chance.
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3- Risk transfer
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In private insurance, a pure risk is transferred
from the insured to the insurer, which typically
is in a better financial position to pay the loss
than the insured.
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4- Indemnification
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Compensation is given to the victim of a loss, in
whole or in part, by payment, repair, or
replacement.
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Requirements of an Insurable Risk
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General Requirements
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1- Large number of exposure units
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2- Accidental and unintentional loss
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3- Determinable and measurable loss
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4- No catastrophic loss
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5- Calculable chance of loss
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6- Economically feasible premium
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Application of the Requirements
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How the risk of fire to a private dwelling
satisfies the requirements
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How the risk of unemployment fails to meet the
requirements
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Adverse Selection and Insurance
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1. Nature of adverse selection
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2. Consequences of adverse selection
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Description of Insurable and Uninsurable Risks
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Insurable Risks
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1. Personal
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2. Property
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3. Liability
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Generally Uninsurable Risks
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1. Market
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2. Financial
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3. Production
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4. Political
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These risks are generally uninsurable for several
reasons - many of these risks are speculative
risks, which are difficult to insure privately.
- the potential for a catastrophic loss is
great this is particularly true for political
risks, such as the risk of war. - calculation
of the proper premium may be difficult because
the chance of loss cannot be accurately estimated.
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Insurance Distinguished from Other Transactions
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How Insurance Differs from Gambling
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1. Insurance eliminates a pure risk, while
gambling creates a new speculative risk.
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• Insurance is socially productive, since both the
  insured and insurer win if the loss does not
  occur
• while gambling is socially unproductive, since
  the winner's gain comes at the expense of the
  loser .

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How Insurance Differs from Hedging
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Hedging is a technique for handling risks that
are typically uninsurable, such as protection
against a substantial decline in the price of
commodities.
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1. Insurance transfers a pure risk, while
hedging involves the transfer of a speculative
risk.
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2. Insurance reduces objective risk, because of
application of the law of large numbers while
hedging does not. Hedging typically involves
only risk transfer, not risk reduction.
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Types of Insurance
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Private Insurance
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Life and health insurance
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Property and liability insurance
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Government Insurance
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Social insurance
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Other government insurance programs
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Social Benefits and Costs of Insurance
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Benefits of Insurance to Society
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1. Indemnification for loss
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2. Less worry and fear
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3. Source of investment funds
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4. Loss prevention
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5. Enhancement of credit
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Costs of Insurance to Society
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1. Cost of doing business
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2. Fraudulent claims
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3. Inflated claims
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