Brief Introduction to Risk & Insurance
1. The Concept of Risk
The term ‘risk’ has several meanings.
It implies uncertainty about an outcome in
a given situations.
Chance – implies some doubt but in favorable way
Some defn of risk include:
Risk is the possibility of unfortunate occurrence
Risk is a combination of hazards/perils
Risk is unpredictability – the tendency that actual
results may differ from predicted results
Risk is uncertainty of loss (financial /material /human)
Risk is the possibility of loss
Common in the definitions are
a) Uncertainty
o 100% certainty almost ‘impossible’
o Uncertainty due to
o lack or imperfection in knowledge or
information
o Uncertainty exists whether we know or not
o Thus, the basis of risk is primarily lack of
knowledge; no risk if we know what is
going to happen
b) Differing levels or degrees in risks
oRisk is a combination of
likelihood of an event happening (frequency)
The severity should the event occur (severity)
oExamples:
o Collision VS overturning in motor vehicles
o Fire in residential houses VS Office Buildings
o Motor vehicle risks VS aviation risks
o Frequency & severity of loss predictable from
statistical data gathered over reasonable
number of years
c) Perils & Hazards
We often use risk, peril, hazard interchangeably
but they differ in insurance usage.
PERIL - Immediate cause of losses or the event
which bring about losses.
HAZARD - A condition which increases likelihood
of operation of peril or which worsen the
progression of the peril already in operation.
o Physical hazard - arises from physical
features.
o Moral hazard – personal character, integrity,
attitude.
d) Classification of Risks
i) Pure & Speculative Risks
Pure risk – where no prospect of gain, only involve
loss or no loss. (Business or trade risks)
Speculative risk – where chance of gain exists
(also called Risks of business or trade)
ii) Financial & Non-financial
Financial – where loss is quantifiable in money
o Theft of property, loss profit due to fire, etc.
Non-financial – where money not measure the
loss
o Selection of a career; purchase of a car
iii) Fundamental & Particular Risks
Fundamental – risks occurring outside everyone’s
control with far-reaching consequences
Particular – limited in cause & effect
e) Handling of Risks (Handling Mechanisms)
Risks can be handled broadly in four ways:
i) Avoidance
Rarely practical
Consider it at planning time
ii) Risk Prevention or Reduction
Quite practicable
Planning stage is more sound in
prevention/reduction
Weigh Costs VS benefits
“Prevention is better than cure”
iii) Risk Retention
Practical
but think of cost of retention
Consider putting fund aside or
Financing
iv) Risk Transfer
Outsourcing / subletting
Insurance- best mechanism of risk transfer
2) Insurance
a) Insurance is:
Sharing financial losses of “a few”
from a common fund formed by
contribution of the “many” who are
equally exposed to the same risk.
Spreading “the losses” of an individual
or a group of individuals.
The rate of contribution (the premium)
varies according to the degree of
hazard or exposure to loss/damage.
b) How does insurance function or what
are its functions?
Primary functions
Risk transfer & spread financial losses
Creation of common pool
Equitable premiums
Secondary functions
Releasing funds otherwise tied up for reserves
Investment sources/insurers invest a lot
Remove fear & build confidence (peace of mind)
Means of saving
Social benefits (insure continuity of business, thus
employment, production, foster international trade, etc)
Invisible exports
Loss control & reduce national loss
Rating, inspection/safety audit
Loss inspection/salvage recovery
D/t professional associations
c) Nature of insurable risks
Insurable risks - characteristics
Fortuitous /accidental
tear, wear, depreciation, etc excluded
damage intentionally caused not covered
Profitable U/W depends on accurate risk
Financialvalue
Insurable interest
Homogeneous exposures
Given sufficient no. of exposure to
similar risks, insurers can forecast expected
extent of loss
Law of large numbers
Pure risks
Particular risks
d) Limitations of insurance
Only pure risks can be insured
Legal entitlement to insure – insurable interest
Insurance limited financial value – indemnity
There must be large no. of similar risks
It must be possible to calculate the risk of loss
Loss must not be catastrophic
Loss must have element of uncertainty or
accident, &
So on
e) Classes of insurance
Two main branches
Life Insurance
General Insurance
Marine
Fire
Motor
Miscellaneous
OR
Insurance of property (Fire, marine, motor, etc)
Insurance of person (personal accident, WC,
etc)
Insurance of interest (fidelity g., bonds, etc)
Insurance of liability (public liab., general liab.,
etc)
End of Part I
Thank You all!