Principles Of Insurance

1. Principles Of Insurance

2. Meaning of Risk • Risk is the potential that a chosen action or activity (including the choice of inaction) will lead to a loss (an undesirable outcome) OR • Risk is an uncertainty concerning the occurrence of a loss • In insurance industry we define risk to identify the property or life being insured • “that driver is a poor risk”, “cancer patient is an unacceptable risk”

3. Types of Risk • Objective Risk: relative variation of actual loss from expected loss • For eg: An insurer has 100000 cars insured for a long period of time, and on the average 10000 cars meet with at least one accident and claim for damages each year. However, for a particular year, it is unlikely that there will be exactly 10000 claims. Under certain assumptions, it can be proven that over a long period of time, the deviation of the number of claim in a year from 10000 will, on the average be 100. • Thus there is a variation of 100 claims from the expected number of 10000 or a variation of 1%. • This relative variation of actual loss from expected loss is known as objective risk

4. Types of Risk • Subjective Risk-an uncertainty in the individual’s personal estimate of the chance of loss. • It can vary from one person to another. • For eg-Somebody who has lost a lot of money in the stock market will probably feel more risk investing in the market than someone who has profited handsomely. • Subjective risk may alter the behavior of the risk taker if it is an undesirable risk

5. Types of Probabilities • Objective probability is the probability of an occurrence, calculated by either deduction or induction • Subjective probability is a person’s perception of the likelihood of an event.

6. Chance of Loss • is the probability that a loss will occur, which can either be an expected loss or an actual loss

7. Peril and Hazard • peril is something that can cause a loss. Examples include falling, crashing your car, fire, wind, hail, lightning, water, volcanic eruptions, choking, or falling objects • Hazard is a condition that creates or increases the chance of loss

8. Types of Hazards • Physical hazard • Moral Hazard • Morale hazard • Legal hazard

9. Physical Hazard • Physical condition that increases the chance of loss • Examples- • Icy roads that increase the chance of an auto accident • Defective wiring in a building that increases the chance of fire • working from heights, including ladders, scaffolds, roofs, or any raised work area

10. Moral Hazard • Dishonesty or character defects in an individual that increase the frequency or severity of loss • Examples- • Submitting a fraudulent claim, • inflating the amount of a claim, • Intentionally burning unsold merchandise that is insured

11. Morale Hazard • Carelessness or indifference to a loss because of the existence of insurance • Examples • Leaving car keys in an unlocked car which increases the chance of theft • Leaving a door unlocked that allows a burglar to enter • “Its insured so why should I worry about safety of my house/property/own health. If anything goes wrong, insurer is there to indemnify me. So, Why should I worry about safety?”

12. Legal Hazard • Characteristics of the legal system or regulatory environment that increase the frequency or severity of losses • Examples: • Laws that require insurers to include coverage for certain benefits in health insurance plans, such as alcholism

13. Categories of Risks • Pure and Speculative Risks • Fundamental and Particular Risks • Enterprise Risk

14. Pure Risk & Speculative Risk • Pure risk : there are only the possibilities of loss or no loss • Examples: Damage to property from fire, lightning, flood or earthquake etc • Speculative risk : either profit or loss is possible • Examples: investment in shares or real estate, betting on horse race • ONLY Pure Risks are insured but exceptions always exist….. Like some insurers will insure institutional portfolio investments

15. Fundamental & Particular Risks • Fundamental risk affects the entire economy or large number of persons or groups within the economy – rapid inflation, cyclical unemployment, war, natural disaster, terrorist attack • Particular Risk affects only individuals and not the entire community . For e.g.. Car thefts, bank robberies, dwelling fires

16. Enterprise Risk • Relatively new term that encompass major risks faced by a business firm • Pure Risk • Speculative Risk • Strategic Risk: uncertainty regarding the firm’s financial goals and objectives • Operational Risk: results from the firm’s business operations like a bank that offers new online banking services may incur losses if hackers break into the bank ‘s computers

17. Enterprise Risk contd… • Financial risk: refers to the uncertainty of loss because of adverse changes in commodity prices, interest rates, foreign exchange rates, an the value of money • Examples- • A food company that agrees to deliver a commodity at a fixed price to a supermarket in six months may lose money if grain price rises

18. Types of Pure Risks • Premature Death • Insufficient income during retirement • Poor health • Unemployment • Property risks • Liability risks

19. A Contract • An agreement between two or more parties to do or abstain from doing an act • Create a legally binding relationship

20. Essentials of a valid Contract- • The intention to create legal relations • Offer and acceptance • Consideration • Certainty of terms • Consensus ad idem (a genuine meeting of minds) • Legality of purpose • Possibility of performance

21. Requirements of an Insurance Contract • Offer and acceptance • Consideration • Competent parties • Legal Purpose

22. Requirements of an Insurance Contract • Offer and Acceptance: Applicant for insurance makes the offer and the company accepts or rejects the offer • An agent merely solicits the prospective insured to make the offer • In property & Liability insurance especially personal line insurance – auto , home insurance , the agents typically have the power to bind the insurer through the use of binder. • Binder is a temporary contract for insurance • In life insurance, agent does not have the power to bind the insurer • A conditional premium receipt is given to the applicant after filling the application form

23. Consideration • Consideration is the value that each party gives to the other

24. Competent Parties • Each party must be legally competent/ must have legal capacity to enter into a binding contract • Most adults are legally competent to enter into the insurance contracts but there are some exceptions like • Insane persons, intoxicated persons, minors • Also, insurer must be licensed to sell insurance in that country

25. Legal Purpose • An insurance contract that encourages something illegal or immoral is contrary to the public interest and can not be enforced • For e.g. policy can not cover seizure of the drugs by the police

26. Distinct Legal Characteristics of Insurance Contracts • Aleatory Contract • Unilateral Contract • Personal Contract • Conditional Contract • Contract of Adhesion

27. Distinct Legal Characteristics of Insurance Contracts • Aleatory Contract: where the values exchanged may not be equal but depend on an uncertain event . For e.g..- ?????????? (Commutative Contract?) • Unilateral Contract: only one party makes a legally enforceable promise. Only the insurer makes a legally enforceable promise to pay a claim . After the first premium is paid, the insured can not be legally forced to pay the premiums (Bilateral Contract?) • Personal Contract: the contract is between the insured and the insurer

28. Distinct Legal Characteristics of Insurance Contracts • Conditional Contract: Insurer’s obligations to pay a claim depends on whether the insured has compiled with all policy conditions • For e.g. In a homeowner’s policy , the insured must give immediate notice of loss. If the insured delays for an unreasonable period in reporting the loss, the insurer can refuse to pay the claim • Contract of Adhesion: means the insured must accept the entire contract, with all of its terms and conditions

29. Principles of Insurance • Utmost Good Faith • Insurable Interest • Indemnity • Corollaries of Indemnity • Proximate Cause

30. Utmost Good Faith • Uberrima fides is a Latin phrase meaning "utmost good faith” .This means that all parties to an insurance contract must deal in good faith, making a full declaration of all material facts in the insurance proposal • A minimum standard that requires both the buyer and seller in a transaction to act honestly toward each other and to not mislead or withhold critical information from one another • A positive duty voluntarily to disclose ,accurately and fully, all facts material to the risk being proposed ,whether requested or not

31. Representations • Statements made by the applicant for insurance • For e.g. If you apply for life insurance, you may be asked questions concerning your age, weight, height, occupation, state of health, family history etc. Your answers to these questions are the representations

32. Contract is voidable if the representation is Representation • (A)Material • (B)False • (C)Relied on by the insurer • Material - If the insurer knew the true facts, the policy would not have been issued, or it would have been issued on different terms • False-the statement is not true or misleading • Reliance – the insurer relies on the representation in issuing the policy at specified premium

33. Examples • Karim applied for life insurance and states in the application that he has not visited a doctor within the last five years • However, six months earlier he had surgery for lung cancer. So, the statement made by him is false, material and relied on by the insurer

34. Misrepresentation in Motor Insurance • The insured misrepresented that she had no traffic violations in the prior three-year period. After the claim, a check of her record revealed that she had two traffic violations in that period. The insurer denied the coverage. • Court Decision-The insured claimed that she had forgotten about the two violations she had made and therefore, she had no intention to deceive. The court ruled that it is unlikely she would forget both events . Decision is for the insurer

35. Misrepresentation • If an applicant for insurance states an opinion that later turns out to be wrong , the insurer must prove that the applicant spoke fraudulently and intended to deceive the company • An innocence misrepresentation of a material fact, if relied on by the insurer , also makes the contract voidable.