Chapter One

Introduction To Insurance
Objectives of the Session
 To understand what is Insurance
 To understand the purpose & need of
Insurance
 To understand how Insurance works
 To understand the business of Insurance
 Insurance as a social security tool & its role
in economic development
 The advantages of Life Insurance
What is Insurance

What is an asset ?

An asset is anything of cash value

which is owned by a person.

Assets may include personal property, cars,

investments, bank accounts, stocks, mutual
funds, gold, jewellery, antiques, cash.
What is Insurance

Everyone would have some assets

…….like a House, Car etc.

Assets

Income Generating For Comfort /Convenience

Example: Factory Example: Car
 What is Insurance

Asset have a specified Lifetime

However, even before its expected lifetime,
it may…
Become Non- Be
Functional destroyed

This would cause loss to the Owner

What is Insurance

Insurance is a mechanism that helps

to reduce the effect of such
adverse situations.
What is Insurance

The business of Insurance is

related to the protection of the
economic value of assets
Purpose & Need of
Insurance

Assets may get damaged

Due
to

Accidental Occurrences Called Perils

Purpose & Need of
Insurance

What are Perils?

Perils are accidental occurrences that can cause
damage, such as
fire, floods, breakdowns, lightning, earthquake
etc.
Purpose & Need of Insurance
The damage due to the perils is
the Risk the asset is exposed to

Peril Damage/
Financial loss

Asset
Cannot be Risk can be
prevented insured against

Perils are the events

Risks are the consequential losses or damages
Risk & Uncertainties

 Risk only means that there is a possibility of loss or damage.

 In our example if there is lightning by which the house may

get damaged

Insurance is done against the contingency that

it may happen.
Purpose & Need of Insurance
 Insurance Compensates only the financial
losses

But does not protect the asset against the Peril

Insurance Only compensates

cannot protect the monetary loss -
the house to some extent.
against the fire
Purpose & Need of Insurance

Possibility of
RISK Damage

While the event may or may not happen

Purpose of Insurance is
 To replace the uncertainty of loss with
the certainty of compensation
Non Financial Loss
is not covered

 Only economic consequences can be insured

 If the loss is not financial, insurance may not be
possible.

Example:
1. Non economic losses are love and affection of parents
2. Leadership of managers
3. Innovative & creative abilities
How Insurance Works

The manner in which the loss is shared

can be determined before hand.

Contribution Compensation
Fund

Basis of contribution is
how many and not who Unfortunate
Fortunate will suffer Few
Many
How Insurance Works

Thus people who are exposed to the same risks

come together and agree that, if any one of them
suffers a loss, the others will share the loss and
make good to the person who lost.

Example:
All people who send goods by ship are exposed to the same risks,
which are related to water damage, ship sinking, piracy etc.
Insurance as a Loss Sharing Device

People exposed to the same risk come together and agree that if any
one ‘member’ suffers a loss, the same will be shared by others, who
will make good to the person who lost

Larger
Impact
Unfortunate Fortunate
Few Many

Larger Impact reduced to smaller manageable impacts

Insurance is the business of “Sharing”

If a Jumbo Jet with more than 350

passengers crashes, the loss would run into
several crores of rupees. No airline would be
able to bear such a loss.
How can insurance help in mitigating the
financial loss?
Sharing of Loss

100 airline companies

come together to form
an insurance pool
Insurance Pool
Sharing of Loss

Loss of
1 airline

Shared by
100
airlines

The Risk is spread

and
The Loss is Shared
Basic Principles of Insurance

Occurrence has to be random

Occurrence has to be Accidental

Not the Deliberate creation of the Insured

Person
Basic Principles of Insurance

 The`Law of Large Numbers’.

The Law of Large Numbers :

The more times we
observe a particular event, the more likely it is that our
observed results will approximate the true probability
that the event will occur.
Determining the Loss

 The loss to be shared is determined before hand

 It is proportional to the risk each person is exposed

to

 It is indicative of the benefit he would receive

How Insurance Works

Case Study 1:
 In a village there are 400 houses, each valued at Rs 20,000.
 Every year on an average, 4 houses get burnt, resulting
into a total loss of Rs 80,000.

Find a Solution
Solution - Case Study 1

400 owners come Fund

together and Fund Size
contribute
Rs 200 each = 400200
= Rs 80,000
Case Study: Sharing Loss

The Loss of
4 Owners

Shared by
100
owners
The Human Asset

A Human being is an
Income generating asset

It can be lost due to early

death

It can become Non-Functional

due to Accident or Sickness
Insuring Human Life

Accidents and sickness

may or may not happen

But what of death ,

Is it not Certain?

Death will happen,

but the timing is uncertain
Insuring Life

Risk for Human beings

Dying too Early Living too Long

Economic Loss
Insurance of Intangibles

The concept of insurance has been extended

beyond the coverage of tangible assets.

Insurance covers

Tangible Intangibles
Assets Assets
Exporters run the risk of losses
if importers in other country
defaults in payments or in
collecting the goods
Business of Insurance

Insurer
 The business of insurance
is done by insurance
companies, called insurers
 They bring together
persons with common
interests (sharing the
same risks)
 Collect the share of
contribution (called
premium)
 Pay out compensation
(called claims)

Insured
Insurance Business - India

Insurance Business (in India)

Life Insurance General Insurance

Death (Risk of Early Fire (dealing with fire

Death) related risks)

Annuity (Risk of Marine (dealing with

Living too Long) transport related risk &
ships)

Miscellaneous (dealing
with all other like motor,
liability, personal
accident & sickness etc)
‘Life’ vs ‘Non Life’ Insurance

Life Insurance General Insurance

Subject Human Life Property, Building,

matter Ship, Cargo, Motor

Principle of Based on Earning Based on

Coverage Capacity estimated value
How Premiums are calculated

 Premium is based on expectations of the

losses.
 These expectations are based on studies
of occurrences in the past and use of
statistical principles
Business of Insurance

 People who face loss get relief because their loss is

made good.

 People who do not suffer are relieved because they

are spared the loss
Business of Insurance

 Insurer is in the position of a trustee as it manages

a common fund and acts as a fiduciary for the
benefit of the community

 Fiduciary – works for the benefit of society and

ensures nobody takes unfair advantage
Business of Insurance

 Thus it prevents entry of people into a group whose

risks are not same as well as paying charges on
claims which are not accidental

 The process of allowing entry into the group is the

process of underwriting
Insurance as a
Social Security Tool
Any progressive state must take care of the well
being of its people

UN
Indian
declaration
Constitution- Food
of Human
Article 41 Clothing
Rights
Housing
Education
Within its Medical Care
Resources Security for
unemployment
and sickness
 Insurance as a Social Security Tool

Bread Winner Dies State’s Resources

Insurance

Family’s Standard of
Living Affected Weaker Sections
Role of Insurance In Development
Of Economy

 It relieves the worry of the insured there by increasing the

individual’s productivity

 It mobilizes money from people's homes for nation building

 Acts as an Anti-inflationary Force-inflation happens when lot of

spending takes place from income
Benefits of Insurance-
Individual

You are paying Rs 1000 every You are paying Rs 1000 every
month as life insurance month in a bank FD
premium. SA 200000 .

In case of death
after 4 years

You will get You will get

200,000 + bonuses 48,000 + interest
Benefits of Insurance-Individual

 It is superior to a traditional saving vehicle

 It encourages saving and forces thrift

 It provides easy settlement and protection against

creditors
Benefits of
Insurance-Individual
 It helps to achieve the purpose of the life assured

 It can be encashed and facilitates borrowing

 Tax Relief
Key Learnings

 Insurance is a risk sharing device

 Insurance is a function of uncertainty
 Insurance protects the economic value of the asset
 Living too long is as much a risk as dying too early
 Insurance follows the law of large numbers
 Insurance complements the states efforts in reducing
social cost
Thank You