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IF1: Insurance, Legal and Regulatory Principles

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by

James Lucas

on 18 October 2012

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Transcript of IF1: Insurance, Legal and Regulatory Principles

Module 1- What is insurance? IF1: Insurance, Legal and Regulatory Principles Definition of Risk Categories of Risk Financial & Non Financial Risks Insurance is taken out to protect against RISK
The chance of a loss
Unpredictability
The possibility of an unfortunate occurrence Risk Transfer Mechanism The accepting of an unknown future potential risk by an insurer for an agreed premium.
The insurer does this by promising to pay for loss, damage or liability as defined by the policy terms.

INSURANCE = RISK TRANSFER MECHANISM For a risk to be insurable the outcome of the adverse events must be capable of measurement in financial terms.
The cost of repairing accidental damage to a motor car
Loss of business profits following a fire
Liability to pay compensation for personal injury to others There are many situations in life when we speculate with a view to making some kind of gain, but the chance of break even or failure are possibilities:
National Lottery
Stock Market
Setting up a new business
Pricing Decisions Speculative Risks These Risks are NOT insurable These are risks where there is the possibility of a loss or break-even situation but NOT of gain.

The risk of fire
The risk of machinery breakdown
The risk of injury to employees at work Pure Risks These risks are personal in their cause and effect.

A Factory Fire
A Car Collision
Theft from a home Particular Risks Risks that arise from social, economic, political or natural causes and are widespread in their effect

earthquake
economic recession
war Fundamental Risks These risks are generally uninsurable Fortuitous
The event insured against must be accidental and not inevitable
Insurable Interest
A legally recognised relationship with the subject matter of insurance
Not against Public Policy
Cannot insure against things which society considers to be morally wrong
Homogenous Exposure
Lots of similar risks (law of large numbers) Features of Risk Make a list......Insurable/Non insurable Financial
Pure
Particular
Fortuitous Event
Insurable Interest
Not against Public Policy
Homogenous Exposure Insurable Non insurable Non-Financial
Speculative
Fundamental
Deliberate Act
No Insurable Interest
Against Public Policy
‘One Offs’ Components of Risk Uncertainty is central to the concept of risk because if we know what is going to happen then there is no element of risk involved.

There needs to be uncertainty in order for a person to insure. Uncertainty FREQUENCY - How often it will happen?
SEVERITY - How serious it will be if it does happen?

Insurers look at the interaction between frequency and severity to assist with decision making Level of Risk A PERIL can be defined as THAT WHICH GIVES RISE TO A LOSS

A HAZARD can be defined as THAT WHICH INFLUENCES THE OPERATION OF A PERIL Peril & Hazard This relates to the physical nature of the risk
Security protection at a shop - better security, lower physical hazard level as it may prevent a loss altogether
The construction of the property - the higher the standard of construction, the lower the physical hazard for fire and similar risks Physical Hazards Arises from the attitude and conduct of people.

Carelessness - a driver’s lack of care can increase the chance of an accident
Dishonesty - a person who has previously made fraudulent claims represents a greater moral hazard than one who has not Moral Hazard Skills Solutions The basic concept of insurance is that the losses of the few are met by the contributions of many
Contributions from many insured go into the ‘pool’
Claims payments are made out of this ‘pool’ Skills Solutions Enables the insurer to predict the final cost of claims in any one year
There must be a sufficient number of similar risks for insurers to predict what losses will occur
The insurer can then calculate likely losses and charge a fixed premium for the year Skills Solutions A number of pools are set up, one for each main group of risks
Household
Motor
Each person joining the pool must be prepared to make an equitable (fair) contribution
Claim payments are initially paid out of each pool Skills Solutions Peace of Mind
It releases capital within companies
Enterprise is encouraged
Employees are kept in work
Losses are reduced in size and number
The nation benefits from investments made by insurers
The nation benefits from ‘invisible exports’ Skills Solutions “The identification, analysis and economic control of those risks which can threaten the assets or earnings capacity of an enterprise”
Risk Identification
Risk Analysis
Risk Control (Physical / Financial)

The decision to transfer risks (for example by insurance) is an important final stage in the risk management process Skills Solutions Insurers also share risks


CO-INSURANCE WITH OTHER INSURERS
RISK SHARING WITH THE INSURED
REINSURANCE Skills Solutions This involves an insurer agreeing with other insurers the rating and terms to be applied and issuing a ‘collective policy’.
Each insurer receives a stated proportion of the premium and pays the same proportion of losses that occur.
The LEADING OFFICE is the first named insurer in the policy and carries the largest share of the risk and issues the documentation Skills Solutions The term is also used in relation to the amount of a risk that the insured may retain.
The term co-insurance is used when an insured is responsible for a substantial part of each loss.
E.g. ‘Co-insurance 25%’ meaning that the insured would bear 25% of each claim Skills Solutions An insurer is able to reinsure a risk that it holds because it stands to lose financially as a result of any claim payment.
The insurer can pass some (or all) of the risk to another insurer as reinsurance
The main difference between reinsurance and co-insurance is that the insured need not know this has happened Dual Insurance
Occurs when 2 or more policies cover the same risk
Self Insurance
Occurs when an insured decides not to transfer a risk through insurance
Excesses
Insurers not reinsuring
Full transcript