Insurance Defined
There are a whole bunch of glossorary of terms needed to be understood about insurance. From the different types of insurance, health, automobiles, travel, life, and etc.
As insurance defined, it basically came from the legal and economic point of view. Insurance is a form of risk management basically used to hedge against the risk of a contigent loss. Put plainly, insurance works to protect yourself from huge losses in case of say, your home accidentally got burned down. And then, your insurer will tell you they are going to pay all the damages.
Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of a contingent loss. Insurance is defined as the equitable transfer of the risk of a loss, from one entity to another, in exchange for a premium. Insurer, in economics, is the company that sells the insurance. Insurance rate is a factor used to determine the amount, called the premium, to be charged for a certain amount of insurance coverage. Risk management, the practice of appraising and controlling risk, has evolved as a discrete field of study and practice.
Put plainly, how insurance works is that, if you would like to protect yourself from huge losses in case of say, a car accident, then you go to an insurance company, who says that they will pay for all damages to you, in case of an accident, in exchange for a periodic (monthly, yearly, etc) payment (called insurance premium) you keep making to the insurance company. So you are covered in case of that misfortune. But is the insurance company in the business of losing money ? No, what it does, is that essentially it has statistics information, saying that only, say, 5 out of a hundred of its policy holders, will face such accidents (and large losses), so the small insurance premiums collected from the 100 insured folks, will more than cover for the money paid out to the 5 folks who did go through the losses. So, essentially, insurance refers to spreading out the risk of an event, among many parties, so that in the worst case, the losses suffered by any single insured party, is much less than the losses suffered if that party were not insured. so, insurance offers peace-of-mind to the parties buying the insurance.
Principle of Insurance
Commercially insurable risks typically share seven common characteristics
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A large number of homogeneous exposure units. The vast majority of insurance policies are provided for individual members of very large classes. Automobile insurance, for example, covered about 175 million automobiles in the United States in 2004. The existence of a large number of homogeneous exposure units allows insurers to benefit from the so-called “law of large numbers,” which in effect states that as the number of exposure units increases, the actual results are increasingly likely to become close to expected results. There are exceptions to this criterion. Lloyd's of London is famous for insuring the life or health of actors, actresses and sports figures. Satellite Launch insurance covers events that are infrequent. Large commercial property policies may insure exceptional properties for which there are no ‘homogeneous’ exposure units. Despite failing on this criterion, many exposures like these are generally considered to be insurable.
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- Definite Loss. The event that gives rise to the loss that is subject to insurance should, at least in principle, take place at a known time, in a known place, and from a known cause. The classic example is death of an insured on a life insurance policy. Fire, automobile accidents, and worker injuries may all easily meet this criterion. Other types of losses may only be definite in theory. Occupational disease, for instance, may involve prolonged exposure to injurious conditions where no specific time, place or cause is identifiable. Ideally, the time, place and cause of a loss should be clear enough that a reasonable person, with sufficient information, could objectively verify all three elements.
- Accidental Loss. The event that constitutes the trigger of a claim should be fortuitous, or at least outside the control of the beneficiary of the insurance. The loss should be ‘pure,’ in the sense that it results from an event for which there is only the opportunity for cost. Events that contain speculative elements, such as ordinary business risks, are generally not considered insurable.
- Large Loss. The size of the loss must be meaningful from the perspective of the insured. Insurance premiums need to cover both the expected cost of losses, plus the cost of issuing and administering the policy, adjusting losses, and supplying the capital needed to reasonably assure that the insurer will be able to pay claims. For small losses these latter costs may be several times the size of the expected cost of losses. There is little point in paying such costs unless the protection offered has real value to a buyer.
- Affordable Premium. If the likelihood of an insured event is so high, or the cost of the event so large, that the resulting premium is large relative to the amount of protection offered, it is not likely that anyone will buy insurance, even if on offer. Further, as the accounting profession formally recognizes in financial accounting standards (See FAS 113 for example), the premium cannot be so large that there is not a reasonable chance of a significant loss to the insurer. If there is no such chance of loss, the transaction may have the form of insurance, but not the substance.
- Calculable Loss. There are two elements that must be at least estimable, if not formally calculable: the probability of loss, and the attendant cost. Probability of loss is generally an empirical exercise, while cost has more to do with the ability of a reasonable person in possession of a copy of the insurance policy and a proof of loss associated with a claim presented und er that policy to make a reasonably definite and objective evaluation of the amount of the loss recoverable as a result of the claim.
- Limited risk of catastrophically large losses. The essential risk is often aggregation. If the same event can cause losses to numerous policyholders of the same insurer, the ability of that insurer to issue policies becomes constrained, not by factors surrounding the individual characteristics of a given policyholder, but by the factors surrounding the sum of all policyholders so exposed. Typically, insurers prefer to limit their exposure to a loss from a single event to some small portion of their capital base, on the order of 5 percent. Where the loss can be aggregated, or an individual policy could produce exceptionally large claims, the capital constraint will restrict an insurers appetite for additional policyholders. The classic example is earthquake insurance, where the ability of an underwriter to issue a new policy depends on the number and size of the policies that it has already underwritten.
- Wind insurance in hurricane zones, particularly along coast lines, is another example of this phenomenon. In extreme cases, the aggregation can affect the entire industry, since the combined capital of insurers and reinsurers can be small compared to the needs of potential policyholders in areas exposed to aggregation risk. In commercial fire insurance it is possible to find single properties whose total exposed value is well in excess of any individual insurer’s capital constraint. Such properties are generally shared among several insurers, or are insured by a single insurer who syndicates the risk into the reinsurance market.
Attention Readers: This definitions and information that has been explained in this entire page were basically taken from the wikipedia website. there might be some statement that may not be applicable in today's situation, so please use some caution if you want to use this onformation. i will not be responsible for any content on this as there are numerous contributors to this website wikipedia. some are verified and some are not, so use them at your own risk. Thank you
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