Nature and Operations of Insurance

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Questions and Answers

What determines the premium amount in insurance?

The length of the insurance policy

The age of the insured individual

The type of insured asset

The frequency and severity of the risk (correct)

What is considered a primary function of insurance?

Providing employment opportunities

Risk transfer mechanism (correct)

Investment of funds

Encouraging saving

How does insurance stimulate business enterprise?

By providing direct funding for startup costs

By offering lower premiums to investors

By allowing businesses to transfer risks to insurers (correct)

By covering all operational costs for businesses

What is one of the secondary functions of insurance?

Release of funds tied in reserves Signup and view all the answers

What is the effect of insurance on individuals and businesses regarding fear and worry?

It reduces fear and worry by providing peace of mind Signup and view all the answers

Which of the following is NOT categorized as a secondary function of insurance?

Providing comprehensive risk coverage Signup and view all the answers

In the context of insurance, what does 'risk transfer mechanism' mean?

The insured pays a premium to shift the responsibility of loss to the insurer Signup and view all the answers

What is a benefit of releasing funds from reserves in the context of insurance?

It allows for more capital to be available for investments Signup and view all the answers

What is the primary reason insurers require a large number of similar risks?

To accurately predict losses and calculate suitable premiums Signup and view all the answers

What is one benefit of insurance related to financial stability?

It provides financial compensation against personal risks. Signup and view all the answers

Which characteristic must be true for a loss to be considered insurable?

The loss must be accidental and unintentional Signup and view all the answers

What is the primary function of insurance according to the definition provided?

To share the fortuitous losses among a group Signup and view all the answers

How does insurance help in risk management?

By reducing losses in frequency and severity. Signup and view all the answers

What type of risks will insurers typically avoid insuring?

Speculative risks Signup and view all the answers

In insurance operations, what is typically done with the premiums collected from policyholders?

They are used to pay for the losses of a few individuals Signup and view all the answers

What role does insurance play in personal finance planning?

It offers systematic saving through premium payments. Signup and view all the answers

Which aspect must be present in an insurance contract regarding insurable interest?

The insured must have financial responsibility for the item Signup and view all the answers

What indirect function of insurance relates to economic growth?

Investment of funds in public and private sectors. Signup and view all the answers

Why are catastrophic losses generally not insurable?

They can lead to losses across many policies simultaneously Signup and view all the answers

Why is the common pool concept important in insurance?

It enables sharing of losses among many insured individuals Signup and view all the answers

How does the Law of Large Numbers relate to insurance?

It helps to stabilize loss estimates by pooling a large number of risks Signup and view all the answers

What does the term 'reasonable premium' refer to in insurance?

A premium proportional to the potential loss Signup and view all the answers

Why is insurance considered important for societal welfare?

It minimizes social problems resulting from personal risks. Signup and view all the answers

Which of the following is characteristic of pure risks?

They have no possibility of gain Signup and view all the answers

What differentiates life insurance from general insurance regarding the duration of coverage?

Life insurance usually extends beyond 12 months, often for many years Signup and view all the answers

How do insurers contribute to employment in society?

By creating various employment opportunities in the insurance industry. Signup and view all the answers

What type of losses must be assessed and measurable in monetary terms for an event to be classified as insurable?

Financial losses Signup and view all the answers

What is meant by the term 'invisible exports' in the context of insurance?

Insurance coverage provided to other countries. Signup and view all the answers

What role does the insurer have in the process of pooling premiums?

To create and manage the common pool for covering losses Signup and view all the answers

What can be inferred about policyholders in an insurance system?

Policyholders share risk, even though only a few may suffer losses Signup and view all the answers

What psychological benefit does insurance provide?

Peace of mind against future uncertainties. Signup and view all the answers

What aspect of risk does insurance primarily address?

Risk sharing Signup and view all the answers

Study Notes

Nature of Insurance

Insurance is an agreement where a group of individuals with similar risks share the losses of a unlucky few.
The insurance company (insurer) compensates the losses.

Operations of Insurance

Premium: Contributions from many insured.
Common Pool: Premiums pooled together.
Measuring Effectiveness: Paying losses suffered by the unlucky few.

How Insurance Works

Insurers collect premiums from a group of people in similar circumstances.
Not all will suffer losses in any one year, typically over a period of 12 months, though life insurance can be more than 12 months.
Premiums are pooled together to pay losses.
Losses are shared among all policyholders, not just a few unlucky ones.

Concept of Common Pool

Insurance uses a common pool concept, with contributions from many insured.
The pool pays for losses suffered by a few.
Insurance companies operate this pool with premiums from many insured.
The Law of Large Numbers is vital in determining the operations of the common-pool.

Insurance Premium

Insurers assess risk and set premiums, which reflect the hazard and risk associated.
Contribution from many insured.
A common pool where the funds are pooled together.
To pay losses suffered by a few.

Characteristics of Insurable Risk

Fortuitous Losses: Accidental, unintentional, randomly caused losses.
Financial Value: Losses are assessable and measurable.
Insurable Interest: Legal recognition of the relationship between insured and potential financial loss.
Large Number of Similar Risks (Homogenous Exposure): Allows for accurate loss predictions and premium calculation.
Pure Risks: Only losses or no loss, no profit potential.

Characteristics of Insurable Risk (continued)

Legal and Not Against Public Policy: Insured items must be legal and not against public interest.
No Catastrophic Loss: No huge losses occurring at the same time (like wars or natural disasters).
Reasonable Premium: Premium must be fair based on potential loss. High frequency/high severity = higher premium, while low frequency/low severity = lower premium.

Functions of Insurance

Primary Function (1): Risk transfer mechanism.
Secondary Functions (6):
- Funds released otherwise tied up in reserves.
- Stimulate business enterprise.
- Reduce fear and worry for loss.
- Reduce losses.
- Encourage saving.
- Offer social benefits.
Indirect Functions (3):
- Investment of funds inside pool.
- Invisible exports - insurance coverage sold to other countries.
- Source of employment.

Primary Function - Risk Transfer Mechanism

Insurance transfers risk from the insured (individuals/businesses) to the insurer (insurance company).

Benefits of Insurance

Peace of mind.
Loss control
Invisible earnings
Social benefits
Investment of fund

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Description

This quiz covers the fundamental principles of insurance, including the nature of risk sharing and how premiums are collected and pooled. Learn how insurance companies manage losses and the concept of common pool within the insurance framework. Assess your understanding of these key concepts in insurance operations.