Module1_Insurance Definition & Principlesv1.0(1)

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16/25/2014INSEIT Confidential

Insurance Definition

&Principles of Insurance

Anand Arragunta



26/25/2014INSEIT Confidential 26/25/2014INSEIT Confidential

Item 1 • Risk & Hazard

Item 2• Insurance Meaning & Definition

Item 3• Principles of Insurance

Agenda




What is Risk & Hazard?

• Risk is the probability that a hazard will turn into a disaster Vulnerability and

hazards are not dangerous, taken separately But if they come together, theybecome a risk or, in other words, the probability that a disaster will happen.

• A hazard is a phenomenon or a process, either natural or human made, that

can endanger a group of people, their belongings and their environment, if

they do not take precautions .







Agenda




Insurance - Meaning

• Insurance provides financial protection against a loss arising out of

happening of an uncertain event

• A person can avail this protection by paying premium to an insurance

company

• A pool is created through contributions made by persons seeking to

protect themselves from common risk

• Premium is collected by insurance companies which also act as trustee

to the pool

• Any loss to the insured in case of happening of an uncertain event is

paid out of this pool

• Insurance works on the basic principle of risk-sharing

• A great advantage of insurance is that it spreads the risk of a few

people over a large group of people exposed to risk of similar type




Insurance - Definition

• In law and economics, insurance is a form of risk management primarily

used to hedge against the risk of a contingent, uncertain loss.

OR

• A contract (policy) in which an individual or entity receives financial

protection or reimbursement against losses from an insurance

company The company ‘pools clients’ risks to make payments moreaffordable for the insured.

OR

• Insurance is a contract between two parties whereby one party agrees

to undertake the risk of another in exchange for consideration known

as premium and promises to pay a fixed sum of money to the other

party on happening of an uncertain event (death) or after the expiry of

a certain period in case of life insurance or to indemnify the other party

on happening of an uncertain event in case of general insurance.


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Concept of Insurance/How Insurance Works

• In today's world, insurance plays an important role It exists to

safeguard nearly everything, ranging from human life to financial

investments

• The concept behind insurance is that a group of people exposed to

similar risk come together and make contributions towards formation

of a pool of funds

• In case a person actually suffers a loss on account of such risk, he is

compensated out of the same pool of funds

• Contribution to the pool is made by a group of people sharing

common risks and collected by the insurance companies in the form of

premiums



Example 1 Example 2

SUPPOSE

· Houses in a village = 1000

· Value of 1 House = Rs 40,000/-

· Houses burning in a yr = 5

· Total annual loss due to fire = Rs 2,00,000/-

· Contribution of each house owner = Rs 300/-

SUPPOSE

· Number of Persons = 5000

· Age and Physical condition = 50 years & Healthy

· Number of persons dying in a yr = 50

· Economic value of loss suffered by family of each dying

person = Rs 1,00,000/-

· Total annual loss due to deaths = Rs 50,00,000/-

· Contribution per person = Rs 1,200/-

UNDERLYING ASSUMPTION All 1000 house owners are exposed to a common risk,

ie fire

UNDERLYING ASSUMPTION All 5000 persons are exposed to common risk, ie death

PROCEDURE

All owners contribute Rs 300/- each as premium to the

pool of funds

Total value of the fund = Rs 3,00,000 (ie 1000 houses *

Rs 300)5 houses get burnt during the year

Insurance company pays Rs 40,000/- out of the pool to

all 5 house owners whose house got burnt

PROCEDURE

Everybody contributes Rs 1200/- each as premium to the

pool of funds

Total value of the fund = Rs 60,00,000 (ie 5000 persons *

Rs 1,200)50 persons die in a year on an average

Insurance company pays Rs 1,00,000/- out of the pool to

the family members of all 50 persons dying in a year

EFFECT OF INSURANCE

Risk of 5 house owners is spread over 1000 house

owners in the village, thus reducing the burden on any

one of the owners

EFFECT OF INSURANCE

Risk of 50 persons is spread over 5000 people, thus

reducing the burden on any one person

Example:


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Agenda



Principles of Insurance

• Utmost Good Faith (Uberrimae fidei)

• Insurable Interest

• Principle of Indemnity

• Principle of Contribution

• Principle of Subrogation

• Principle of Loss Minimization

• Principle of ‘CAUSA PROXIMA’



• Utmost Good Faith

– 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 fromone another The doctrine of utmost good faith applies to many common financial

transactions.


• Insurable Interest

– A person has an insurable interest in something when loss or damage to it would

cause that person to suffer a financial loss or certain other kinds of losses.

E.g. If you are applying for life/health insurance, you are required to disclose any previous health

problems you may have had. Likewise, the insurance agent selling you the coverage must disclose

the critical information you need to know about your contract and its terms.

E.g. If the house you own is damaged by fire, the value of your house has been reduced by the

damages sustained in the fire. Whether you pay to have the house rebuilt or you end up selling it

at a reduced price, you have suffered a financial loss resulting from the fire.



• Principle of Indemnity

– Financial compensation sufficient to place the Insured in the same financialposition at the time of a loss, as he was enjoying immediately prior to the

loss.


E.g. When your old Maruti 800 is stolen, you can't expect your insurer to replace it with a

brand new Mercedes-Benz. In other words, you will be remunerated according to the

total sum you have assured for the car.

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• Principle of contribution

–

Under this principle the insured can claim the compensation only to theextent of actual loss either from any one insurer or all the insurers.


E.g. Mr A insures his property worth Rs100,000 with two insurers “ABC Ltd” for Rs 100,000

and “XYZ Ltd” for Rs 50,000. Property destroyed is worth Rs 50,000, Mr A can claim the

full loss of Rs 50,000 either from ABC Ltd or XYZ Ltd, or he can claim Rs 25,000 from ABC

Ltd and Rs 25,000 from XYZ Ltd .

• Principle of Subrogation

– After the insured is compensated for the loss due to damage to property

insured, then the right of ownership of such property passes on to the

insurer

– Subrogation means substituting one creditor for another

E.g. Mr A gets his house insured for Rs 50,000 with an insurance company. The house is

intentionally destroyed by Mr B. A claims the loss from the insurance company. A

cannot sue B for getting the compensation because he has already been compensated

by the insurance company. Now, insurance company can sue Mr B on behalf of Mr A

because of making good the loss suffered by Mr A, the insurance company steps into

the shoes of Mr A.

i i l f



• Principle of Loss Minimization

– Under this principle it is duty of the insured to take all possible steps to

minimize the loss to the insured property on the happening of uncertain

event


E.g. Assume, Mr A's house is set on fire due to an electric short-circuit. In this tragic

scenario, Mr A must try his level best to stop fire by all possible means, like first calling

nearest fire department office, asking neighbours for emergency fire extinguishers, etc.

He must not remain inactive and watch his house burning hoping, "Why should I worry?

I've insured my house” .

• Principle of Causa Proxima

– Principle of Proximate (ie Nearest) Cause, means when a loss is caused by

more than one causes, the proximate or the nearest or the closest cause

should be taken into consideration to decide the liability of the insurer

E.g. A cargo ship's base was punctured due to rats and so sea water entered and cargo

was damaged. Here there are two causes for the damage of the cargo ship - (i) The

cargo ship getting punctured because of rats, and (ii) The sea water entering ship

through puncture. The risk of sea water is insured but the first cause is not. The nearest

cause of damage is sea water which is insured and therefore the insurer must pay the

compensation.



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Module1_Insurance Definition & Principlesv1.0(1)