Nature of Insurance PDF

1/13 NATURE OF INSURANCE INS510 NEXT  2/13 DEFINITION Insurance is an agreement whereby a group of individuals facing similar risks can share the fortuitous losses of the unlucky few by...

1/13 NATURE OF INSURANCE INS510 NEXT  2/13 DEFINITION Insurance is an agreement whereby a group of individuals facing similar risks can share the fortuitous losses of the unlucky few by the transfer of such risks to the insurance company (insurer) who agrees to compensate the losses NEXT  THE OPERATIONS OF INSURANCE 01 02 03 Premium Common Pool Measuring Effectiveness... contributions from many insured...... pooled together...... pay losses suffered by the unlucky few... 3/13 NEXT 4/13 The insurer collect premiums from a group of people in HOW DOES similar circumstances (similar risks) Not all will suffer losses in any one year. In general insurance the period of insurance is 12 months durations whereas the life inurance the period of insurance usually INSURANCE more than 12 months duration. i.e 5 years These premiums are then pooled together and used by the insurer to pay losses WORK Losses are thus shared out among all the policyholders rather then borne solely by the unlucky few NEXT  5/13 CONCEPT OF COMMON POOL Insurance uses the common pool concept. It involved contributions from many insured pooled togehter to pay for the losses suffered by a few The common pool mechanism involves the following :- ⚬ An insurance companu sets itself up to operate the pool ⚬ It takes contributions in the form of insurance premiums from many insured and pay for the losses of a few ⚬ The operations of common pool is very much based on the successful appliation of the Law of Large Numbers. The law states that the ;arger the group of similar risks, the closer the actual losses experienced by the group will approach the expected loss NEXT  6/13 INSURANCE PREMIUM In fixing the premium, the insurer has to assess the risk and fix a premium reflects the hazard and value of the risk which an insured brings to the pool Contribution from 2. Common pool 3. Pay losses suffered by many insureds a few NEXT CHARACTERISTICS OF INSURABLE RISK Fortuitous Losses - The loss must be accidental, unintentional and randomly curred by chance in nature Financial Value - The losses must be assessable and can be measured in monetary terms or financially measurable Insurable Interest - Must be legally recognize relationship between the insured and the financial loss. Therefore, the insured must stand to suffer the financial loss of the risk does occur Large Number of Similar Risks (Homogenous Exposure) - In order for insurer to be able to predict the losses and calculate a suitable premium accurately, there must be a large number of similar risks. Therefore if there are large number of similar risks only then can the risk be classified as an insurable risk Pure Risks - Insurer will only insure pure risks because there is no element of gain (profit). In this situation, one will suffer a loss or incur no loss. Hence, there is no possibility of profiting from a pure risk 7/13 NEXT CHARACTERISTICS OF INSURABLE RISK Legal and Not Against Public Policy - The item to be insured should be legal and not against public policy. The insurance contract is said to be against public policy, if they tend ti promote breach of the law or tend to harm the state or its citizens. No Catastrophic Loss - A catastrophic loss arise when a large number of risks incur losses at the same time or when one huge loss takes place such as wars and natural disasters. Reasonable Premium - Premium must be reasonable and be in relation to the potential loss. Risks that have high frequency and high severity will result a much higher premium than risks that have low frequency and low severity. 8/13 NEXT  2. SECONDARY FUNCTIONS (6) THE release funds otherwise tied up in reserves FUNCTIONS OF stimulate business enterprise reduce fear and worry INSURANCE reduce losses encourage saving offer social benefits 1. PRIMARY FUNCTION (1) risk transfer mechanism 3. INDIRECT FUNCTIONS (3) investment of funds invisible exports source of employment 9/13  PRIMARY FUNCTION Risk Transfer Mechanism Insurance acts as a risk transfer mechanism where the insured in exchange for protection, pays a sum of premium to the insurer and transfer the responsibility of loss or damage to the insurer 10/13 NEXT  SECONDARY FUNCTIONS Release funds otherwise tied up in reserves business enterprises / individual do not have to freeze their capital to provide financial protetion against losses. The fund released would be available for investment Stimulate business enterprise many business enterpprises could not have started without transferring many of their risks to the insurers Reduce fear and worry insurance provides peace of mind to business enterprises/ individual by removing fears and worries of lossess. The removal of fears and worries helps to establish confidence and enable forward planning of economic activities Reduce losses insurers help to educe losses both in frequency and severity through through their actions and recommendations in risk assessment activities Encourage saving insureance acts as a mean of committed and systematic saving due to payment of regular premium. The insured will get the lump sum amount at the maturity oof the policy contract Offer social benefits people of the society were exposed to a number of personal risks due to their accidental death, unemplyment , disability and etc. Such event bring serious economical problem to the individual and his dependents. In such circumstances, the insurance considered as an effective measure to minimize such social problem. For this, insurance provides financial compensation against the losses due to such events 11/13 NEXT  12/13 INDIRECT FUNCTIONS OF INSURANCE Investment of funds Invisible exports Source of employment Common pool accumulates large funds Insurance promotes invisible exports The insurance industry in Malaysia has which insurers hold as custodians and such as providing the insurance created various categories of they will invest these funds in the funds coverage to other countries employment opportunitities in the public and private sectors to earn profit NEXT  THE BENEFITS OF INSURANCE Peace of mind Loss control Invisible earnings Social benefits Investment of fund 13/13 END