Chapter 1:- Introduction to Insurance

NOTE* Highlighted Points are the one that are frequently asked in exams... so please do remember them...

In this Chapter we shall learn Following things:-
1. History of insurance and the evolution of general insurance industry
2. How insurance works
3. Appraise ways of managing risk
4. Concept of risk
5. Role of insurance in economic development

*Although the Insurance actully started by the rule of Jettison. Which means throwing away some of the cargo to reduce weight of the ship and restore balance. The inhabitants of Rhodes adopted a practice whereby, if some goods were lost due to jettisoning1 during distress, the owners of goods (even those who lost nothing) would bear the losses in proportion.
Chinese traders in ancient days would keep their goods in different boats or ships sailing over the treacherous rivers. They assumed that if one of the boats suffered such a fate, the loss of goods would be only partial and not total. The loss could be distributed and thereby reduced.

*The earliest kind of risks to be addressed through the concept of insurance was losses due to misadventure at sea – what we call marine risk. Marine insurance was thus the forerunner to other kinds of insurance.

*“The Great Fire of London” in 1666, in which more than 13000 houses were lost, gave a boost to insurance and the first fire insurance company, called the Fire Office, was started in 1680.

*Lloyds: The origins of insurance business as practiced today, is traced to the Lloyd‟s Coffee House in London. This Person had this Coffee house near by sea. Traders, who used to gather there, would agree to share the losses to their goods being carried by ships, due to perils of the sea. Such losses used to occur because of maritime perils, such as pirates who robbed on the high seas or bad sea weather spoiling the goods or sinking of the ship due to perils of the sea.
He started a newspaper back then... It was all handwritten regarding the insurance and marine. You will be surprised to hear, but this limited edition newspaper is even today handwritten.

*Modern insurance in India began in early 1800 or thereabouts, with agencies of foreign insurers starting marine insurance business. The first life insurance company to be set up was an English company, the Oriental Life insurance Co. Ltd.
and the first non-life insurer to be established in India was the Triton Insurance Co. Ltd.
The first Indian insurance company was the Bombay Mutual Assurance Society Ltd., formed in 1870 in Mumbai. Many other Indian companies were set up subsequently as a result of the Swadeshi movement at the turn of century.
In 1912, the Life Insurance Companies Act and the Provident Fund Act were passed to regulate the insurance business. The Life Insurance Companies Act, 1912 made it compulsory that premium-rate tables and periodical valuation of companies be certified by an actuary. However, the disparity and discrimination between Indian and foreign companies continued. The oldest insurance company in India which still exists is National Insurance Company Ltd., which was founded in 1906. It is still in business.

*There were total 170 Life Insurance companies out of which 75 were dealing in Provident Fund.
Government of India on 1st september 1956 clubbed all the 170 companies and that is how LIC i.e., Life Insurance Corporation Of India was created.

*In 1972 GIC i.e., General Insurance Company was formed the same way by clubbing 106 General Insurance companies.

*GIC had four companies under it.
 National Insurance Co. Ltd. Head office in Kolkata
 The Oriental [Fire & General] Insurance Co. Ltd. Head office in New Delhi
 The New India Assurance Co. Ltd Head office in Mumbai

 United India [Fire & General] Insurance Co. Ltd. Head office in Chennai

* In 1993, A commitee was formed which submitted there report to Government in 1997 and then IRDA was formed.

* Insurance Regulatory and Development Authority (IRDA) was established in 2000 by an act of Parliament of 1999 “to protect the interests of holders of insurance policies and to regulate, promote and ensure orderly growth of the insurance industry”.

*In 2002 all four companies Delinked from GIC.

* GIC works as National Re-Insurance of the Country.
Reinsurance in of two kinds.
-Treety
-Facultive
All Reinsurance comes under Treety business. Only the insurance that has too high risk comes under Facultive or in case treety business is full.



Q- Which among the following is not a function of insurance?
I. Risk mitigation
II. Risk transfer
III. Risk tracking
IV. Risk reduction

Ans- RISK TRACKING (A POLICY NEVER INDICATES WHEN THE RISK WILL COME)


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* General Insurance have pools. For example in case of Fire Insurance. All same kind of House will be taken under one single pool. but as we all can understand all houses can never be exactly same. so in that case sub pools are designed. all the wooden house are in one sub pool. stone made house in another sub pools. pools indicate the Risk behind the Insured.

THE QUESTION IS... IS INSURANCE THE SOLUTION FOR ALL THE RISK THAT IS INVOLVED.
ANSWER IS NO, INSURANCE IS NOT THE ONLY SOLUTION. INSURANCE IS THE FINAL STEP TO COVER THE LOSS


*Step 1- Understand the Risk of losing. The loss is further of two kinds.
-Primary Loss: It is Physically Visible loss (BAD HEALTH)
-Secondary Loss: The one that is effected Due to Primary Loss. (BUSINESS LOSS)

*Peril And Hazard:- Peril is Hazard. In one line if we say, Hazard is the condition that increases the peril.
There was a storage, Where they use to store mustered seed. Once while storing, workers ignored a oily jute bag, and places the mustered over it. the bags of mustered seeds kept on coming. there was a bulb in the storage. after sometime the reaction between Mustered, Oily Jute bag and Heated Bulb's energy caused Spontaneous Combustion. In case of Spontaneous Combustion there is no fire at all, but everything is destroyed in the same way fire do.
Peril was Spontaneous Combustion and Hazard was that oily Jute bag.

*Step 2- Contingency Fund- In case of any problem 1st thing is to use this fund. maintaining this fund is high time strain.

*Step 3- Risk Avoidance: Controlling risk by avoiding a loss situation is known as “Risk avoidance”. Thus one may try to avoid any property, person or activity with which an exposure may be associated.
One may refuse to bear certain manufacturing risks by contracting out the manufacturing to someone else or one may not venture outside the house for the fear of meeting with an accident or may not travel at all for the fear of falling ill while abroad.
But risk avoidance is a negative way to handle risk. Individual and social advancements come from activities that require for some risks to be taken. By avoiding such activities, individuals and society would lose the benefits that such risk taking activities can provide.

*Step 4- Risk Retention- One tries to manage the impact of risk and decide to bear the risk and its effects. This is known as self insurance. A business house may decide based on experience that it has the capacity to bear small losses upto certain limit and decide to retain the risk with itself.

*Step 5- Risk reduction and control- It is a more practical and relevant approach than risk avoidance. It means taking steps to lower the chance of occurrence of a loss and/or to reduce severity of its impact, if such loss should occur.
The measures to reduce chance of occurrence are known as „Loss Prevention‟ measures while the measures to reduce degree of loss are known as „Loss Reduction‟ measures.
Risk reduction which involves reducing the frequency and/or size of losses through one or more of:-
a) Education and training, such as holding regular “fire drills” for employees, or ensuring adequate training of drivers, forklift operators, and so on. An example could be, educating school going children to avoid junk food.
b) Environmental changes, such as improving “physical” conditions, e.g. better locks on doors, bars or shutters on windows, installing burglar or fire alarms. The state can take measures to curb the pollution and noise levels to improve the health status of its people. Regular spraying of Malaria medicine helps in prevention of outbreak of the disease.
c) Changes to dangerous or hazardous operations while using machinery, equipment and in the performance of other tasks is a way to reduce the probability of a risk. For example, leading a healthy lifestyle and eating properly at right time helps in reducing the incidence of falling ill.
d) Separation, spreading out various items of property into varied locations rather than concentrating them at one location, is a method to control risks. The idea is, if a mishap were to occur in one location, its impact could be reduced by not keeping everything at that one place. For example, corporate entities could carry out free health check up camps for its employees for early signs of onset of any ailment thus reducing the risk of high claims ratio. One could reduce the loss of inventory by storing it in different warehouses. Even if one were to be destroyed, the impact would be reduced considerably.

*Step 6- Financing Risk- And the Final step is Financing the Risk. Even That Involve two stages. in Stage one Self Financing where as much as you can finance from your own pocket in case of risk you should do it, and the stage two comes where Risk is Transferred. Risk transfer is an alternative to risk retention. Risk transfer involves transferring the responsibility for losses to another party. Here the losses that may arise as a result of a fortuitous event [or peril] are transferred to another entity.
 Insurance is one of the major forms of risk transfer, and it permits uncertainty to be replaced by certainty through insurance indemnity.
 When a firm is part of a group, the risk may be transferred to the parent group which would then finance the losses.
Thus, insurance is only one of the methods of risk transfer..

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Role of Insurance in Economic Development

Insurance companies play an important role in a country.s economic development. They are contributing in a significant sense to ensuring that the wealth of the country is protected and preserved. Some of their contributions are given below:
Diagram 1: Role of Insurance in Economic Development

Summary
a) Insurance is “risk transfer through risk pooling”.
b) When persons having similar assets exposed to similar risks contribute into a common pool of fund it is known as pooling.
c) Risk retention, risk avoidance, risk reduction and control, risk financing are ways to manage risk.
d) The thumb rules of insurance state that one should risk not more than he can afford to lose, ensure that the reward is worth the risk and study all possible outcomes of a risk carefully.
e) Insurance plays an important role in the economic development of a country.


Key terms
a) Risk
b) Pooling
c) Asset
d) Burden of risk
e) Risk avoidance
f) Risk control
g) Risk retention
h) Risk financing
i) Risk transfer

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SELF EXAMINATION QUESTIONS
Question 1
Lloyds Coffee House is regarded as the place where insurance started the way it is practised today. Lloyds is located in __________.
I. Bangalore
II. Singapore
III. London

IV. Dubai

Question 2
Risk transfer through risk pooling is called________.
I. Savings
II. Investments
III. Insurance
IV. Transfer

Question 3
The measures to reduce chances of occurrence of risk are known as _____.
I. Risk retention
II. Loss prevention
III. Risk transfer
IV. Risk avoidance

Question 4
By transferring risk to insurer, it becomes possible:
I. To enjoy from floods
II. To enjoy and make money from insurance
III. To enjoy a fire in the factory
IV. To enjoy peace of mind and plan one‟s business more effectively

Question 5
Origins of modern insurance business can be traced to________.
I. Bottomry
II. Lloyds
III. Rhodes
IV. Malhotra Committee

Question 6
In the insurance context „risk retention‟ indicates a situation where__________.
I. possibility of loss or damage is not there
II. loss producing event has no value
III. property is covered by insurance
IV. one decides to bear the risk and its effects

Question 7
Which of the following statement is true?
I. Insurance protects the asset
II. Insurance prevents its loss
III. Insurance reduces possibilities of loss
IV. Insurance pays when there is loss of asset

Question 8
Out of 400 houses, each valued at Rs.20, 000, on an average 4 houses get burnt every year resulting in a combined loss of Rs.80, 000. What should be the annual contribution of each house owner to make good this loss?
I. Rs.100/-
II. Rs.200/-
III. Rs.80/-
IV. Rs.400/-

Question 9
Which of the following statements is true?
I. Insurance is a method of sharing the losses of a „few. by the „many.
II. Insurance is a method of transferring the risk of an individual to another individual
III. Insurance is a method of sharing the losses of „many. by a few
IV. Insurance is a method of transferring the gains of a few to the many

Question 10
Before acceptance of a risk, the insurer arranges a survey and inspection of the property. Why?
I. To assess the risk for rating purposes
II. To find out how the insured purchased the property
III. To find out whether other insurers have also inspected the property
IV. To find out whether neighbouring property also can be insured




Answers to All Questions

Answer 1
The correct option is III.
Lloyds is located in London.

Answer 2
The correct option is III.
Risk transfer through risk pooling is called insurance.

Answer 3
The correct option is II.
Loss prevention measures reduce the chance of occurrence of risk.

Answer 4
The correct option is IV.
Insurance provides peace of mind and helps one plan his business effectively.

Answer 5
The correct option is II.
Origins of modern insurance can be chased to Lloyds.

Answer 6
The correct option is IV.
When one decides to bear the consequence of a risk, he is said to have retained risk.

Answer 7
The correct option is IV.
Insurance compensates for the loss of an asset.

Answer 8
The correct option is II.
Each house owner needs to contribute Rs 200.

Answer 9
The correct option is I.
Insurance is a method of sharing the losses of a few by the many.

Answer 10
The correct option is I.
Before acceptance of the risk, an insurer conducts an investigation in order to assess the risk for rating purpose.