WHAT IS INSURANCE
Insurance in broad terms may be described as a method of sharing financial losses of few from a common fund who are equally exposed to the same loss. Insurance is a form of risk management in which the insured transfers the cost of potential loss to another entity in exchange for monetary compensation known as the premium
Insurance allows individuals, businesses and other entities to protect themselves against significant potential losses and financial hardship at a reasonably affordable rate. We say "significant" because if the potential loss is small, then it doesn't make sense to pay a premium to protect against the loss. After all, you would not pay a monthly premium to protect against a loss because this would not be considered a financial hardship for most.
HISTORYOF INSURANCE
In India, insurance has a deep-rooted history. Insurance in various forms has been mentioned in the writings of Manu (Manusmrithi), Yagnavalkya (Dharmashastra) and Kautilya (Arthashastra). The fundamental basis of the historical reference to insurance in these ancient Indian texts is the same i.e. pooling of resources that could be re-distributed in times of calamities such as fire, floods, epidemics and famine. The early references to Insurance in these texts has reference to marine trade loans and carriers' contracts.
Insurance in its current form has its history dating back until 1818, when Oriental Life Insurance Company was started by Anita Bhavsar in Kolkata to cater to the needs of European community. The pre-independence era in India saw discrimination between the lives of foreigners (English) and Indians with higher premiums being charged for the latter. In 1870, Bombay Mutual Life Assurance Society became the first Indian insurer.
RISK AND INSURANCE
All uncertainties in insurance fall into one or the other of two broad categories: speculative or pure. A speculative uncertainty is one in which there is both the possibility of a financial gain and the possibility of a financial loss. For example, a property owner is exposed to the speculative uncertainty that various forces may either increase or decrease the value of his property. Generally, speculative uncertainties may not be insured.
A pure uncertainty involves the possibility of a financial loss only. For example, a property owner exposed to the uncertainty of loss by fire, a pure uncertainty, can only lose.
TYPES OF RISK
Pure and speculative risks
One of the most useful distinctions is that between pure risk and speculative risk. Speculative risk describes a situation where there is a possibility of loss, but also a possibility of gain. Gambling is a good example of a speculative risk. In a gambling situation, risk is deliberately created in the hope of gain. The person wagering $10 on the outcome of a game faces the possibility of loss, but this is accompanied by the possibility of gain. The entrepreneur or capitalist faces speculative risk in the quest for profit. The investment made may be lost if the product is not accepted by the market at a price sufficient to cover costs, but this risk is borne in return for the possibility of profit. The term pure risk, in contrast, is used to designate those situations that involve only the chance of loss or no loss.
One of the best examples of pure risks is the possibility of loss surrounding the ownership of property. The person who buys an automobile, for example, immediately faces the possibility that something may happen to damage or destroy the automobile. The possible outcomes are loss or no loss.
The distinction between pure and speculative risks is an important one, because normally only pure risks are insurable. Insurance is not concerned with the protection of individuals against those losses arising out of speculative risks. Speculative risk is voluntary accepted because of its two-dimensional nature, which includes the possibility of gain. Not all pure risks are insurable, and a further distinction between insurable and uninsurable pure risks may also be made.
Static and dynamic risks
A second important distinction is between static and dynamic risks.
Dynamic risks are those resulting from changes in the economy. Changes in the price level, consumer tastes, income and output, and technology may cause financial loss to members of the economy. These dynamic risks normally benefit society over the long run, since they are the result of adjustments to misallocation of resources. Although these dynamic risks may be affected a large number of individuals, they are generally considered less predictable than static risks, since they do not occur with any precise degree of regularity.
Static risks involve those losses that would occur even if there were no changes in the economy, if we could hold consumer tastes, output and income, and the level of technology constant, some individuals would still suffer financial loss. These losses arise from causes other than the changes in the economy, such as the perils of nature and the dishonesty of other individuals. Unlike dynamic risks, static risks are not a source of gain to society. Static losses involve either the destruction of the asset or a change in its possession as a result of dishonesty or human failure. Static losses tend to occur with a degree of regularity over time and, as a result, are generally predictable. Because they are predictable, static risks are more suited to treatment by insurance than are dynamic risks.
Group and individual risks
The distinction between group and individual risks is based on the difference in the origin and consequences of the losses.
Group risks involve losses that are impersonal in origin and consequence. The yare group risks caused fro the most part by economic, social, and political phenomena, although the y may also result from physical occurrences. They affect large segments or even all of the population. Individual risks involve losses that arise out of individual events and are felt by individuals rather than by entire group. They may be static or dynamic. Unemployment, war, inflation, and floods are all group risks. The burning of a house and the robbery of a bank are individual risks.
Since group risks are caused by conditions more or less beyond the control of the individuals who suffer the losses and since the y are not the fault of anyone in individual, it is held that society rather than the individual has a responsibility to deal with them. Although some group risks are dealt with though private insurance, it is an inappropriate tool for dealing with most group risks. Usually, some form of social insurance or other government transfer program is used to deal with group risks. Unemployment and occupational disabilities are group risks treated through social insurance. Flood damage or earthquakes make a district a disaster area eligible for federal funds.
Individual risks are considered to be the individual's own responsibility, inappropriate subjects for action by society as a whole. They are dealt with by the individual through the use of insurance, loss prevention, or some other technique.
Example
An example of impossibility can be quoted say the 9/11 incident where insurance companies were washed out.
Hyderabadis never in their dreams thought of taking cover for flood. When the encroached drains could not contain rains for 2 days, the resultant floods had washed away score of vehicles, property etc.
Pure and speculative risks
One of the most useful distinctions is that between pure risk and speculative risk. Speculative risk describes a situation where there is a possibility of loss, but also a possibility of gain. Gambling is a good example of a speculative risk. In a gambling situation, risk is deliberately created in the hope of gain. The person wagering $10 on the outcome of a game faces the possibility of loss, but this is accompanied by the possibility of gain. The entrepreneur or capitalist faces speculative risk in the quest for profit. The investment made may be lost if the product is not accepted by the market at a price sufficient to cover costs, but this risk is borne in return for the possibility of profit. The term pure risk, in contrast, is used to designate those situations that involve only the chance of loss or no loss. One of the best examples of pure risks is the possibility of loss surrounding the ownership of property. The person who buys an automobile, for example, immediately faces the possibility that something may happen to damage or destroy the automobile. The possible outcomes are loss or no loss.
The distinction between pure and speculative risks is an important one, because normally only pure risks are insurable. Insurance is not concerned with the protection of individuals against those losses arising out of speculative risks. Speculative risk is voluntary accepted because of its two-dimensional nature, which includes the possibility of gain. Not all pure risks are insurable, and a further distinction between insurable and uninsurable pure risks may also be made.
Classifications of pure risk
While it would be impossible to list all the risks confronting an individual or business, we can briefly outline the nature of the various pure risks that we face. For the most part, these are also static risks. Pure risks that exist for individuals and business firms can be classified under one of the following:
Personal risks
These consist of the possibility of loss of income or assets as a result of the loss of the ability to earn income. In general, earning power is subject to four perils:
- premature death,
- dependant old age,
- sickness or disability, and
- unemployment
Property risks
Anyone who owns property faces property risks simply because such possessions can be destroyed or stolen. Property risks embrace two distinct types of loss: direct loss and indirect or "consequential" loss. Direct loss is the simplest to understand: if a house is destroyed by fire, the owner loses the value of the house. This is a direct loss. However, in addition to losing the value of the building itself, the property owner no longer has a place to live, and during the time required to rebuild the house, it is likely that the owner will incur additional expenses living somewhere else. This loss of use of the destroyed asset is an indirect, or "consequential," loss. An even better example is the case of a business firm. When a firm's facilities are destroyed, it loses not only the value of those facilities but also the income that would have been earned through their use. Property risks, then, can involve two types of losses:
· the loss of the property, and
· loss of use of the property resulting in lost income or additional expenses
Liability risks
The basic peril in the liability risk is the unintentional injury of other persons or damage to their property through negligence or carelessness; however, liability may also result from intentional injuries or damage. Under our legal system, the laws provide that one who has injured another, or damaged another's property through negligence or otherwise, can be held responsible for the harm caused. Liability risks therefore involve the possibility of loss of present assets or future income as a result of damage assessed or legal liability arising out of either intentional or unintentional torts, or invasion of the rights of others.
Risks arising from failure of others
When another person agrees to perform a service for you, he or she undertakes and obligation that you hope will be met. When the person's failure to meet this obligation would result in your financial loss, risk exists. Examples of risks in tis category would include failure of a contractor to complete a construction project as scheduled, or failure of debtors to make payments as expected.
Methods of Treating Risk
There are a number of ways to treat risk, including: (1) retention, (2) elimination of loss possibility, (3) hedging, (4) transfer of risk, and (5) anticipation of loss.
Many individuals simply assume risk, retaining it by conscious decision or by indifference. Some risk is retained because there is no alternative; in other risk, retention is a superior method of treatment.
Some risks are managed through the elimination or minimization of hazard. This is the underlying rationale of the loss prevention and loss minimization practices of individuals, business firms, and insurers.
Risk may be reduced by transferring the loss possibility to another person or organization. For example, a surety bond guaranteeing the completion of a building in accordance with the specifications involves the transfer of the risk from the person having the building constructed to the surety.
Risk can be reduced by anticipation, that is, by measuring in an aggregate sense the losses that probably will occur. Statistical inference and other estimating devices (broadly referred to in insurance as actuarial techniques) are important tools in anticipating losses. This ability, based on past experience, to estimate future losses with reasonable accuracy reduces risk (decreases uncertainty). Insurance involves anticipation combined with an accumulation of funds from individuals who transfer their risks to the insurer. The insurer must have funds in order to pay the anticipated losses. An insurance policy, signed by the insurer and the insured, sets forth the terms of the agreement.
Insurers, hoping to anticipate the dollar volume of losses, rely on the theoretical principle of large numbers. A practical statement of this principle, a part of the subject of probability, is: as the number of units of experience or exposure increases, the margin of error in estimating the expected losses decreases, thus reducing the risk to the insurer.
Events that are the result of pure chance occur with increasing regularity as the number of instances observed becomes larger. Just as the National Safety Council in the United States predicts with reasonable accuracy the number of motorists who will meet death on the highways, insurers with statistics on millions of lives can foretell reasonably accurately the number of people from a given population who will die in a stipulated period.
CONCLUSION
Insurance is an integral part of any personal financial plan. The type of insurance and the amount of coverage you obtain all depends on your unique financial and family circumstances, and must be evaluated carefully. When considering purchasing coverage, you should review all the potential risks and the financial impact of these risks on your financial health. This will help you determine what options to look for and what questions to ask. What you need to keep in mind is that you do not want to be underinsured or overinsured, which means you have to do your homework before you buy. And as with any type of financial product, you must read the fine print and consult with a competent advisor.
BIBLOGRAPHY
Ø Wikipedia, the free encyclopedia
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