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Introduction

Insurance is a cooperative mechanism that spreads losses from risks among individuals, characterized by pooling of losses, payment of fortuitous losses, risk transfer, and indemnification. Essential requirements for an insurable risk include a large number of exposure units, accidental losses, and calculable chances of loss. Unlike gambling, which creates speculative risks, insurance addresses existing pure risks and is socially productive.

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Ashik Shikder
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2 views7 pages

Introduction

Insurance is a cooperative mechanism that spreads losses from risks among individuals, characterized by pooling of losses, payment of fortuitous losses, risk transfer, and indemnification. Essential requirements for an insurable risk include a large number of exposure units, accidental losses, and calculable chances of loss. Unlike gambling, which creates speculative risks, insurance addresses existing pure risks and is socially productive.

Uploaded by

Ashik Shikder
Copyright
© All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
Available Formats
Download as PDF, TXT or read online on Scribd

Basics of

Insurance
Insurance
• Insurance is a co-operative device to spread losses caused by a
particular risk over a number of persons who are exposed to it or
agreed to ensure themselves against that risk.
Basic characteristics:
Pooling of losses
Payment of fortuitous losses
Risk transfer
Indemnification
Cont…
• Pooling of losses: Spreading of losses by the few over the entire
group, so that in the process average loss is substituted for actual
loss. It 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 that are subject to the same
perils.
• Payment of fortuitous losses: A fortuitous loss is one that is
unforeseen and unexpected and occurs as a result of chance. In other
words, the loss must be accidental. Insurance policies don't cover
intentional losses.
Cont…
• Risk transfer: Risk transfer means that a pure risk is transferred from
the insured to the insurer, who typically is in a stronger financial
position to pay the loss than the insured. From the view point of the
individual, pure risks that are typically transferred to insurers include
premature death, poor health, disability and theft of property.
• Indemnification: Indemnification means that the insured is restored
to his/her approximate financial position prior to the occurrence of
the loss. Thus if your home burns in a fire a home owner policy will
indemnify you or restore you to your previous position.
Requirements of an insurable risk
• There must be a large number of exposure units.
• The loss must be accidental and unintentional.
• The loss must be determinable and measurable.
• The loss should not be catastrophic.
• The chance of loss must be calculable.
• The premium (service charge+ profit+ present value of money) must
be economically feasible.
Insurance and gambling compared
• Gambling creates a new speculative risk while insurance is a
technique for handling an already existing pure risk.
• Gambling is socially unproductive because the winners gain comes at
the expense of the losers in contrast insurance is always socially
productive because neither the insurer nor the insured is placed in a
position where the gain of the winner comes at the expense of the
loser.
Adverse Selection and Insurance
• Adverse selection is the tendency of persons with a higher than
average chance of loss to seek insurance at standard rates, which if
not controlled by underwriting results in higher than expected loss
levels.
• Adverse selection can be controlled by – underwriting and policy
provisions.

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