INSURANCE

What is Insurance?
Legal agreement between two parties – the insurer and
the insured. The insurer provides financial coverage for
the losses of the insured that s/he may bear under certain
circumstances by pooling the resources of policyholders.

Allows individuals or organizations to exchange the risk of a large loss for

the certainty of smaller periodic payments, known as premiums. The
exchange (or transfer) of risk is laid out in a legal contract called the
insurance policy, which spells out the coverage, compensation, and/or other

Meaning of Risk in Insurance – uncertainty concerning the occurrence of loss or

damage
Two major types of risks: pure risks and speculative risks
 Pure risks: possibility of loss or no loss, but no gain. Associated with events
that may result in financial insecurity or loss. Examples: natural disasters
(earthquakes, fires – property risks), accidents, illness, death or injury (personal
risks)
 Speculative risks: possibility of gain and loss. Associated with investment
activities and business ventures. Examples: investment in stock markets, stat of a
new business
Types of insurance:
Private insurance
1. Health insurance: coverage for medical expenses.
2. Life insurance: financial protection to beneficiaries in the event of the
policyholder’s death.
3. Property insurance: indemnifies property owners against the loss or damage or
personal property.
4. Liability insurance: covers the insured’s legal liability arising out of property
damage or bodily injury to others.
Government insurance
1. Social insurance programs
2. Other government insurance programs
Benefits of insurance to society
 Indemnification for loss
 Reduction of worry and fear
 Source of investment funds
 Loss prevention
 Enhancement of credit
Costs of insurance to society
 Costs of doing business
 Fraudulent claims
 Inflated claims
Basic characteristics of insurance
- Payment of fortuitous losses (unexpected)
- Risk transfer
- Indemnification
Characteristics of an ideally insurable risk
 Large number of units: predict average loss
 Accidental and unintentional loss: assume random occurrence of events
 Determinable and measurable loss: how much should be paid
 No catastrophic loss
 Calculate chance of loss
 Economically feasible premium

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Objectives of Risk Management
Before loss:
 Prepare for potential losses in the most economical way
 Reduce anxiety
 Meet any legal obligations
After loss:
 Survival of the firm
 Continue operating
 Stability of earnings
 Continued growth of the firm
 Minimize the effects that a loss will have on other people and on society
Risk exposure?
Benefits of risk management
 Enables firm to attain its pre-loss and post-loss objectives easily

Types of Private Insurers

 Stock insurer – corporation owned by stockholders
 Mutual insurers – corporation owned by the policy owners
 Lloyd’s – NOT an insurer BUT is an insurance market that provides services
and physical facilities
  Reciprocal exchanges – unincorporated organization in which insurance is
exchanged among the members (called subscribers)
 Blue Cross and Blue Shield Plans – nonprofit, community oriented plans
 Managed care plans -
 Captive insurance companies – insurer owned by a parent firm for the
purposes of insuring the parent firm’s loss exposures
 Savings Bank Life Insurance – life insurance that is sold by mutual savings
banks, over the phone or through web sites

Types of Public Insurers

Agents and Brokers Someone who legally represents the

insured.

Someone who legally represents the

insured.
Types of marketing systems – the various methods for selling and marketing insurance
products

Insurance Companies’ Operation

Ratemaking: also considered as price determination deals with rates charged by
insurance companies.
Underwriting: the process of assessing the amount of risk an individual present to the
insurer.
Production: this is the function of selling and marketing of various insurance products.
Claim settlement: payment due to a customer in response to a claim.
Reinsurance: a way of transferring some of the financial risk that insurance companies
assume (treaty and facultative).
Investments: having part of your insurance premium invested after a certain period.
Other operations: accounting, legal services, loss control, and information systems.

Reasons for Insurance Regulation

 Maintain insurer solvency
 Compensate for inadequate consumer knowledge
 Ensure reasonable rates
 Make insurance available
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and legislatives acts????
Methods of regulation
- Legislation, through both state and federal laws
- Within the EU, Commission Delegated Regulation (EU)
- Courts decisions, e.g., interpreting policy provisions
- State insurance departments
What areas are regulated? – all states have requirements for the formation and
licensing of insurers

Important legal principles

 Principle of Indemnity – the insurer agrees to pay no more than the actual
amount of the loss.
 Principle of Insurable Interest – the insured must be in a position to lose
financially if a covered loss occurs.
 Principle of Subrogation – substitution of the insurer in place of the insured for
the purpose of claiming indemnity from a third party for a loss covered by
insurance.
 Principle of Utmost Good Faith – higher degree of honesty is imposed on both
parties to an insurance contract than is imposed on parties to other contracts.

Law and the Insurance Agent (how affects the actions and duties of insurance agents)
An agent is someone who has the authority to act on behalf of a principle (the insurer).
Several laws govern the actions of agents and their relationship to insurers
 There is no presumption of an agency relationship
 An agent must be authorized to represent the principal
 A principal is responsible for the act of agents acting within the scope of their
authority
 Limitations can be placed on the powers of agents

Fundamentals of life insurance

 Whole life insurance: provides coverage for the entire life of the insured and
pays out a death benefit to the beneficiary upon the insured’s death.
 Universal life: flexible type of life insurance that allows the policyholder to
adjust the premium and death benefit over time.
 Variable life insurance: allows the policyholder to invest the cash value
component in various investment options, such as stocks and bonds.
Premature death – death of a family head with outstanding unfulfilled financial
obligations
 Can cause serious financial problems for the surviving members;
 The deceased’s future earning are lost forever;
 Additional expenses are incurred, e.g., funeral expenses
 Some families will experience a reduction in their standard of living.
Financial impact on different types of families: single people; single-parent families;
two-income earners with children; traditional families; blended families; sandwiched
families.
The purchased of life insurance is financially justified if the insured has earned income
and others are dependent on those earnings for financial support
Amount of life insurance to own (methods/approach)
 Human life value – the present value of the family’s share of the deceased
breadwinner’s future earnings
 Need approach – depends on the financial need that must be met if the family
head should die

Social insurance programs (mandatory government insurance programs enacted to

deal with problems that are difficult to address through private insurance)
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Reasons for social insurance programs
 To help solve complex social problems
 To provide coverage for risks that are difficult to insure privately
 To provide a base of economic security to the population
Characteristics for social insurance programs
 Most programs are compulsory
 Designed to provide a floor of income
 Pay benefits based on social adequacy rather than individual equity
 Benefits are loosely related to earnings and prescribed by law
 A formal means test is not required
 Full fundings of benefits is unnecessary
Examined the provisions of three important social insurance programs:
This program provides old age, survivors, and disability income payments – Social
Security.
In addition, health insurance benefits are provided through the Medicare program.
Unemployment insurance: during economic slowdowns and recessions, unemployment
insurance provides benefits to workers who have been laid-off from work and who are
actively seeking work.
Worker’s compensation: instituted by states to provide benefits to workers who are
injured at work or who develop an employment-related illness.
The program provides disability income, medical benefits, rehabilitation benefits, and
death benefits to survivors of those who die at work.