What is Insurance?
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Most People’s Definition of Insurance
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Definition of Insurance #1
Insurance is the pooling of fortuitous losses
by transfer of such risks to insurers,
who agree to indemnify insureds of such losses,
to provide other pecuniary benefits
on their occurrence,
and to render services connected with the risk.
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Definition of Insurance #2
Insurance is a social device in which a group
of individuals (insureds) transfer risk
to another party (insurer) in order to combine loss
experience, which permits
statistical prediction of losses and provides for
payment of losses from funds contributed
(premiums) by all members who transferred risk.
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Basic Characteristics of Insurance
• Economic risk transfer
• Law of Large Numbers
• Discrimination (Pooling of insureds)
• Pooling of losses
• Contractual payments for defined losses
• Indemnification
• Premium
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Value to Society
• Stability
• Credit transactions
• Business & Personal Planning
• Reducing Cost of Capital
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What Insurers Do
• Economic Risk
• Loss Prevention & research
• Financial Intermediaries
• Regulatory
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Types of Insurance
• Personal or Commercial
• Property & Casualty or Life & Health
(Property-Liability)
• Private or Public
• Voluntary or Involuntary
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Types of Insurance - Examples
Homeowners
• Personal
• Property-Liability
• Private
• Voluntary
Automobile
• Personal or Commercial
• Property-Liability
• Private
• Voluntary or Involuntary
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Types of Insurance - Examples
Social Security
• Personal
• Life-Health
• Government
• Involuntary
Medical Malpractice
• Commercial
• Property-Liability
• Private
• Voluntary
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Basic Characteristics of Insurance
• Economic risk transfer
• Law of Large Numbers
• Discrimination (Pooling of insureds)
• Pooling of losses
• Contractual payments for defined losses
• Indemnification
• Premium
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Ideal Requisites for Insurability
1.
2.
3.
4.
5.
6.
Large Number of Similar Exposure Units
Determinable Probability Distribution
Fortuitous Losses
Definite Losses
Catastrophe Unlikely
Economic Feasibility
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What kind of things are Insured?
• Cars, Houses, Motor Homes, Boats, Big Toys,…
• Jewelry, Televisions, Money, Clothes, …
• Businesses, Construction Sites,…
• Merchandise & Equipment, Business Property
• Personal and commercial liability to others
• Loss of Income, Loss of Rent,
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What kind of losses are Insured?
• “Coverages”
• Legal Liability
• Wind, Flood, Hail, Smoke, Explosion, Aircraft,
Vehicles, Brglary, Robbery, Mysterious
Disappearance, Collapse,
Vandalism and malicious mischief, …
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Perils & Hazards
Perils - Immediate Causes of Loss
Hazards - Conditions Affecting Perils
Physical Hazards - Property Conditions
Intangible Hazards - Attitudes and Culture
Moral Hazard - Fraud
Morale Hazard - Indifference
Societal Hazards - Legal and Cultural
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Perils & Hazards
Perils
• Robbery
• Burglary
• Employee Activities
• Flood
• Fire
• Tornadoes
• Lawsuits
Hazards
• Dishonesty
• Maintenance
• Inattention
• Weather
• Economy
• Business Activities
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Risk = Unpredictable Outcome
Pure Risk
Loss
No Loss
Insurance Risk
Hazard Risk
Speculative Risk
Loss
No Loss
Gain
Financial Risk
Strategic Risk
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Risk Tolerance
Risk Neutral - Indifferent Toward Risk
Value of Risky Situation is Expected Loss
Risk Averse - Prefer to Avoid Risk
Willing to Pay More than Expected Loss to Avoid Risk
Risk Seeking - Prefer to Take Risk
Would Pay More than Expected Return to Engage in
Risky Situation
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Risk
Management
Process
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Risk Management Process
1.
2.
3.
4.
5.
6.
7.
Set Objectives
Indentify Threat
Evaluate Loss Exposure
Analyze Alternatives
Choose Alternatives
Implement Program
Monitor Outcome
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Methods of Hazard Reduction
• Avoidance
• Loss Control
– Loss Prevention - Reduce Loss Frequency
– Loss Reduction - Lower Loss Severity
• Retention
• Transfer
– Corporations
– Contractual Agreements
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Insurance Versus Gambling
Gambling Creates Risk
Insurance Transfers Existing Risk
Gambling is Speculative Risk
Insurance Deals with Pure Risk
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