Brief Introduction to Risk & Insurance

1. The Concept of Risk

 The term ‘risk’ has several meanings.

It implies uncertainty about an outcome in

a given situations.
 Chance – implies some doubt but in favorable way

 Some defn of risk include:

 Risk is the possibility of unfortunate occurrence
 Risk is a combination of hazards/perils

 Risk is unpredictability – the tendency that actual

results may differ from predicted results
 Risk is uncertainty of loss (financial /material /human)

 Risk is the possibility of loss

Common in the definitions are
a) Uncertainty
o 100% certainty almost ‘impossible’
o Uncertainty due to
o lack or imperfection in knowledge or

information
o Uncertainty exists whether we know or not

o Thus, the basis of risk is primarily lack of

knowledge; no risk if we know what is
going to happen
b) Differing levels or degrees in risks
oRisk is a combination of
 likelihood of an event happening (frequency)
The severity should the event occur (severity)
oExamples:

o Collision VS overturning in motor vehicles

o Fire in residential houses VS Office Buildings

o Motor vehicle risks VS aviation risks

o Frequency & severity of loss predictable from

statistical data gathered over reasonable
number of years
c) Perils & Hazards
 We often use risk, peril, hazard interchangeably

but they differ in insurance usage.

PERIL - Immediate cause of losses or the event
which bring about losses.

HAZARD - A condition which increases likelihood

of operation of peril or which worsen the
progression of the peril already in operation.
o Physical hazard - arises from physical

features.
o Moral hazard – personal character, integrity,

attitude.
d) Classification of Risks
i) Pure & Speculative Risks
 Pure risk – where no prospect of gain, only involve
loss or no loss. (Business or trade risks)
 Speculative risk – where chance of gain exists
(also called Risks of business or trade)
ii) Financial & Non-financial
 Financial – where loss is quantifiable in money
o Theft of property, loss profit due to fire, etc.
 Non-financial – where money not measure the
loss
o Selection of a career; purchase of a car

iii) Fundamental & Particular Risks

 Fundamental – risks occurring outside everyone’s
control with far-reaching consequences
 Particular – limited in cause & effect
e) Handling of Risks (Handling Mechanisms)
Risks can be handled broadly in four ways:
i) Avoidance
 Rarely practical
 Consider it at planning time

ii) Risk Prevention or Reduction

 Quite practicable
 Planning stage is more sound in
prevention/reduction
 Weigh Costs VS benefits
 “Prevention is better than cure”
iii) Risk Retention
Practical
but think of cost of retention
Consider putting fund aside or

Financing

iv) Risk Transfer

Outsourcing / subletting

Insurance- best mechanism of risk transfer

2) Insurance
a) Insurance is:
 Sharing financial losses of “a few”
from a common fund formed by
contribution of the “many” who are
equally exposed to the same risk.
 Spreading “the losses” of an individual
or a group of individuals.
 The rate of contribution (the premium)
varies according to the degree of
hazard or exposure to loss/damage.
b) How does insurance function or what
are its functions?
 Primary functions
 Risk transfer & spread financial losses
 Creation of common pool
 Equitable premiums
 Secondary functions
 Releasing funds otherwise tied up for reserves
 Investment sources/insurers invest a lot
 Remove fear & build confidence (peace of mind)
 Means of saving
 Social benefits (insure continuity of business, thus
employment, production, foster international trade, etc)
 Invisible exports
 Loss control & reduce national loss
 Rating, inspection/safety audit
 Loss inspection/salvage recovery
 D/t professional associations
c) Nature of insurable risks
 Insurable risks - characteristics
Fortuitous /accidental
 tear, wear, depreciation, etc excluded
 damage intentionally caused not covered

 Profitable U/W depends on accurate risk

Financialvalue
Insurable interest

Homogeneous exposures
 Given sufficient no. of exposure to
similar risks, insurers can forecast expected
extent of loss
 Law of large numbers
Pure risks
Particular risks
d) Limitations of insurance
 Only pure risks can be insured
 Legal entitlement to insure – insurable interest

 Insurance limited financial value – indemnity

 There must be large no. of similar risks

 It must be possible to calculate the risk of loss

 Loss must not be catastrophic

 Loss must have element of uncertainty or

accident, &
 So on
e) Classes of insurance
 Two main branches
 Life Insurance
 General Insurance
 Marine
 Fire

 Motor

 Miscellaneous

 OR

 Insurance of property (Fire, marine, motor, etc)

 Insurance of person (personal accident, WC,

etc)
 Insurance of interest (fidelity g., bonds, etc)

 Insurance of liability (public liab., general liab.,

etc)
 End of Part I

Thank You all!