Here are the notes of Insurance subject for all those candidates who have cleared OICL AO Pre Examination. It will help you to prepare well for the mains examination as far as Insurance Subject is concerned.
What is Peril?
Life is Very Un-Certain. Any Person can meet with Death, due to Some Un-Fortunate or Un-Expected Event, at Any Point of Time. Assets are also likely to be destroyed, or made Non-Functional, due to Accidental Occurrences, before the Expected Life-Time. Hence, Assets need to be insured.
Peril is the Cause of Loss. Anything that causes the Loss, is a Peril.
Example: Fire, Flood, Earth-Quake, Lightning, Lane-Slide, etc.
An Event or Incident, that may cause a Loss, is called, a Peril.
I. Insurance Does Not Protect the Asset. It Does Not Prevent its Loss, due to the Peril, and the Peril cannot be avoided through Insurance. Insurance Only Tries to Reduce the Impact of the Financial Loss to the Owner or Beneficiary of the Asset.
Example: A Person takes Fire Insurance for His Office, so that, He can protect Him-Self against Any Losses due to Fire in His Office. In this Case, Fire is the Peril. But, taking Fire Insurance cannot prevent the Occurrence of the Peril (Fire in the Office). The Impact of Peril (Fire) can be reduced, by installing Smoke-Detectors and Fire-Extinguishers in the Office Premises. In the Event of Fire (Peril) in the Office, Insurance can only compensate the Owner against the Losses suffered due to Fire. Insurance tries to put the Person in the Same Position, that He or She was, before the Fire occurred in the Office.
II. Insurance can compensate Only Economic or Financial Losses. It cannot compensate for Non-Economic Losses, which cannot be measured in Monetary Terms, as in the Case of Death of a Person.
Example: Examples of Non-Economic Losses can be Love and Affection to the Family, Sentimental Attachments, Innovative and Creative Abilities, etc. These are Not Quantifiable in Monetary Terms.
Risks: Perils differ according to Frequency and Intensity. If such Peril can cause Damage to an Asset, we say that, the Asset is exposed to that Risk.
Definition; Risk is Un-Certainty of Outcome. If there is a Chance that the Outcome will be Different from Expectations, there is a Risk.
Example: People staying in Buildings in the Hills, are Not Exposed to the Risk to Tidal Waves. They are exposed to the Risk of Land-Slides. Similarly, People staying near the Sea-Shore, may not be that much exposed to the Risk of Land-Slides. But, they are Certainly more exposed to the Risk of Tidal Waves.
Perils are the Events, like, Land-Slides or Tidal Waves, which can lead to Losses or Damages. Risks are the Likelihood of Loss or Damage, resulting from the Occurrences of Perils. The Risk to the Owner of a Building, due to the Occurrence of a Peril, like, Fire, can be a Few Lakhs or a Few Crores of Rupees, depending on the Extent of the Damage. It is also possible that, there may be No Damage, at all. Insurance is not taken to prevent the Peril or to pay Compensation, if the Peril happens. Insurance is taken against the Likely Damage or the Loss, that the Peril may cause.
A Person takes Fire Insurance for His Office. Here, the Fire is the Peril. Insurance cannot prevent the Fire from occurring. Now, take a Hypothetical Situation, in which, the Fire (Peril) occurs, and there is No Damage or No Loss. The Peril has occurred, but there is No Damage or No Loss, therefore there will be No Compensation, paid by the Insurance Company. The Insurance Company will pay Compensation, only when, there is Accidental Fire (Peril) in the Office, and Financial Loss arises due to the Fire.
This Example makes it clear, that, Insurance is for the Risk (Loss or Damage) arising out of the Peril.
Insuring Some Assent is More Risky than Others. For Example, insuring a Very Old Building is More Risky than insuring a New Building in the Context of Fire, Earth-Quake or Floods. Similarly, insuring a Tanker, carrying Petroleum Products is More Risky than insuring a Tanker, carrying Water.
Risk only means that, there is a Possibility of Loss or Damage. The Damage may happen or may not happen. Insurance is obtained against the Possibility, that the Loss or Damage may happen. The Word : Possibility, implies Un-Certainty, There has to be Un-Certainty about the Risk. Insurance covers only those Risks, where, the Possibility of Occurrence, is Un-Certain. If the Possibility of the Occurrence of the Event is Certain, then, that Risk will Not be covered by the Insurance Company.
Example: A Person want to take Insurance for His Office, against the Risk of Loss due to Fire. The Occurrence of Fire, in this Case, is Un-Certain. The Fire may occur or may not occur. So, the Insurance Company will issue a Policy, to cover the Risk of Loss due to Fire. But, if a Forest Fire has already started nearby, and is threatening to burn-down the office, it is Certain that, the Fire will occur and destroy the Office leading to Losses, then, the Insurance Company will Not cover the Risk.
In the Case of a Human Being, Death is Certain, but the Time of Death is Un-Certain. So, Life Assurance Companies cover the Risk of Loss due to Death, even though Death is Certain, but the Timing of Death is Un-Certain. In the Case of a Person, suffering from a Killer Disease, like, Human Immuno-Deficiency Virus (H.I.V.) Acquired Immuno-Exactly Known. The Life-Span of such People, is Short, and hence, it is Un-Likely they can be insured.
Classification of Risks:
- Risks can be classified into 5 Broad Categories:
- Catastrophic Risks and Important Risks:
- Risks can be classified on the Basis of Extent of Damage, likely to be caused. Critical Risks or Catastrophic Risks are the Risks, where, a Single Event of Major Magnitude leads to a Significantly Higher than Usual Number and/or Amount of Claims on an Insurer. Catastrophic Risks are Big Enough to cause Bankruptcy of the Owner, or even the Insurer.
Examples can be, Natural Disasters, like, Earth-Quake, Floods, or Tsunami, where, everything gets destroyed. It can also happen, if the Deceased Person had Lot of Outstanding Loans, Like, Home loan, Car Loan, Credit Card Dues, etc.
There could be Important Risks, which may upset Family Finances or Business Finances, badly, requiring a Lot of Time to recover. But, such Risks may not be categorized as Catastropic Risks.
Examples can be, Credit Card Dues and Personal Loans, taken for enjoying the Vacations. These don’t add much value, but still have to be paid for. Adverse Effects of an Economic Recession, like Temporary Job-Loss or Huge Losses due to Fall in the Stock-Markets are Important Risks.
Risks, that are Less-Damaging, like, Temporary Illnesses or Accidents, may not be that Important for the Insurer, though, they may be Important for the Affected Person, for Some Period of Time.
Financial and Non-Financial Risks:
Risks can also be classified as Financial Risks and Non-Financial Risks. Financial Risks are those Risks, that lead to Losses, that can be quantified or measured in Monetary Terms.
Example: Financial Risks are related to Changes in the Value of Assets, like, Shares or Property.
Non-Financial Risks are those, that can’t be measured or quantified in Monetary Terms.
Example of Non-Financial Risk can be Health, but it can lead to Financial Losses, through Treatment and Temporary Loss of Income due to Incapacity to Work. Bad Business Decisions may cause Inability to pay Debts. Non-Financial Risks are Not Insurable as such, but are, sometimes, paid through Insurance. Though Ill-Health is Non-Financial, Loss of Earnings due to Ill-Health or Treatment Costs, can be quantified and insured. Similarly, Courts impose Damages for Mental Agony or Loss of Reputation, due to Reasons, like, Professional Mis-Conduct, Mis-Use of Power and Harassment. Mental Agony and Loss of Reputation are Not Financial Losses. When the Court imposes a Penalty, a Person becomes Duty-Bound to pay the Amount. The Financial Liability is Insurable under Insurance Policies. Non-Financial Risks, where, the Financial Impact cannot be estimated, cannot be insured.
Dynamic Risks and Static Risks:
Dynamic Risks are those resulting from Changes in the Economy. Changes in the Price-Level, Consumer Tastes, Fashions, Income and Output, Technology, Political Upheavals or Government suddenly losing Vote of Confidence may cause Financial Loss to the Members of the Economy. Dynamic Risks normally benefit Society over the Long-Run. Since Dynamic Risks may affect a Large Number of individuals, they are generally considered Less Predictable than Static Risks.
Static Risks involve those Losses, that occur, even if, there were No Changes in the Economy. If Consumer-Tastes, Output and Income, and the Level of Technology do not change, some Individuals would still suffer Financial Loss. These Losses arise from Causes, other than, the Changes in Economy, such as, Perils of Nature and Dis-Honesty of Other Individuals. Unlike Dynamic Risks, Static Risks are Not a Source of Gain to Society. Static Losses involve either the Destruction of an Asset or a Change in its Possession as a Result of Dis-Honesty 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.
Example of Static Risk can be Small Fire or Theft in One Particular House. Static Risks are More Predictable and More Likely to Occur, as compared to Dynamic Risks. Static Risks can be managed through Insurance, as, their Frequency and Possibility can be studied and forecasted.
Pure Risks and Speculative Risks:
- Speculative Risks are under the Control of the Person-Concerned.
- Examples of Speculative Risks, can be, Horse-Racing, Lottery, Gambling or Speculating in Stock-Markets. In Speculative Risks, there is a Chance of Loss as well as Gain.
- For Example, a Person betting in a Lottery or Horse-Racing, may win or lose the Money.
- Pure Risks are Not under the Control of the Concerned Person. In Pure Risks, there is a Chance of Loss, but No chance of Gain.
- Insurance covers Only Pure Risks, and Non Speculative Risks.
- Some Examples of Pure Risks, are, Fire, Earth-Quake, Theft, or Death of a Person.
Fundamental Risks and Particular Risks:
- Fundamental Risks are those Risks, that affect a Lot of People, together.
- Example: A Train Accident is a Fundamental Risk, as, it affects a Lot of People.
- Particular Risks affect Only Specific Persons.
- Example: Theft in a Particular House, affects Only the Owner.
- Life Assurance Business deals with Particular Risks. But in the Case of a Natural Disaster, like, Earth-Quake, a Lot of Individual People, get affected. Such Events affect the Experience of the Life Assurance Company, in Calculating Probabilities and pricing the Premium.