UNIT - 1

INTRODUCTION
BASIC CONCEPT

 RISK

 UNCERTAIN EVENT

 POSSIBILITY OF OUTCOME DIFFERENT THAN

EXPECTED
An unwanted event in the future. Such as
fire, accident, thefts, explosion etc.
Risk is in every steps, but world has to
continue, even in the face of risk, the
most we can do is to try to manage our
exposure to risk.
Risk-chance or probability of loss.
Risk- unfortunate things which may
happen in future
 Uncertainty- in this world nothing is certain
except death.

 Uncertainty-unpredictability of danger.

 Can we ban motor vehicles to stop road

acidents?
CLASSIFICATION OF RISK

 Pure Risk
Such as which causes loss with no
possibility of gain. Eg:Fire, storm, death,
injury etc. These are insurable risk.
 Speculative risk:
Outcome of such risk may causes loss or
profit. Eg: business risk, Change of
fashion, change of Foreign-ex rate.
These risk are uninsurable risk.
MANAGEMENT OF RISK

 AVOIDENCE
 RETENTION

 TRANSFER

 SHARED

 REDUCTION/CONTROL
AVOIDENCE

 Most drastic way to handle risk.

 Choosing not to participate in an activity

because of the risk involved.

 Ceasing to undertake the activity which

creates the risk.
 Performing it in another way or at some
other places.

 Example: Payment through bank to avoid

loss of cash in transit/ Shift of site to
other place to avoid flooding damage.
RETENTION

 Paying for the small losses out of own

resource when they occur.

 Set aside a contingency fund for large

losses.

 Self Insurance.
TRANSFER

 Transfer of the activity that creates the

risks

 Transfer of the financial losses arising

from the occurrence of risks
 Insurance is simply a risk transfer
mechanism

 With payment of certain amount of

premium one can relieved of the
uncertainty as to how costly any future
loses will be as the benefit of insuring is
that loss costs are fixed.
REDUCTION

 Elimination of risk is impossible.

 It is loss prevention.

 Reduction of chances of loss producing

events ocuring.
 Reduction of potential size of losses that
do occur. (FEA)
TYPES OF PURE RISK

 Personal Risks

 Property Risks

 Liability Risks
PERSONAL RISKS
 Personal risks are risks that directly affect and
individual or family.
 They involve the possibility of a loss or

reduction in income, extra expenses or

depletion of financial assets, due to
 Premature death of family head
 Insufficient income during retirement

 Poor health (catastrophic medical bills and loss of

earned income)
 Involuntary unemployment
PROPERTY RISKS
 Property risks involve the possibility of losses
associated with the destruction or theft of property
 Direct loss vs. indirect loss
 Direct loss is a financial loss that results from the
physical damage, destruction, or theft of the property,
such as fire damage to a home
 An indirect or consequential loss is a financial loss that
results indirectly from the occurrence of a direct
physical damage or theft loss, e.g., the additional living
expenses after a fire
LIABILITY RISKS
 Liability risks involve the possibility of being
held legally liable for bodily injury or
property damage to someone else .
 There is no maximum upper limit with respect
to the amount of the loss .
 A lien can be placed on your income and
financial assets.
 Legal defense costs can be enormous.
 Major Commercial Risks
 Firms face a variety of pure risks that can have
serious financial consequences if a loss occurs
 Property risks, such as damage to buildings,
furniture and office equipment
 Liability risks, such as suits for defective products,
pollution, and sexual harassment
 Loss of business income, when the firm must shut
down for some time after a physical damage loss
BURDEN OF RISK ON SOCIETY

 The presence of risk results in three major

burdens on society:
 In the absence of insurance, individuals and
business firms would have to maintain large
emergency funds to pay for unexpected losses
 The risk of a liability lawsuit may discourage
innovation, depriving society of certain goods and
services
 Risk causes worry and fear
Peril and Hazard
 Peril is defined as the cause of the loss
 In an auto accident, the collision is the peril

 Hazard is a condition that increases the chance

of loss
 A physical hazard is a physical condition that
increases the frequency or severity of loss
 Moral hazard is dishonesty or character
defects in an individual that increase the
frequency or severity of loss
Attitudinal Hazard (Morale Hazard) is
carelessness or indifference to a loss,
which increases the frequency or
severity of a loss
Legal Hazard refers to characteristics
of the legal system or regulatory
environment that increase the frequency
or severity of loss
Why is risk important for insurance?

 Risk is what makes you decide whether or

not you need insurance.

 Risk is what insurance companies measure

when determining whether to offer you
insurance and how much it will cost.
 INSURANCE

Form of risk
management
from uncertain
loss

Insurance
is Sharing
losses of Distribution
few of risk
among
many

Contract between
Insurer and Insured
(Written
agreement)
 Most practical method for handling a major
risk.
 It’s a technique which provides for collection

of small amounts of premium from many

individuals and firms out of which losses
suffered by a few are reimbursed
 Individuals or firms are able to buy
protection through payment of small amount
of premium
 Insurance comes in to play only after
there is some loss sustained by insured.
 Insurance is to compensate the sufferer

financially and it tries to restore the

sufferer in original position.
 Thus, It’s a transfer of risk for
consideration i.e Premium and being free
from anxieties and uncertainty
DEFINITION OF INSURANCE

 A contract between insured and insurer in

which insurer promise to indemnify loss
suffered by insured due to insured perils
and insured pays premium as
consideration.
TYPES OF INSURANCE

 NON LIFE INSURANCE

 LIFE INSURANCE

 RE-INSURANCE
CHARACTERISTICS OF INSURANCE

 Pooling of losses
 Payment of fortuitous losses

 Risk Transfer

 Indemnification
POOLING OF LOSSES
 Pooling involves spreading losses incurred by
the few over the entire group
 Risk reduction is based on the Law of Large

Numbers
 According to the Law of Large Numbers, the

greater the number of exposures, the more

closely will the actual results approach the
probable results that are expected from an
infinite number of exposures.
PAYMENT OF FORTUITOUS LOSSES

 A fortuitous loss is one that is

unforeseen, unexpected, and occur as a
result of chance.

 Loss must be accidental.

RISK TRANSFER

 Pure risk is transferred from the insured to

the insurer, who typically is in a stronger
financial position to pay the loss than
insured.
INDEMNIFICATION

 The insured is restored to his or her

approximate financial position prior to
the occurrence of the loss
FUNCTION OF INSURANCE AND INSURER

 Major function of insurance is to minimize

the risk and loss of the insured
 It is catagorized in:

 PrimaryFunctions
 Secondary Functions
PRIMARY FUNCTIONS

 Providing protections
 Collective risk bearing

 Evulating risk

 Provide certainty
PROVIDING PROTECTION

 Provide security against future risk,

accident and uncertainty.

 Protection against economic loss by

apportioning the risk with others.
COLLECTIVE RISK BEARING

 Insurance is an instrument to share financial

loss.
 Medium through which losses are divided

among larger number of people.

 All the insured add the premium towards

the fund and out of which the person

facing a specific risk is paid.
EVALUATING RISK

 Insurance fixes the likely volume of risk by

assessing diverse factors that give rise to
risk.

 Risk is basis for ascertaining the premium

rate.
PROVIDE CERTAINTY

 Insurance is a device which assists in

changing uncertainty to certainty.

 Insurance company has been committed to

provide fanancial support against the loss
incurs as per the policy.
SECONDARY FUNCTIONS
 Preventing losses
 Covering larger risks with small capital
 Helps in the development of larger industries
 Financial intermediary
 Medium of earning foreign exchange
 Risk free trade
PREVENTING LOSSES

 Insurance warns individuals and

businessmen to embrace appropriate
device to prevent unfotunate aftermaths
of risk by observing safety instructions.
 Installation of FEA, Alarm systems

 Recruiting the security personnal

COVERING LARGER RISK WITH SMALL CAPITAL

 Insurance assuages the business men from

security investment.

 This is done by paying small amount of

premium against larger risks.
DEVELOPMENT OF LARGER INDUSTRIES

 Insurance povides an opportunity to

develop the larger industries which
have higher risks in their functions.
FINANCIAL INTERMEDIARIES

 Insurance is the best saving and

investment options
 Restrict unnecessary expenses of insured

 Tax saving

 Insurance companies becomes large

source of funds for the national
development projets.
MEDIUM OF EARNING FOREIGN EXCHANGE

 International business has been possible

due to the insurance
 Gets opportunity of exporting goods and

earns foreign currency.

 Reinsurance companies and Marine insurers

provide services to foreign clients and

collect foreign curency.
RISK FREE TRADE

 Insurance boosts exports, making foreign

trade risk free.

 International trade has been increased

due to insuranec service.
EVOLUTION OF INSURANCE

 Insurance like activities since ancient period

in the form of trust/Society
 Modern Insurance-14th Century-Northern
Italy through marine insurance.
 In 1680-UK-Edward Lloyd’s coffee house-

practice of individual underwriting

 1666 Great Fire of London. (85% houses
destroyed)
 1680 Est Fire office in London

 1681 Nicholas Barbon established

Englands first Insuarnce company
(Insuarnce office for Houses)
 1732 USA established their first Insuarnce
co.
 1780 to 1850 Industrial revolution.
 19th Cent. Accident insurance started with
invention of railways
 1898-UK-Motor TP insurance started with

invention of motor vehicle

 And continued to develop
 The first company to offer life insurance
was the Amicable Society for a Perpetual
Assurance Office,

 Founded in London in 1706 by William

Talbot and Sir Thomas Allen
 From 1905 to 1912 Insurance Business
started in India.
 1938 The Insurance Act

 1956 Life Insurance Act

 Life Insurance Corporation (LIC India)

established
INSURANCE IN NEPAL

 Insurance like activities-Guthi systems

 In 2004 BS Indian Insurance Co. writing

business in Nepal
 Malchalani Ra Bima Company in 2004 B.S

 Est. of Nepal Insurance & Transportation Co.

in 2016 B.S (Known as NIC at present) a

captive co of Nepal Bank Ltd.
 Nepal Insurance Co ltd in 2048 B.S
 Rastriya Beema Corp under insurance
act in 2025
 New Insurance act introduced in 2043

 NLGI established in 2043

 2024 BS est. of Beema Sansthan as a life &
Non life insurance Co.
 2025 BS Est. of Beema Samitee and

Insurance Act 2025

 2044 BS Est NLGI

 2049 BS Insuranc Act 2049

 Open to Public limited Co

Requirements of Insurable Risks
 Inurers insure only pure risks.
 However all pure risk are not insurable.
 Certain requirements must be fulfilled before pure
risk can be insured.
 Large number of exposure units
 Accidental and unintentional loss

 Determinable and measurable loss

 No catastrophic loss

 Calculable chance of loss

 Economically feasible premium

Large number of exposure units

 To predict average loss based on the law

of large numbers.
 It is easy to for insurers to calculate or

predict the expected loss based on law

of large number
 Risk can be spresd out to more number of
exposures of similar risk class which helps
to reduce the rate of premium.
Accidental and unintentional loss
 To assure random occurrence of events.
 The loss should be fortuitous and outside the insured’s
control.
 If intentional losses were paid moral hazard would be high
and premium would rise as a result.
 Increase in premium could result fewer people buying
insurance policies
 The loss should be accidental because the law of
large number is Based on the random occurance
of events.
 A deliberately caused loss in not random event.
Determinable and measurable loss

 To determine how much should be paid.

 Life insuranec in most cases meets this
requirements easily
 Death claims
 Cause and time of death can be readily
determined
 Some losses are difficult to determine and
measure
 Disability claims
No catastrophic loss
 Large proportion of exposure units should not
incur loses at the same time.
 To allow the pooling technique to work.

 Premium may be increased

 Insurers wish to avoid all catastrophic losses

 Exposures to catastrophic loss can be managed

by using reinsurance, dispersing coverage over

a large geographic area, or using financial
instruments, such as catastrophe bonds
Calculable chance of loss

 The insurer must be able to calculate the

frequency and severity of future losses with
some accuracy

 To establish a premium that is sufficient to

pay all claims and expenses and yields a
profit during the policy period
Economically feasible premium

 People can afford to purchase the policy

 For insurance to be an attractive purchase,

the premiums paid must be substantially less
than the face value, or amount, of the policy
 Based on all above requirements
 Most personal, property and liability risks
can be insured

 Market risks, financial risks, production risks

and political risks are difficult to insure
Difference between Insurance and Gambling

• Insurance is a technique for handing an

already existing pure risk

INSURANCE • Insurance is always socially productive: –

both parties have a common interest in
the prevention of a loss

• Gambling creates a new speculative risk

• Gambling is socially unproductive – The
GAMBLING winner’s gain comes at the expense of
the loser
Difference between Insurance and Hedging

• Risk is transferred by a contract

• Insurance involves the transfer of pure
INSURANCE (insurable) risks
• Insurance can reduce the objective risk
of an insurer – through the Law of Large
Numbers

• Risk is transferred by a contract

• Hedging involves risks that are typically
HEDGING uninsurable
• Hedging does not result in reduced risk
BENEFITS OF INSURANCE TO SOCIETY

 Indemnification for Loss

 Reduction of Worry and Fear

 Source of Investment Funds

 Loss Prevention

 Enhancement of Credit
INDEMNIFICATION FOR LOSS
 Individuals and families to be restored to their
former financial positions after a loss occurs
 Imdemnification yo business firms also permits

firms to remain in business and employees to

keep their jobs
 Indemnification contributes greatly to family
and business stability and therefore is one of
the most important social and eonomical
benefits of insurance
REDUCTION OF WORRY AND FEAR

 If family heads have adequate amount of life

insurance they are less likely to worry about
the financial security

 Similarly Property owners who are insured

enjoys greater peace of mind
SOURCE OF INVESTMENT FUNDS

 Premiums are collected in advance of the loss

and fund not needed to pay immediate losses
and expensescan be loaned to business firms.

 The funds are invested in shares, bonds and in

developments sectors.
LOSS PREVENTION

 Insurance companies are actively involved in

numerous loss prevention programs.

 These activities reduce both direct and

indirect or consequential losses of the society.
Social Costs of Insurance
 Cost of Doing Business
 Anexpense loading is the amount needed to pay all
expenses, including commissions, general
administrative expenses, state premium taxes,
acquisition expenses, and an allowance for
contingencies and profit
 Fraudulent Claims
 Inflated Claims

 Higherpremiums to cover additional losses reduce

disposable income and consumption of other goods
and services
Home Assignment
1. Explain types of risk and ways of handling it [10]
2. Describe insurance and its characteristics. [10]
3. What are the major functions of insurance and insurer
[10]
4. Briefly explain the evolution of insurance in Nepal[10]
5. Explain the impotance of insurance to society. [10]

Submission date : After Dashain Tihar Vacation