DEFINITION Insurance is an agreement whereby a group of individuals facing similar risks can share the fortuitous losses of the unlucky few by the transfer of such risks to the insurer who agrees to compensate the losses
HOW DOES INSURANCE WORK? Insurer can collect premiums from a group of people in similar circumstances not all of whom will suffer losses in any one year. These premiums are then pooled together and used by the insurer to pay losses. Losses are thus shared out among all the policyholders rather than borne solely by the unlucky few.
COMMON POOL An insurance company sets itself up to operate the pool. It takes contributions, in the form of insurance premiums from many insureds and pay for the losses of a few. The operation of the common pool is very much based on the successful application of the Law of Large Numbers.
LAW OF LARGE NUMBERS Law of large numbers states that the larger the group of similar risks, the closer the actual losses experienced by the group will approach the expected losses This law implies that the greater the number of similar risk, the more accurate the insurer can be in predicting the future losses. Allows the insurer to fix premium in advance Insurer can assess the risk and fix a premium which reflects the hazard and value of the risk which an insured brings to the pool.
INSURANCE PREMIUM Contribution = premium which is the consideration an insured pays to the insure for an insurance coverage of a specified nature for a specified policy period
BREAKDOWN OF THE PREMIUM PURE PREMIUM RISK EXPENSE LOADING CONTINGENCY LOADING PROFIT LOADING
PREMIUM CALCULATION SUM INSURED x Expense Loading – to cover the expenses PREMIUM RATE = occurred in maintaining PREMIUM the insureds contribution. PAYABLE. Contingency Loading – to Premium Rate = cover the possible variability of claims Average Total costs. Claims / Average Profit Loading – to cover Total Value expected dividend payments to the insurer’s Insured X 100% shareholders.
CXTS OF INSURABLE RISKS Financial Value Large number of similar risks Pure risks only No catastrophic loss Fortuitous Loss Insurable Interest Legal and not against public policy Reasonable premium
FUNCTION OF INSURANCE PRIMARY FUNCTION – Risk transfer mechanism
FUNCTION OF INSURANCE SECONDARY FUNCTIONS – Releasing funds otherwise tied up in reserves. – Stimulate business enterprise – Insurance also stimulates business – Remove fear and worry – Reduction of losses – Savings – Social benefits
FUNCTION OF INSURANCE INDIRECT FUNCTION – Investments of funds – Invisible exports
OTHERS Sources of Employment – Insurance industry has generated numerous employment opportunities Classes of Insurance – Life Assurance – General Insurance Risks Covered by Life Assurance – Premature Death – Continuous Stream of Income during retirement – Sickness or Disability Risks Covered by General Insurance – Motor Vehicles – Marine and Aviation – Products or goods sold
DIFFERENCES BETWEEN LIFE AND OTHER FORMS OF INSURANCE Life – Certain event, the only uncertainty is when the time it will occur General – term of contract is only one year and it is cancelable by both parties Life longer term and can only be cancel by insured General is subject to principle of indemnity