Insurance and Risk:

1. Insurance and Risk: Ch 3

2. Definition of Insurance There is no single definition of insurance. Insurance can be defined from the viewpoint of several disciplines, including law, economic, history, actuarial, science, risk theory, and sociology. Insurance is the pooling of for fortuitous losses by transfer of such risks to insurers, who agree to indemnity insured for such losses, to provide other pecuniary benefits on their occurrence, or to render service connected with the risk.

3. Basic Characteristics of Insurance, 1- Pooling of losses 2- Payment of fortuitous losses 3- Risk transfer 4- Indemnification

4. Pooling of losses Pooling of losses or sharing of losses is the heart of insurance. Pooling is the spreading of losses incurred by few over the entire group, so that process, average loss is substituted for actual loss. In addition, pooling involves the grouping of large number can operate to provide a substantially accurate prediction of future losses.

5. Pooling of losses The primary purpose of pooling, or the sharing of losses, is to reduce the variation in possible outcomes as measured by standard deviation or some other measure of dispersion, which reduced risk. For example, assume that to business owners each own an identical storage building valued at $50,000. Assume there is a 10 percent chance in any years that each building will be destroyed by peril and that loss to either building is an independent event. The expected annual loss for each owner is $5000 as shown below: Expected loss = 0.90*$0 + 0.10*$50,000 = $5000 A common measure of risk is standard deviation, which is square root of the variance. The standard deviation (SD) for the expected value of the loss is $15,000, as below: SD= 0.90 ( 0 - $5000)^2 + 0.10 ($50,000 -$5000)^2 = $15,000

6. Payment of fortuitous losses A second characteristic of private insurance is Payment of fortuitous losses. A fortuitous losses is one that is unforeseen and unexpected by insured and occurs as a result of chance.

7. Risk transfer Risk transfer is another essential element of insurance. With the expection of self-insurance, a true insurance plan always involves risk transfer means that a pure risk is transferred from the insured to the insurer , who typically is in a stronger financial position to pay the loss than insured.

8. Indemnification A final characteristic of insurance is indemnification for losses. Indemnification mean that the insured is restored to his or her approximate financial position prior to the occurrence of the loss. Thus, if your home burns in a fire, a homeowner policy will indemnify you restore you to your previous position.

9. Adverse selection • Adverse selection is the tendency of person with a higher than average chance of loss to seek insurance at average rate, which, if not controlled by underwriting, resulting in higher-than-expected loss level.

10. Types of insurance: Insurance can be classified into private and government insurance. 1- Private insurance: consist of life and health insurance and property and liability insurance. 2- Government insurance: consist of social insurance and other government programs.

11. The major benefits of insurance to society are as follows: 1-Indemnification for loss 2-Reduction of worry and fear 3-Source of investment funds 4-Loss prevention 5-Enhancement of credit

12. Insurance imposes certain social costs to society, which include the following: 1-Cost of doing business 2-Fraudulent claims 3-Inflated claims