Meaning of RiskRisk is the potential that a chosen action or activity (including

the choice of inaction) will lead to a loss (an undesirable outcome)

ORRisk is an uncertainty concerning the occurrence of a lossIn insurance industry we define risk to identify the property or

life being insured “that driver is a poor risk”, “cancer patient is an unacceptable

risk”

Types of RiskObjective Risk: relative variation of actual loss from expected

lossFor eg: An insurer has 100000 cars insured for a long period of

time, and on the average 10000 cars meet with at least one accident and claim for damages each year. However, for a particular year, it is unlikely that there will be exactly 10000 claims. Under certain assumptions, it can be proven that over a long period of time, the deviation of the number of claim in a year from 10000 will, on the average be 100.

Thus there is a variation of 100 claims from the expected number of 10000 or a variation of 1%.

This relative variation of actual loss from expected loss is known as objective risk

Types of RiskSubjective Risk-an uncertainty in the individual’s personal

estimate of the chance of loss.It can vary from one person to another.For eg-Somebody who has lost a lot of money in the stock

market will probably feel more risk investing in the market than someone who has profited handsomely.

Subjective risk may alter the behavior of the risk taker if it is an undesirable risk

Types of ProbabilitiesObjective probability is the probability of an occurrence,

calculated by either deduction or induction Subjective probability is a person’s perception of the

likelihood of an event.

Chance of Loss

is the probability that a loss will occur, which can either be an expected loss or an actual loss

Chance of Loss = Expected or Actual Loss───────────────────Number of Possible Losses

Peril and Hazardperil is something that can cause a loss. Examples include

falling, crashing your car, fire, wind, hail, lightning, water, volcanic eruptions, choking, or falling objects

Hazard is a condition that creates or increases the chance of loss

Types of HazardsPhysical hazardMoral HazardMorale hazardLegal hazard

Physical HazardPhysical condition that increases the chance

of lossExamples-Icy roads that increase the chance of an auto

accidentDefective wiring in a building that increases

the chance of fireworking from heights, including ladders,

scaffolds, roofs, or any raised work area

Moral HazardDishonesty or character defects in an

individual that increase the frequency or severity of loss

Examples-Submitting a fraudulent claim, inflating the amount of a claim,Intentionally burning unsold merchandise

that is insured

Morale HazardCarelessness or indifference to a loss because of the existence

of insurance

ExamplesLeaving car keys in an unlocked car which increases the

chance of theftLeaving a door unlocked that allows a burglar to enter

“Its insured so why should I worry about safety of my house/property/own health. If anything goes wrong, insurer is there to indemnify me. So, Why should I worry about safety?”

Legal HazardCharacteristics of the legal system or regulatory environment

that increase the frequency or severity of lossesExamples:Laws that require insurers to include coverage for certain

benefits in health insurance plans, such as alcholism

Categories of RisksPure and Speculative RisksFundamental and Particular RisksEnterprise Risk

Pure Risk & Speculative RiskPure risk : there are only the possibilities of loss or no lossExamples: Damage to property from fire, lightning, flood or

earthquake etcSpeculative risk : either profit or loss is possibleExamples: investment in shares or real estate, betting on horse

raceONLY Pure Risks are insured but exceptions always exist…..

Like some insurers will insure institutional portfolio investments

Fundamental & Particular RisksFundamental risk affects the entire economy or large number

of persons or groups within the economy – rapid inflation, cyclical unemployment, war, natural disaster, terrorist attack

Particular Risk affects only individuals and not the entire community . For e.g.. Car thefts, bank robberies, dwelling fires

Enterprise RiskRelatively new term that encompass major risks faced by a

business firmPure RiskSpeculative RiskStrategic Risk: uncertainty regarding the firm’s financial goals

and objectivesOperational Risk: results from the firm’s business operations

like a bank that offers new online banking services may incur losses if hackers break into the bank ‘s computers

Enterprise Risk contd…Financial risk: refers to the uncertainty of loss because of

adverse changes in commodity prices, interest rates, foreign exchange rates, an the value of money

Examples-A food company that agrees to deliver a commodity at a fixed

price to a supermarket in six months may lose money if grain price rises

Types of Pure RisksPremature DeathInsufficient income during retirementPoor healthUnemploymentProperty risksLiability risks

A Contract

An agreement between two or more parties to do or abstain from doing an act

Create a legally binding relationship

Essentials of a valid Contract-

The intention to create legal relationsOffer and acceptanceConsiderationCertainty of termsConsensus ad idem (a genuine meeting of minds)Legality of purposePossibility of performance

Requirements of an Insurance ContractOffer and acceptanceConsiderationCompetent partiesLegal Purpose

Requirements of an Insurance Contract Offer and Acceptance: Applicant for insurance makes the offer and the

company accepts or rejects the offerAn agent merely solicits the prospective insured to make the offer In property & Liability insurance especially personal line insurance – auto ,

home insurance , the agents typically have the power to bind the insurer through the use of binder.

Binder is a temporary contract for insurance In life insurance, agent does not have the power to bind the insurerA conditional premium receipt is given to the applicant after filling the

application form

ConsiderationConsideration is the value that each party gives to the

other

Competent PartiesEach party must be legally competent/ must have legal

capacity to enter into a binding contractMost adults are legally competent to enter into the

insurance contracts but there are some exceptions likeInsane persons, intoxicated persons, minorsAlso, insurer must be licensed to sell insurance in that

country

Legal PurposeAn insurance contract that encourages something illegal

or immoral is contrary to the public interest and can not be enforced

For e.g. policy can not cover seizure of the drugs by the police

Aleatory ContractUnilateral ContractPersonal ContractConditional ContractContract of Adhesion

Distinct Legal Characteristics of Insurance Contracts

Distinct Legal Characteristics of Insurance ContractsAleatory Contract: where the values exchanged may not be

equal but depend on an uncertain event . For e.g..- ?????????? (Commutative Contract?)

Unilateral Contract: only one party makes a legally enforceable promise. Only the insurer makes a legally enforceable promise to pay a claim . After the first premium is paid, the insured can not be legally forced to pay the premiums (Bilateral Contract?)

Personal Contract: the contract is between the insured and the insurer

Distinct Legal Characteristics of Insurance ContractsConditional Contract: Insurer’s obligations to pay a claim

depends on whether the insured has compiled with all policy conditions

For e.g. In a homeowner’s policy , the insured must give immediate notice of loss. If the insured delays for an unreasonable period in reporting the loss, the insurer can refuse to pay the claim

Contract of Adhesion: means the insured must accept the entire contract, with all of its terms and conditions

Principles of InsuranceUtmost Good FaithInsurable InterestIndemnityCorollaries of IndemnityProximate Cause

Utmost Good FaithUberrima fides is a Latin phrase meaning "utmost good

faith” .This means that all parties to an insurance contract must deal in good faith, making a full declaration of all material facts in the insurance proposal

A minimum standard that requires both the buyer and seller in a transaction to act honestly toward each other and to not mislead or withhold critical information from one another

A positive duty voluntarily to disclose ,accurately and fully, all facts material to the risk being proposed ,whether requested or not

RepresentationsStatements made by the

applicant for insuranceFor e.g. If you apply for

life insurance, you may be asked questions concerning your age, weight, height, occupation, state of health, family history etc. Your answers to these questions are the representations

Representation(A)Material(B)False(C)Relied on by the insurerMaterial - If the insurer knew the true facts, the

policy would not have been issued, or it would have been issued on different terms

False-the statement is not true or misleadingReliance – the insurer relies on the

representation in issuing the policy at specified premium

Contract is voidable if the

representation is

ExamplesKarim applied for life insurance and states in

the application that he has not visited a doctor within the last five years

However, six months earlier he had surgery for lung cancer. So, the statement made by him is false, material and relied on by the insurer

Misrepresentation in Motor InsuranceThe insured misrepresented that she had no

traffic violations in the prior three-year period. After the claim, a check of her record revealed that she had two traffic violations in that period. The insurer denied the coverage.

Court Decision-The insured claimed that she had forgotten about the two violations she had made and therefore, she had no intention to deceive. The court ruled that it is unlikely she would forget both events . Decision is for the insurer

MisrepresentationIf an applicant for insurance states an

opinion that later turns out to be wrong , the insurer must prove that the applicant spoke fraudulently and intended to deceive the company

An innocence misrepresentation of a material fact, if relied on by the insurer , also makes the contract voidable.