INDIAN INSTITUTE OF LEGAL STUDIES

___________________________________________________________________________

ASSIGNMENT ON –
“THE LIFE BLOOD OF AN INSURANCE CONTRACT IS THE
RISK IT DEALS WITH” – HIGHLIGHT ON THE CONCEPT OF
RISK AS THE SUBJECT MATTER OF INSURANCE

SUBJECT – INSURANCE LAW

SUPERVISED BY:
Ms. Rinkey Sharma,
Asst. Professor in Law

SUBMITTED BY:
NAME : Kaushal Soni
ROLL NO. : 14
COURSE : LL.B.(3 Years)
SEMESTER : V
 ACKNOWLEDGEMENT

With profound gratitude and sense of indebtedness I place on record my sincerest thanks to

Ms.Rinkey Sharma, Assistant Professor in Law, Indian Institute of Legal Studies, for her

invaluable guidance, sound advice and affectionate attitude during the course of my studies.

I have no hesitation in saying that she molded raw clay into whatever I am through her

incessant efforts and keen interest shown throughout my academic pursuit. It is due to her

patient guidance that I have been able to complete the task.

I would also thank the Indian institute of Legal Studies Library for the wealth of information

therein. I also express my regards to the Library staff for cooperating and making available

the books for this project research paper.

Finally, I thank my beloved parents for supporting me morally and guiding me throughout the

project work.

Date:

KAUSHAL SONI

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 TABLE OF CONTENTS

Acknowledgement 1

Research Methodology 3

Chapter I: Introduction 4

Chapter II: Understanding the concept of risk 5

Chapter III: Types of Risk 7

Chapter IV: Risk Management And Insurance 10

Chapter V : Basic Insurance Concepts 13

Conclusion 15

Bibliography 16

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 RESEARCH METHODOLOGY

AIMS AND OBJECTIVES

The aims and objectives of this project are to understand the concept of risk as the subject
matter of insurance.

STATEMENT OF PROBLEM
This research work is an attempt to understand the principle of“Risk”, which is an essential
part of any insurance Contract. It is an attempt to know the concept risk; sources of risk,
types of risk; limitations relating to the ascertainment and minimization of risk and how risk
is an inevitable part of any insurance contract.

RESEARCH OBJECTIVES

1. To understand the principle of risk.

2. To have a clear idea about the importance of risk factor in an insurance contract.

RESEARCH QUESTIONS

1. What is a risk?

2. How are risk classified?

3. What is the extent of risk cover?

RESEARCH METHOD

“Methodology” implies more than simply the methods the researcher used to collect data. It
is often necessary to include a consideration of the concepts and theories which underlie the
methods. The methodology opted for the study on the topic is Doctrinal. Doctrinal research in
law field indicates arranging, ordering and analysis of the legal structure, legal frame work
and case laws by extensive surveying of legal literature but without any field work.

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 CHAPTER I : INTRODUCTION

Risk is the potential for uncontrolled loss of something of value. Values (such as physical
health, social status, emotional well-being, or financial wealth) can be gained or lost when
taking risk resulting from a given action or inaction, foreseen or unforeseen (planned or not
planned). Risk can also be defined as the intentional interaction
with uncertainty.1 Uncertainty is a potential, unpredictable, and uncontrollable outcome; risk
is an aspect of action taken in spite of uncertainty.

Contract of insurance is a specific contract dealing with insurance of life and general
insurance under which the insurer undertakes to protect the insured from a specified loss if it
occurs. To bear the loss is called the risk. Thus, all insurance contracts involve risk. Virtually
to bear the specified risk is the subject matter of the insurance contract.The insurer
undertakes to bear the loss in case of contingencies. Insurance contact may also be taken as a
device to indemnify the loss arising from uncertain risks for a consideration called the
premium. The purpose of the contact is to trade with risks.

For both the parties to a contact of insurance, the most crucial element is the determination of
risk involved. The insurer is able to make an advantageous estimate of the premium only if he
knows the nature and degree of the likely risk, and on the part of the assured, it is of great
importance to know the exact extent of his cover so as to avoid unnecessary double or over
insurance.The risk remains uncertain till the contingencies happen but when the
contingencies or uncertain event takes place, loss becomes definite.

The principles of common law do not allow for cessation of the insurers liability in cases of
increase of risk; this may happen only where the policy permits the same, or where there is
material alteration in the nature of the risk and not merely in its degree.

1
Preston B. Cline, “The Merging of Risk Analysis and Adventure Education”, Wilderness Risk Management
Conference, available at: https://www.outdoored.com/sites/default/files/documents/files/wrmc_proceedings
_05_adventure_cline.pdf (last visited on 13th October, 2019).

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 CHAPTER II : UNDERSTANDING THE CONCEPT OF RISK

Risk is part of every human endeavor. From the moment we get up in the morning, drive or
take public transportation to get to school or to work until we get back into our, we are
exposed to risks of different degrees.

Risk is the potential of loss (an undesirable outcome, however not necessarily so) resulting
from a given action, activity and/or inaction. The notion implies that a choice having an
influence on the outcome sometimes exists (or existed). Potential losses themselves may also
be called "risks". Any human endeavor carries some risk, but some are much riskier than
others.

Risk can be defined in several different ways :

 The probability of something happening multiplied by the resulting cost or benefit if it

does.
 The probability or threat of quantifiable damage, injury, liability, loss, or any other
negative occurrence that is caused by external or internal vulnerabilities, and that may
be avoided through preemptive action.
 Risk is the name of uncertainty and uncertainty is one of the basic realities of life. “In
this world, nothing can be said to be certain except death and taxes”. Therefore,
uncertainty and risk remain in every part of life. -Benjamin Franklin
 “Risk is the chance of loss or injury” - Boon and Kurtz
 “Risk is a measurable uncertainty” - Frank H. Knight
 “Risk is the variation in the possible outcome that exists in nature in a given
situation”. - Williams and Heins

Thus risk is the uncertainty or chance of loss or injury, which is one of the realities of life.

UNCERTAINITY

Uncertainty is at the very core of the concept of risk itself. It is uncertainty about the outcome
in a given situation. Uncertainty does not exist in the natural order of things though there are
a number of outcomes, which are uncertain.
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In 1921, Frank Knight summarized the difference between risk and uncertainty thus: "…
Uncertainty must be taken in a sense radically distinct from the familiar notion of Risk, from
which it has never been properly separated. … The essential fact is that "risk" means in some
cases a quantity susceptible of measurement, while at other times it is something distinctly
not of this character; and there are far-reaching and crucial differences in the bearings of the
phenomena depending on which of the two is really present and operating. It will appear that
a measurable uncertainty, or "risk" proper, as we shall use the term, is so far different from an
un-measurable one that it is not in effect an uncertainty at all."

PERIL & HAZARD

We often use the word risk to mean both the event which will give rise to some loss, and the
factors which may influence the outcome of a loss. When we think about cause, we must be
clear that there are at least these two aspects to it. We can see this if we think back to the two
houses on the river bank and the risk of flood. The risk of flood does not really make sense,
what we mean is the risk of flood damage. Flood is the cause of the loss and the fact that one
of the houses was right on the bank of the river influences the outcome. Flood is the peril and
the proximity of the house to the river is the hazard. The peril is the prime cause; it is what
will give rise to the loss. Often it is beyond the control of anyone who may be involved. In
this way we can say that storm, fire, theft, motor accident and explosion are all perils. Peril is
defined as the cause of loss. Thus, if a house burns because of a fire, the peril, or cause of,
loss, is the fire. If a car is totally destroyed in an accident with another motorist, accident
(collision) is the peril, or cause of loss. Some common perils that result in the loss or
destruction of property include fire, cyclone, storm, landslide, lightning, earthquakes, theft,
and burglary.

Factors, which may influence the outcome, are referred to as hazards. These hazards are not
themselves the cause of the loss, but they can increase or decrease the effect should a peril
operate. The consideration of hazard is important when an insurance company is deciding
whether or not it should insure some risk and what premium to charge. So a hazard is a
condition that creates or increases the chance of loss.

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 CHAPTER III : TYPES OF RISK

1. Speculative/Dynamic Risk and Pure/Static Risk :

Speculative (dynamic) risk is a situation in which either profit OR loss is possible.
Examples of speculative risks are betting on a horse race, investing in stocks/bonds
and real estate. In the business level, in the daily conduct of its affairs, every business
establishment faces decisions that entail an element of risk. The decision to venture
into a new market, purchase new equipments, diversify on the existing product line,
expand or contract areas of operations, commit more to advertising, borrow additional
capital, etc., carry risks inherent to the business. The outcome of such speculative risk
is either beneficial (profitable) or loss. Speculative risk is uninsurable.
Pure (static) risk is a situation in which there are only the possibilities of loss or no
loss, as oppose to loss or profit with speculative risk. The only outcome of pure risks
are adverse (in a loss) or neutral (with no loss), never beneficial. Examples of pure
risks include premature death, occupational disability, catastrophic medical expenses,
and damage to property due to fire, lightning, or flood. It is important to distinguish
between pure and speculative risks for three reasons. First, through the use of
commercial, personal, and liability insurance policies, insurance companies in the
private sector generally insure only pure risks. Speculative risks are not considered
insurable, with some exceptions. Second, the law of large numbers can be applied
more easily to pure risks than to speculative risks. The law of large numbers is
important in insurance because it enables insurers to predict loss figures in advance. It
is generally more difficult to apply the law of large numbers to speculative risks in
order to predict future losses. One of the exceptions is the speculative risk of
gambling, where casinos can apply the law of large numbers in a very efficient
manner. Finally, society as a whole may benefit from a speculative risk even though a
loss occurs, but it is harmed if a pure risk is present and a loss occurs. For instance, a
computer manufacturer's competitor develops a new technology to produce faster
computer processors more cheaply. As a result, it forces the computer manufacturer
into bankruptcy. Despite the bankruptcy, society as a whole benefits since the
competitor's computers work faster and are sold at a lower price. On the other hand,
society would not benefit when most pure risks, such as an earthquake, occur.

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2. Fundamental Risks and Particular Risk
Fundamental risks affect the entire economy or large numbers of people or groups
within the economy. Examples of fundamental risks are high inflation,
unemployment, war, and natural disasters such as earthquakes, hurricanes, tornadoes,
and floods. Particular risks are risks that affect only individuals and not the entire
community. Examples of particular risks are burglary, theft, auto accident, dwelling
fires. With particular risks, only individuals experience losses, and the rest of the
community are left unaffected. The distinction between a fundamental and a particular
risk is important, since government assistance may be necessary in order to insure
fundamental risk. Social insurance, government insurance programs, and government
guarantees and subsidies are used to meet certain fundamental risks in our country.
For example, the risk of unemployment is generally not insurable by private insurance
companies but can be insured publicly by federal or state agencies. In addition, flood
insurance is only available through and/or subsidized by the federal government.
3. Subjective Risk and Objective Risk
Subjective risk is defined as uncertainty based on a person's mental condition or state
of mind. For example, assume that an individual is drinking heavily in a bar and
attempts to drive home after the bar closes. The driver may be uncertain whether he or
she will arrive home safely without being arrested by the police for drunken driving.
This mental uncertainty is called subjective risk.
Objective risk is defined as the relative variation of actual loss from expected loss.
Objective risk declines as the number of exposures increases. More specifically,
objective risk varies inversely with the square root of the number of cases under
observation. Objective risk can be statistically measured by some measure of
dispersion, such as the standard deviation or coefficient of variation. Since objective
risk can be measured, it is an extremely useful concept for an insurance company or a
corporate risk manager.
4. Financial and Non-Financial Risk
A financial risk is one where the outcome can be measured in monetary terms. This is
easy to see in the case of material damage to property, theft of property or lost
business profit following a fire. In cases of personal injury, it can also be possible to
measure financial loss in terms of a court award of damages, or as a result of

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negotiations between lawyers and insurers. In any of these cases, the outcome of the
risky situation can be measured financially.
There are other situations where this kind of measurement is not possible. Take the
case of the choice of a new car, or the selection of an item from a restaurant menu.
These could be construed as risky situations, not because the outcome will cause
financial loss, but because the outcome could be uncomfortable or disliked in some
other way. We could even go as far as to say that the great social decisions of life are
examples of non-financial risks: the selection of a career, the choice of a marriage
partner, having children. There may or may not be financial implications, but in the
main the outcome is not measurable financially but by other, more human, criteria.

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 CHAPTER IV : RISK MANAGEMENT AND INSURANCE

Risk management is the process of evaluating the risks faced by a firm or an

individual and then minimizing the costs involved with those risks. Any risk entails
two types of costs. The first is the cost that will be incurred if a potential loss becomes
an actual loss. An example is the cost of rebuilding and reequipping an assembly plant
that burns to the ground. The second type consists of the costs of reducing or
eliminating the risk of potential loss.
Risk management ensures that an organization identifies and understands the risks to
which it is exposed. Risk management also guarantees that the organization creates
and implements an effective plan to prevent losses or reduce the impact if a loss
occurs.
A risk management plan includes strategies and techniques for recognizing and
confronting these threats. Good risk management doesn’t have to be expensive or
time consuming; it may be as uncomplicated as answering these three questions:
1. What can go wrong?
2. What will we do, both to prevent the harm from occurring and in response to the
harm or loss?
3. If something happens, how will we pay for it?

Insurance is a contract between two parties. Here one party is the insured and another
party is the insurer. Insurance provides various advantages to the various field. The
elementary purpose of insurance is to provide protection against future risk, accident
and uncertainty.
Insurance is a contract between the insurer and insured under which the insurer
undertakes to compensate the insured for the loss arising from the risk insured against.
In simple words, Insurance is a contract in which one party (the insurer), for a
consideration (the premium), assumes a particular risk of the other party(the
insured) and promises to pay to the other party or his beneficiary, a certain or
ascertainable sum of amount on the happening of specified contingency against which
the insurance is asked for.

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Most people think of risk management as simply buying insurance. However,
insurance, although an important part of risk management, is not the only means of
dealing with risk. Other methods may be less costly in specific situations.
 Risk Avoidance : An individual can avoid the risk of an automobile
accident by not riding in a car. A manufacturer can avoid the risk of product
failure by refusing to introduce new products. Both would be practicing risk
avoidance—but at a very high cost. The person who avoids automobile
accidents by foregoing cars may have to give up his or her job to do so. The
business that does not take a chance on new products probably will fail when
the product life cycle, catches up with existing products. There are, however,
situations in which risk avoidance is a practical technique. At the personal
level, individuals who stop smoking or refuse to walk through a dark city park
late at night are avoiding risks. Jewelry stores lock their merchandise in vaults
at the end of the business day to avoid losses through robbery. And to avoid
the risk of a holdup, many gasoline stations accept only credit cards or the
exact amount of the purchase for sales made after dark. Obviously, no person
or business can eliminate all risks. By the same token, however, no one should
assume that all risks are unavoidable.
 Risk Reduction : If a risk cannot be avoided, perhaps it can be reduced. An
automobile passenger can reduce the risk of injury in an automobile accident
by wearing a seat belt. A manufacturer can reduce the risk of product failure
through careful product planning and market testing. In both situations, the
cost of reducing risk seems to be well worth the potential saving. The risks
involved in management decisions can be reduced only through effective
decision making. These risks increase when a decision is made hastily or is
based on less than sufficient information. However, the cost of reducing these
risks goes up when managers take too long to make decisions. Costs also
increase when managers require an overabundance of information before they
are willing to decide.
 Risk Assumption : An individual or firm will—and probably must—take on
certain risks as part of living or doing business. Individuals who drive to work
assume the risk of having an accident, but they wear a seat belt to reduce the
risk of injury in the event of an accident. The firm that markets a new product

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 assumes the risk of product failure— after first reducing that risk through
market testing. Risk assumption, then, is the act of taking responsibility for the
loss or injury that may result from a risk. Generally, it makes sense to assume
a risk when one or more of the following conditions exist:
1. The potential loss is too small to worry about.
2. Effective risk management has reduced the risk.
3. Insurance coverage, if available, is too expensive.
4. There is no other way of protecting against the loss.
 Shifting Risks :Perhaps the most common method of dealing with risk is to
shift, or transfer, the risk to an insurance company. An insurer (or insurance
company) is a firm that agrees, for a fee, to assume financial responsibility for
losses that may result from a specific risk. The fee charged by an insurance
company is called a premium. A contract between an insurer and the person or
firm whose risk is assumed is known as an insurance policy. Generally, an
insurance policy is written for a period of one year. Then, if both parties are
willing, it is renewed each year. It specifies exactly which risks are covered by
the agreement, the dollar amounts the insurer will pay in case of a loss, and the
amount of the premium. Insurance is thus the protection against loss that the
purchase of an insurance policy affords. Insurance companies will not,
however, assume every kind of risk. A risk that insurance companies will
assume is called an insurable risk. Insurable risks include the risk of loss by
fire and theft, the risk of loss by automobile accident, and the risk of sickness
and death. A risk that insurance companies will not assume is called an
uninsurable risk. In general, pure risks are insurable, whereas speculative risks
are uninsurable (see Figure D1). An insurance company will protect a Ford
Motor Company assembly plant against losses due to fire or tornadoes. It will
not, however, protect Ford against losses resulting from a lack of sales orders
for automobiles.

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 CHAPTER V : BASIC INSURANCE CONCEPTS

Insurance is based on several principles, including the principle of indemnity, insurability of

the risk, and low-cost, affordable coverage.

 THE PRINCIPLE OF INDEMNITY

The purpose of insurance is to provide protection against loss; it is neither
speculation nor gambling. This concept is in the principle of indemnity: In the event
of a loss, an insured firm or individual cannot collect from the insurer an amount
greater than the actual dollar amount of the loss. Suppose that you own a home valued
at $250,000. However, you purchase $300,000 worth of fire insurance on your home.
Even if it is destroyed by fire, the insurer will pay you only $250,000, the actual
amount of your loss. The premiums set by actuaries are based on the amount of risk
involved and the amount to be paid in case of a loss. Generally, the greater the risk
and the amount to be paid, the higher is the premium.
 INSURABILITY OF THE RISK
Insurers will accept responsibility for risks that meet at least the following conditions:
1. Losses must not be under the control of the insured. Losses caused by fire, wind, or
accident generally are insurable, but gambling losses are not. Nor will an insurer pay a
claim for damage intentionally caused by the insured person. For example, a person
who sets fire to an insured building cannot collect on a fire insurance policy.
2. The insured hazard must be geographically widespread. That is, the insurance
company must be able to write many policies covering the same specific hazard
throughout a wide geographic area. This condition allows the insurer to minimize its
own risk: The risk that it will have to pay huge sums of money to clients within a
particular geographic area in the event of a catastrophe caused, for example, by a
tornado or an earthquake.
3. The probability of a loss should be predictable. Insurance companies cannot tell
which particular clients will suffer losses. However, their actuaries must be able to
determine, statistically, what fraction of their clients will suffer each type of loss.
They can do so, for insurable risks, by examining records of losses for past years.

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 They can then base their premiums, at least in part, on the number and value of the
losses that are expected to occur.
4. Losses must be measurable. Insured property must have a value that is measurable
in dollars because insurance firms reimburse losses with money. Moreover, premiums
are based partly on the measured value of the insured property. As a result of this
condition, insurers will not insure an item for its emotional or sentimental value but
only for its actual monetary value.
5. The policyholder must have an insurable interest. That is, the individual or firm that
purchases an insurance policy must be the one that would suffer from a loss. You can
purchase insurance on your own home, but you cannot insure your neighbor’s home
in the hope of making a profit if it should burn down! Generally, individuals are
considered to have an insurable interest in their family members.
Therefore, a person can insure the life of a spouse, a child, or a parent. Corporations
may purchase “key executive” insurance covering certain corporate officers. The
proceeds from this insurance help offset the loss of the services of these key people if
they die or become incapacitated.
 LOW-COST, AFFORDABLE COVERAGE
Price is usually a marketing issue rather than a technical concept. However, the price
of insurance is intimately tied to the risks and potential losses involved in a particular
type of coverage. Insurers would like to “produce” insurance at a very low cost to
their policyholders, but they must charge enough in premiums to cover their expected
payouts. Customers purchase insurance when they believe premiums are low in
relation to the possible dollar loss. For certain risks, premiums can soar so high that
insurance is simply not cost-effective. A $1,000 life insurance policy for a 99-yearold
man would cost about $950 per year. Clearly, a man of that age would be better off if
he invested the premium amount in a bank. He would thus be using self-insurance
rather than shifting the risk. Although this is an extreme example, it illustrates that
insurers must compete, through their prices, with alternative methods of managing
risk.

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 CONCLUSION

A contract of insurance is an agreement whereby one party, called the insurer, undertakes, in
return for an agreed consideration, called the premium, to pay the other party, namely the
insured, a sum of money or its equivalent in kind, upon the occurrence of a specified event
resulting in a loss to him. The policy is a document which is an evidence of the contract of
insurance.

Insurance works by pooling the risk and the funds to pay for it. Risk management is the
process of getting insurance, where an insurance agent talks to you about what you want to
insure and gets information from you to help assess the amount of risk you’re bringing to the
pool.

The primary functions of insurance include –

i. Provide protection - The primary function of insurance is to offer

protection against future risk, accidents and uncertainty. Insurance is
actually a shield against economic loss, by sharing the risk with others.
ii. Collective risk - Insurance is a device to contribute to the financial
loss of a few among many. Insurance is a mean by which little losses
are shared among larger number of people. All the insured share the
premiums towards a fund and out of which the persons exposed to a
particular risk are paid.
iii. Evaluation of risk - Insurance concludes the probable volume of risk
by evaluating various factors that give rise to risk. Risk is the origin for
determining the premium rate also.
iv. Provide assurance - Insurance is a device, which helps to modify from
uncertainty to certainty. Insurance is a mechanism whereby uncertain
risks may be made more certain.

Thus it can be rightly said that -“THE LIFE BLOOD OF AN INSURANCE CONTRACT
IS THE RISK IT DEALS WITH”

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 BIBLIOGRAPHY

BOOKS

 Dr. Avtar Singh, Law of Insurance, 3rd ed. 2017, Eastern Book Company Publishing
Co.

WEBSITES REFFERED

 https://shodhganga.inflibnet.ac.in/bitstream/10603/106259/9/09_chapter%202.pdf
 https://www.icsi.in/Study%20Material%20Professional/NewSyllabus/ElectiveSubject
s/IL&P.pdf
 http://www.cengage.com/resource_uploads/downloads/1305511069_532005.pdf
 https://www.soa.org/globalassets/assets/files/edu/P-21-05.pdf
 https://www.biz.uiowa.edu/wmc/basic-principles/rmi

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