Principles Of Insurance

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Principles Of Insurance
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Meaning of Risk

• Risk is the potential that a chosen action or
  activity (including the choice of inaction) will
  lead to a loss (an undesirable outcome)
• OR
• Risk is an uncertainty concerning the occurrence
  of a loss
• In insurance industry we define risk to identify
  the property or life being insured
• that driver is a poor risk, cancer patient is
  an unacceptable risk

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Types of Risk

• Objective Risk relative variation of actual loss
  from expected loss
• For eg An insurer has 100000 cars insured for a
  long period of time, and on the average 10000
  cars meet with at least one accident and claim
  for damages each year. However, for a particular
  year, it is unlikely that there will be exactly
  10000 claims. Under certain assumptions, it can
  be proven that over a long period of time, the
  deviation of the number of claim in a year from
  10000 will, on the average be 100.
• Thus there is a variation of 100 claims from the
  expected number of 10000 or a variation of 1.
• This relative variation of actual loss from
  expected loss is known as objective risk

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Types of Risk

• Subjective Risk-an uncertainty in the
  individuals personal estimate of the chance of
  loss.
• It can vary from one person to another.
• For eg-Somebody who has lost a lot of money in
  the stock market will probably feel more risk
  investing in the market than someone who has
  profited handsomely.
• Subjective risk may alter the behavior of the
  risk taker if it is an undesirable risk

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Types of Probabilities

• Objective probability is the probability of an
  occurrence, calculated by either deduction or
  induction
• Subjective probability is a persons perception
  of the likelihood of an event.

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Chance of Loss

• is the probability that a loss will occur, which
  can either be an expected loss or an actual loss

Chance of Loss Expected or Actual Loss-------------------Number of Possible Losses
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Peril and Hazard

• peril is something that can cause a loss.
  Examples include falling, crashing your car,
  fire, wind, hail, lightning, water, volcanic
  eruptions, choking, or falling objects
• Hazard is a condition that creates or increases
  the chance of loss

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Types of Hazards

• Physical hazard
• Moral Hazard
• Morale hazard
• Legal hazard

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Physical Hazard

• Physical condition that increases the chance of
  loss
• Examples-
• Icy roads that increase the chance of an auto
  accident
• Defective wiring in a building that increases the
  chance of fire
• working from heights, including ladders,
  scaffolds, roofs, or any raised work area

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Moral Hazard

• Dishonesty or character defects in an individual
  that increase the frequency or severity of loss
• Examples-
• Submitting a fraudulent claim,
• inflating the amount of a claim,
• Intentionally burning unsold merchandise that is
  insured

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Morale Hazard

• Carelessness or indifference to a loss because of
  the existence of insurance
• Examples
• Leaving car keys in an unlocked car which
  increases the chance of theft
• Leaving a door unlocked that allows a burglar to
  enter
• Its insured so why should I worry about safety
  of my house/property/own health. If anything goes
  wrong, insurer is there to indemnify me. So, Why
  should I worry about safety?

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Legal Hazard

• Characteristics of the legal system or regulatory
  environment that increase the frequency or
  severity of losses
• Examples
• Laws that require insurers to include coverage
  for certain benefits in health insurance plans,
  such as alcholism

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Categories of Risks

• Pure and Speculative Risks
• Fundamental and Particular Risks
• Enterprise Risk

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Pure Risk Speculative Risk

• Pure risk there are only the possibilities of
  loss or no loss
• Examples Damage to property from fire,
  lightning, flood or earthquake etc
• Speculative risk either profit or loss is
  possible
• Examples investment in shares or real estate,
  betting on horse race
• ONLY Pure Risks are insured but exceptions always
  exist.. Like some insurers will insure
  institutional portfolio investments

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Fundamental Particular Risks

• Fundamental risk affects the entire economy or
  large number of persons or groups within the
  economy rapid inflation, cyclical unemployment,
  war, natural disaster, terrorist attack
• Particular Risk affects only individuals and not
  the entire community . For e.g.. Car thefts, bank
  robberies, dwelling fires

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Enterprise Risk

• Relatively new term that encompass major risks
  faced by a business firm
• Pure Risk
• Speculative Risk
• Strategic Risk uncertainty regarding the firms
  financial goals and objectives
• Operational Risk results from the firms
  business operations like a bank that offers new
  online banking services may incur losses if
  hackers break into the bank s computers

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Enterprise Risk contd

• Financial risk refers to the uncertainty of loss
  because of adverse changes in commodity prices,
  interest rates, foreign exchange rates, an the
  value of money
• Examples-
• A food company that agrees to deliver a
  commodity at a fixed price to a supermarket in
  six months may lose money if grain price rises

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Types of Pure Risks

• Premature Death
• Insufficient income during retirement
• Poor health
• Unemployment
• Property risks
• Liability risks

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A
Contract

• An agreement between two or more parties to do or
  abstain from doing an act
• Create a legally binding relationship

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Essentials of a valid Contract-

• The intention to create legal relations
• Offer and acceptance
• Consideration
• Certainty of terms
• Consensus ad idem (a genuine meeting of minds)
• Legality of purpose
• Possibility of performance

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Requirements of an Insurance Contract

• Offer and acceptance
• Consideration
• Competent parties
• Legal Purpose

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Requirements of an Insurance Contract

• Offer and Acceptance Applicant for insurance
  makes the offer and the company accepts or
  rejects the offer
• An agent merely solicits the prospective insured
  to make the offer
• In property Liability insurance especially
  personal line insurance auto , home insurance ,
  the agents typically have the power to bind the
  insurer through the use of binder.
• Binder is a temporary contract for insurance
• In life insurance, agent does not have the power
  to bind the insurer
• A conditional premium receipt is given to the
  applicant after filling the application form

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Consideration

• Consideration is the value that each party gives
  to the other

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Competent Parties

• Each party must be legally competent/ must have
  legal capacity to enter into a binding contract
• Most adults are legally competent to enter into
  the insurance contracts but there are some
  exceptions like
• Insane persons, intoxicated persons, minors
• Also, insurer must be licensed to sell insurance
  in that country

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Legal Purpose

• An insurance contract that encourages something
  illegal or immoral is contrary to the public
  interest and can not be enforced
• For e.g. policy can not cover seizure of the
  drugs by the police

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Distinct Legal Characteristics of Insurance
Contracts

• Aleatory Contract
• Unilateral Contract
• Personal Contract
• Conditional Contract
• Contract of Adhesion

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Distinct Legal Characteristics of Insurance
Contracts

• Aleatory Contract where the values exchanged may
  not be equal but depend on an uncertain event .
  For e.g..- ?????????? (Commutative Contract?)
• Unilateral Contract only one party makes a
  legally enforceable promise. Only the insurer
  makes a legally enforceable promise to pay a
  claim . After the first premium is paid, the
  insured can not be legally forced to pay the
  premiums (Bilateral Contract?)
• Personal Contract the contract is between the
  insured and the insurer

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Distinct Legal Characteristics of Insurance
Contracts

• Conditional Contract Insurers obligations to
  pay a claim depends on whether the insured has
  compiled with all policy conditions
• For e.g. In a homeowners policy , the insured
  must give immediate notice of loss. If the
  insured delays for an unreasonable period in
  reporting the loss, the insurer can refuse to pay
  the claim
• Contract of Adhesion means the insured must
  accept the entire contract, with all of its terms
  and conditions

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Principles of Insurance

• Utmost Good Faith
• Insurable Interest
• Indemnity
• Corollaries of Indemnity
• Proximate Cause

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Utmost Good Faith

• Uberrima fides is a Latin phrase meaning "utmost
  good faith .This means that all parties to an
  insurance contract must deal in good faith,
  making a full declaration of all material facts
  in the insurance proposal
• A minimum standard that requires both the buyer
  and seller in a transaction to act honestly
  toward each other and to not mislead or withhold
  critical information from one another
• A positive duty voluntarily to disclose
  ,accurately and fully, all facts material to the
  risk being proposed ,whether requested or not

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Representations

• Statements made by the applicant for insurance
• For e.g. If you apply for life insurance, you may
  be asked questions concerning your age, weight,
  height, occupation, state of health, family
  history etc. Your answers to these questions are
  the representations

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Representation
Contract is voidable if the representation is

• (A)Material
• (B)False
• (C)Relied on by the insurer
• Material - If the insurer knew the true facts,
  the policy would not have been issued, or it
  would have been issued on different terms
• False-the statement is not true or misleading
• Reliance the insurer relies on the
  representation in issuing the policy at specified
  premium

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Examples

• Karim applied for life insurance and states in
  the application that he has not visited a doctor
  within the last five years
• However, six months earlier he had surgery for
  lung cancer. So, the statement made by him is
  false, material and relied on by the insurer

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Misrepresentation in Motor Insurance

• The insured misrepresented that she had no
  traffic violations in the prior three-year
  period. After the claim, a check of her record
  revealed that she had two traffic violations in
  that period. The insurer denied the coverage.
• Court Decision-The insured claimed that she had
  forgotten about the two violations she had made
  and therefore, she had no intention to deceive.
  The court ruled that it is unlikely she would
  forget both events . Decision is for the insurer

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Misrepresentation

• If an applicant for insurance states an opinion
  that later turns out to be wrong , the insurer
  must prove that the applicant spoke fraudulently
  and intended to deceive the company
• An innocence misrepresentation of a material
  fact, if relied on by the insurer , also makes
  the contract voidable.