Insurance and Risk: Chapter 2

• Chapter 2 is about Insurance and Risk.

Definition of Insurance

• Insurance involves pooling fortuitous losses.
• Risk is transferred to insurers who agree to indemnify insureds for losses.
• Insurers provide pecuniary benefits or render services connected to risk occurrence.

Basic Characteristics of Insurance

• Pooling involves spreading losses incurred by a few over an entire group.
• Risk reduction includes medical care, fire departments, security guards, sprinkler systems, and burglar alarms.
• These attempt to deal with risk by preventing a loss or reducing the chance it will occur.

Example of Pooling

• Two business owners own identical buildings valued at $50,000
• There is 10-percent chance each building will be destroyed by a peril in any year.
• The loss to either building is an independent event.
• Each owner faces a potential loss of $50,000, with an expected loss of $5,000.
• The standard deviation is $15,000.

Insurance vs. Gambling

• Insurance handles an already existing pure risk and is always socially productive.
• Both parties have a common interest in the prevention of a loss with insurance.
• Gambling creates a new speculative risk and is not socially productive.
• The winner's gain comes at the expense of the loser with gambling.

Types of Private Insurance

• Life insurance pays death benefits to beneficiaries when the insured dies.
• Health insurance covers medical expenses because of sickness or injury.
• Property insurance indemnifies property owners against the loss or damage of real or personal property.
• Liability insurance covers the insured's legal liability arising out of property damage or bodily injury to others.
• Casualty insurance refers to insurance that is not covered by fire, marine, and life insurance.

Other insurance types

• Personal lines coverages include real estate and personal property for individuals/families.
• Protection against legal liability is also a part of personal lines insurance.
• Commercial lines of insurance include coverages for business firms, nonprofit organizations, and government agencies.

Social Insurance Programs

• Financed entirely or in large part by contributions from employers, employees or both.
• Benefits are heavily weighted in favor of low-income groups.
• Eligibility and benefits are prescribed by statute.
• Examples include Social Security, Unemployment, and Workers' Compensation.
• Other government insurance programs are found at both the federal and state level.
• Examples include Federal flood insurance, and state health insurance pools

Social Benefits of Insurance

• Indemnification for loss
• Reduction of worry and fear
• Source of investment funds
• Loss prevention
• Enhancement of credit

Social Costs of Insurance

• The cost of doing business is a social cost of insurance.
• An expense loading is the amount needed to pay all expenses, including commissions, general administrative expenses, state premium taxes, acquisition expenses, and an allowance for contingencies and profit.
• Fraudulent claims and inflated claims are also social costs.
• Higher premiums to cover additional losses reduce disposable income and consumption of other goods and services.