I B.

COM Insurance and Risk Management

UNIT – I
Introduction to Insurance
Definition of Insurance - Characteristics of Insurance – Principles of Contract of Insurance –
General Concepts of Insurance – Insurance and Hedging – Types of Insurance – Insurance
Intermediaries.
What Is Insurance?
Insurance is a contract, represented by a policy, in which a policyholder receives financial
protection or reimbursement against losses from an insurance company. The company pools clients’
risks to make payments more affordable for the insured. Most people have some insurance: for their
car, their house, their healthcare, or their life.
Definition of Insurance?
Insurance is a legal contract between a person and an insurance business in which the insurer
promises to provide financial protection (Sum guaranteed) against unforeseen events for a certain
price (premium). The many types of insurance plans available today may be grouped into two
groups:
Life Insurance
General Insurance
Characteristics of Insurance
1. Contract
Insurance is a contract between the insurance company an
d the policyholder wherein the policyholder (insured) makes an offer and the insurance company
(insurer) accepts his offer. The contract of insurance is always made in writing.
2. Consideration
Like other contracts, there must be lawful consideration in insurance also. The consideration is in
the form of premium which the insured agrees to pay to the insurer.
3. Co-operative Device
All for one and one for all is the basis for cooperation. The insurance is a system wherein large
numbers of persons, exposed to a similar risk, are covered and the risk is spread over among the
larger insurable public. Therefore, insurance is a social or cooperative method wherein a loss of one
is borne by the society.
4. Protection of financial risks
An insurer is protected from financial risks which can be measured in terms of money. As such
insurance compensates only financial or monetary loss or risks.
5. Risk sharing and risk transfer
Insurance is a social device for division of financial losses which may fall on an individual or his
family on the happening of some unforeseen events. When insured, the loss arising out of the events
are shared by all the insured in the form of premium. Therefore the risk is transferred from one
individual to a group.
6. Based upon certain principles
The insurance is based upon certain principles like insurable interest, utmost good faith, indemnity,
subrogation, causa-proxima, contribution, etc.
7. Regulated by Law
Insurance companies are regulated by statutory laws in almost all the countries. In India, life
insurance and general insurance are regulated by Life Insurance Corporation of India Act 1956, and
General Insurance Business (Nationalization) Act 1972, and IRDA Regulations etc.
8. Value of Risk
Before insuring the subject matter of the insurance contract, the risk is evaluated in order to
determine the amount of premium to be charged on the insured. Several methods are being adopted
to evaluate the risks involved in the subject matter. If there is an expectation of heavy loss, higher
premiums will be charged. Hence, the probability of occurrence of loss is calculated at the time of
insurance.
9. Payment at contingency
An insurer is liable to pay compensation to the insureds only when certain contingencies arise. In
life insurance, the contingency — the death or the expiry of the term will certainly occur. In such
cases, the life insurer has to pay the assured sum.
10. Insurance is not gambling
An insurance contract cannot be considered as gambling as the person insured is assured of his loss
indemnified only on the happening of such uncertain event as stipulated in the contract of
insurance, whereas the game of gambling may either result into profit or loss.
11. Insurance is not a charity
Premium collected from the policyholders under an insurance is the cost of risk so covered. Hence,
it cannot be taken as charity. Charity lacks the element of contract of indemnity and compensation
of loss to the person whosoever makes it.
12. Investment portfolio
Since insurers’ liability to pay compensation to the insured arises on the happening of certain
uncertain event, the insurers do not have to keep the collected premium with them. They invest the
premium received in selected securities and earn interest and dividend on them.
What are the definitions in an insurance contract?
An insurance contract is a document representing the agreement between an insurance company and
the insured. Central to any insurance contract is the insuring agreement, which specifies the risks
covered the limits of the policy, and the term of the policy
What is the meaning of basic principles of insurance?
The basic principle of insurance is that an entity will choose to spend small periodic amounts of
money against a possibility of a huge unexpected loss. Basically, all the policyholder pool their
risks together.
Principles of Contract of Insurance
Utmost Good Faith (Uberrimae Fidei): This principle requires both parties, the insurer, and the
insured, to act honestly and disclose all material facts relevant to the insurance contract. The insured
must provide accurate information about the risk being insured, and the insurer must be transparent
about the terms and conditions of coverage.
Insurable Interest: Insurable interest refers to the legal or financial interest that the insured party
has in the subject matter of the insurance contract. The insured must demonstrate that they would
suffer a financial loss if the insured event occurs. This principle ensures that insurance contracts are
not used for speculative purposes.
Indemnity: The principle of indemnity states that insurance contracts are designed to compensate
the insured for the actual financial loss suffered, up to the limit of the policy coverage. Insurance is
not intended to provide a financial gain; its purpose is to restore the insured to the same financial
position they were in before the loss occurred.
Contribution: Contribution applies when the insured has multiple insurance policies covering the
same risk. In such cases, each insurer contributes proportionately to the loss based on the coverage
provided by their policy. This principle prevents overcompensation and ensures fairness among
insurers.
Subrogation: Subrogation gives the insurer the right to step into the shoes of the insured and
pursue legal remedies against third parties responsible for causing the insured loss. Once the insurer
has compensated the insured, it can seek reimbursement from the party at fault. This principle
prevents the insured from being unjustly enriched by recovering twice for the same loss.
Proximate Cause: Proximate cause refers to the dominant, most immediate cause of loss in an
insurance claim. Insurance policies typically cover losses caused by specified perils or events. The
principle of proximate cause helps determine whether the loss is covered under the policy based on
the cause that set the chain of events in motion.
Mitigation of Loss: The insured has a duty to take reasonable steps to minimize or mitigate the
extent of the loss once an insured event occurs. Failure to mitigate losses could affect the insurer's
obligation to pay a claim.
Loss Minimization
In an uncertain event, it is the insured’s responsibility to take all precautions to minimize the loss on
the insured property.
Insurance contracts shouldn’t be about getting free stuff every time something bad happens.
Therefore, a little responsibility is bestowed upon the insured to take all measures possible to
minimize the loss on the property. This principle can be debatable, so call a lawyer if you think you
are being unfairly judged under this principle.
What is the meaning of general insurance?
General insurance is an agreement between a policyholder and insurer wherein the insurance
company protects your valuable assets from fire, theft, burglary, or any other unfortunate accident.
Definition general insurance: Insurance contracts that do not come under the ambit of life
insurance are called general insurance. The different forms of general insurance are fire, marine,
motor, accident and other miscellaneous non-life insurance
General Concepts of Insurance
1. Risk Management: Insurance is a vital tool in risk management, helping individuals, businesses,
and organizations mitigate the financial impact of uncertain events. It involves identifying,
assessing, and addressing risks to minimize potential losses.
2. Risk Pooling: Insurance operates on the principle of risk pooling, where many individuals or
entities pay premiums into a common fund. This pool of premiums is used to cover the losses of
those who experience covered events. By spreading the risk among a large group, the financial
impact on any single member is reduced.
3. Premiums: Premiums are the payments made by policyholders to insurance companies in
exchange for coverage. The amount of the premium is determined by factors such as the type and
level of coverage, the insured's risk profile, and the insurer's expenses and desired profit margin.
4. Underwriting: Underwriting is the process by which insurers assess the risk presented by
potential policyholders and decide whether to offer coverage and at what price. Underwriters
evaluate factors such as the applicant's risk profile, claims history, and the nature of the insured
property or liability.
5. Policy: An insurance policy is a legal contract between the insured and the insurer that outlines
the terms and conditions of coverage. It specifies the risks covered, the policy limits, deductibles,
exclusions, premium payment terms, and other relevant details.
6. Insurable Interest: Insurable interest refers to the financial or legal interest that a policyholder
has in the subject matter of the insurance contract. To purchase insurance, the insured must
demonstrate that they would suffer a financial loss if the insured event occurs.
7. Claim: A claim is a request made by the policyholder to the insurer for payment or
reimbursement of covered losses. Insurers investigate claims to determine their validity and assess
the amount of compensation owed to the insured.
8. Deductible: A deductible is the amount that the insured must pay out of pocket before the
insurance coverage kicks in. Choosing a higher deductible typically results in lower premiums,
while a lower deductible leads to higher premiums.
9. Coverage Limits: Insurance policies specify the maximum amount of coverage provided for
various types of losses. Policyholders should carefully review these limits to ensure they have
adequate protection for their needs.
10. Exclusions: Exclusions are specific risks or circumstances that are not covered by the insurance
policy. Policyholders should be aware of these exclusions to understand the scope of their coverage.
What is the meaning of hedging?
Hedging is a strategy that tries to limit risks in financial assets. It uses financial instruments or
market strategies to offset the risk of any adverse price movements.
What Is Hedging Against Risk?
Hedging is a strategy that tries to limit risks in financial assets. It uses financial instruments or
market strategies to offset the risk of any adverse price movements. Put another way, investors
hedge one investment by making a trade in another.
DIFFERENCE BETWEEN INSURANCE AND HEDGING
Nature of Risk:
Insurance: Insurance protects against specific, unforeseen events that may result in financial
losses, such as accidents, natural disasters, or illness.
Hedging: Hedging is primarily used to mitigate risks associated with fluctuations in asset prices,
interest rates, exchange rates, or commodity prices.
Contractual Arrangement:
Insurance: Insurance involves a contractual agreement between the insured and the insurer. The
insured pays premiums to the insurer in exchange for coverage against specified risks.
Hedging: Hedging involves the use of financial instruments such as futures contracts, options,
swaps, or forward contracts to offset potential losses in one asset or liability with gains in another.
Risk Transfer:
Insurance: Insurance involves transferring the risk of potential losses from the insured to the
insurer. In the event of a covered loss, the insurer compensates the insured up to the policy limits.
Hedging: Hedging does not necessarily involve transferring risk to another party. Instead, it aims to
mitigate risk by establishing positions that have an inverse correlation with the asset or liability
being hedged.
Purpose:
Insurance: The primary purpose of insurance is to protect against unexpected financial losses
resulting from specific events.
Hedging: The primary purpose of hedging is to manage and mitigate risks associated with market
fluctuations, asset price movements, interest rate changes, or currency fluctuations.
Scope of Application:
Insurance: Insurance is commonly used by individuals, businesses, and organizations to protect
against various risks, including property damage, liability claims, health issues, and loss of income.
Hedging: Hedging is widely employed in financial markets by investors, businesses, and financial
institutions to manage risks associated with investments, currency exposures, interest rate
fluctuations, and commodity price volatility.
Customization:
Insurance: Insurance policies are standardized to some extent, with specific terms, conditions, and
coverage limits outlined in the policy contract.
Hedging: Hedging strategies can be customized to suit specific risks and objectives, allowing
investors and businesses to tailor their risk management approach to their unique circumstances and
market exposures.
What is the Life Insurance?
Life insurance policies provide protection against unforeseen circumstances such as the
policyholder's death or incapacity. Aside from providing financial security, many types of life
insurance plans enable policyholders to optimize their savings by making recurring payments to
various equity and debt fund alternatives.
Types of Insurance
1. Life Insurance: Provides financial protection to beneficiaries in the event of the insured
individual's death. There are various types of life insurance policies, including term life, whole life,
and universal life, each offering different features and benefits.
2. Health Insurance: Covers medical expenses incurred due to illness, injury, or preventive care.
Health insurance policies may include coverage for doctor visits, hospital stays, prescription drugs,
and other healthcare services.
3. Property Insurance:
Homeowners Insurance: Protects homeowners against damage or loss to their property and
belongings due to perils such as fire, theft, vandalism, or natural disasters.
Renters Insurance: Provides coverage for renters' personal belongings and liability protection
against damages or injuries that occur in their rented property.
Condo Insurance: Similar to homeowners insurance but tailored for condominium unit owners,
covering personal property, liability, and structural elements not covered by the condo association's
master policy.
Landlord Insurance: Covers rental properties owned by landlords, providing protection against
property damage, liability claims, and loss of rental income.
4. Auto Insurance: Mandatory in many jurisdictions, auto insurance provides coverage for vehicles
against damage, theft, and liability for bodily injury or property damage caused by accidents.
5. Liability Insurance:
General Liability Insurance: Protects businesses against financial losses resulting from lawsuits
or claims for bodily injury or property damage caused by the business's operations, products, or
services.
Professional Liability Insurance (Errors and Omissions Insurance): Provides coverage for
professionals against claims of negligence or errors in the performance of their professional duties.
Directors and Officers (D&O) Insurance: Protects directors and officers of companies from
personal losses arising from lawsuits alleging wrongful acts or decisions made in their capacity as
corporate leaders.
 Product Liability Insurance: Covers manufacturers, distributors, and retailers against claims for
damages or injuries caused by defective products.
6. Business Insurance:
Commercial Property Insurance: Protects businesses against damage or loss to their physical
assets, including buildings, equipment, inventory, and furnishings.
Business Interruption Insurance: Provides coverage for lost income and additional expenses
incurred when a business is unable to operate due to covered perils, such as fire or natural disasters.
Workers' Compensation Insurance: Compensates employees for medical expenses and lost
wages resulting from work-related injuries or illnesses.
Commercial Auto Insurance: Covers vehicles used for business purposes against damage, theft,
and liability for accidents.
7. Travel Insurance: Offers coverage for unexpected events that may occur during travel, such as
trip cancellation, lost luggage, medical emergencies, or travel delays.
8. Pet Insurance: Covers veterinary expenses for the treatment of illness, injury, or preventive care
for pets.
What is meant by insurance intermediaries?
An Insurance Intermediary means individual agents, corporate agents including banks and brokers –
they intermediate between the customer and the insurance company. Insurance Intermediary also
includes Surveyors and Third Party Administrators but these intermediaries are not involved in
procurement of business.
Insurance Intermediaries.
1. Insurance Agent:
 An insurance agent is a licensed professional who represents one or more insurance
companies and sells insurance products to individuals and businesses.
 Agents typically work on behalf of the insurer and have the authority to bind
coverage, issue policies, and collect premiums.
 They assist clients in assessing their insurance needs, comparing coverage options,
and selecting suitable policies.
2. Insurance Broker:
 An insurance broker is an independent intermediary who works on behalf of
insurance buyers to help them find the most suitable insurance coverage at the best
price.
 Brokers do not represent specific insurance companies but rather act as
intermediaries between clients and insurers, providing unbiased advice and access
to a wide range of insurance products.
  They analyze clients' insurance needs, shop for policies from multiple insurers, and
negotiate terms and premiums on behalf of their clients.
3. Insurance Producer:
 An insurance producer is a broad term that encompasses both insurance agents and
insurance brokers.
 It refers to individuals or entities authorized to sell insurance products and services
to consumers on behalf of insurance companies or as intermediaries representing
insurance buyers.
4. Insurance Advisor:
 An insurance advisor is a professional who provides advice and guidance to
individuals and businesses on insurance-related matters.
 Advisors may include insurance agents, brokers, consultants, or financial planners
who specialize in insurance planning.
 They help clients assess their insurance needs, evaluate coverage options, and make
informed decisions about purchasing insurance policies.
5. Insurance Consultant:
 An insurance consultant is an expert who provides specialized advice and services to
insurance companies, businesses, or individuals on various aspects of insurance, risk
management, and related regulatory compliance.
 Consultants may offer services such as actuarial analysis, underwriting support,
claims management, risk assessment, and regulatory compliance assistance.
6. Managing General Agent (MGA):
 A managing general agent is an intermediary with underwriting authority delegated
by an insurance company to underwrite and manage insurance policies on its
behalf.
 MGAs act as intermediaries between insurance carriers and retail agents or brokers,
providing specialized expertise in underwriting, policy administration, and risk
management for specific lines of business or market segments.