general principles of risk & insurance

1 - 1Copyright 2008, The National Underwriter Company

General Principles of Risk & Insurance

Definitions and concepts What is insurance?

Purchase of a contract that on behalf of purchaser pledges the payment of a sum-certain amount (the “premium”) in exchange for a promise on behalf of the other party (the insurance company) to provide restitution or indemnity arising from the occurrence of a loss

A device for reducing risk by combining a sufficient number of exposure units to make individual losses collectively predictable

The losses of the few are shared among the many

Chapter 1Risk Management For Financial Planners


Definitions and concepts (cont'd) The law of large numbers

Primary underpinning to the insurance mechanism The more exposure units in the mix, the easier it become to

predict the groups losses

Fortuitousness Non-fortuitous loss (those losses that are certain to occur may not be

insurable)




Peril, Hazard and Risk Although terms may be used synonymously by

practitioners, they do have differing technical meaning

Risk Refers to the uncertainty as to the the outcome of am event Possible outcomes are Loss or No-Loss

Peril The cause of a possible loss

Fire, water damage, mold, etc. Peril may be a covered peril (included under the coverage) or a

peril that is specifically excluded under the policy




Peril, Hazard and Risk (cont'd) Hazard

A specific situation that increases the probability of the occurrence of a loss arising from a peril or that may influence the extent of a loss

Concept of Indemnity Indemnity means to make whole again Insurance puts the person back in the same position he

or she was in prior to the loss – no better, no worse




Insurance Versus Gambling Insurance is not wagering Three outcomes with gambling

Loss No loss Gain

Two possible outcomes with insurance Loss No loss




Other Non-insurance Responses To Risk Retention

One assumes the risk on his or her own Example – Not to purchase collision on an older car Requires careful consideration of the possible losses Corporations use large retention as a financial risk

management strategy

Avoidance Either not doing something or getting rid of the risk

Example – Use of public transportation avoids the risks of physical damage and liability of car ownership




Other Non-insurance Responses To Risk Control

Minimizing hazards Example – Installing a burglar alarm

Non-insurance transfer Transfer of risk to someone other than an insurer

Rental agreement for tools where the customer agrees to bring them back in the same condition.

Failure to do so could result in customers being charged for the price of those tools




Voluntary and Social Insurance Social Insurance

Government agencies that provide social insurance, against loss from

Unemployment, injuries, sickness, old age, premature death Major types of social insurance

Old Age, Survivors, and Disability (Social Security) Workers Compensation Unemployment Compensation

Participation is mandatory Premiums collected via payroll deduction Employees and Employers pay into the social security fund Employers must purchase both workers compensation insurance

and unemployment compensation insurance



general principles of risk & insurance

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