Risk Management and Insurance

Concept of Risk Management

Risk management is concerned with the identification of reasons for loss of properties and selecting the measures to minimise threatening of such loss. The term is ambitious and has different meanings for different managers on the basis of situation and event. According to George E Rejda “Risk management is the process that identifies loss exposures faced by an organization and selects the most appropriate techniques for treating such exposures.”

Risk management is the process of identifying loss of assets, analyzes the reasons of such loss, select the appropriate techniques for treating such reason of loss and implement the risk management programs. One of the important elements of risk management is involving into insurance contract.

Meaning and Concept of Insurance

The concept of insurance was developed through the principle of mutual help through mutual cooperation. However gradual development of business made insurance as a business activity where insurance companies took the responsibility of compensation on contractual basis. Therefore insurance may be studied under two concepts: functional basis and contractual basis

On functional basis, insurance is cooperative device through which risk of financial loss due to an accident at other calamities distributed among the large number of people.

On contractions basis, insurance is a contract between an insurer and insured where the insurer undertakes the responsibility of compensation of financial loss to the insured or to his nominee on the occurrence unexpected event. For this purpose, the insurer charges some amount of premium.

Basic Terms of Insurance

1. Insurer represents to insurance company
2. Insured is a party who wants to enter into insurance contract, in some cases represents insurance policy.
3. Insured amount is the total amount of insurance, it’s also known as assured sum.
4. Insurance premium is installment or sum amount paid to insurance company to enter into insurance contract.
5. Insurance policy is a contract between insurer and insured

Importance of Insurance

Insurance is an important auxiliary of business. Insurance is taken as an important element that helps to minimize the risk of loss. It minimizes risk of financial loss in business, individual and social activities. The following are the area of importance of insurance

1. For individual and family: Economic safeguard, provides scope for employment incentive to economy, profitable investment and maintain living standard
2. For business organizations: Safeguard against the risk of loss, stability in business, increase efficiency, loan facility and promotion of commerce and trade.
3. For society and nation: Maintain living standard, reduce social evil, employment opportunity, formation of capital and economic development

Essentials of Insurance Contract

From insurer’s point of view, there are normally six essential requirements of insurable risk. They are as follow

1. Large number of exposure units: There should be a large group of similar exposure units that are subject to same peril or group of perils. The main objective of this requirement is to enable the insurer to predict loss based on the law of large number
2. Accidental and unintentional loss: The loss should be unexpected and beyond the control of insured. The requirement of an accidental and unintentional loss is necessary for two reasons. Firstly, the payment of intentional loss tends to increase moral hazard resulting increase in the premium amount. Secondly, the law of large numbers is based on the random occurrence of events.
3. Determinable and measurable loss: The loss should be determinable and measurable. It means the loss should be definite regarding place, time, and amount.
4. No Catastrophic loss: The loss should not be catastrophic. It means that a large proportion of exposure units should not incur losses at the same time.
5. Calculable chance of loss: The chance of loss should be calculable. The insurer must be able to calculate both the average frequency and the average severity of future loss with some accuracy.
6. Economically feasible premium The premium should be economically feasible. It should be determined in such a way that the insured must be able to pay the premium.

Principles of Insurance

The concept of insurance is based on some basic principles, violation of those principles either from insurer or insured makes the concept of insurance worthless. Brief descriptions of principles of insurance are as follows:

1. Insurable interest: An insured must have insurable interest in his subject matter insurance. Subject matters may be property, assets, or life.
2. Utmost good faith: There must be full trust and confidence between insurer and insured regarding subject matter of insurance while entering into insurance contract. Both the parties must provide actual and real information.
3. Contract of indemnity: The insurance is a contract of indemnity, except life insurance, where insurer compensation financial loss to the insured on the occurrence of unexpected events. For this purpose, insurer charges a fixed rate of premium
4. Principle of subrogation: This principle focuses that after compensation of loss of any property to insured insurer can acquire the ownership of damaged property. Insurance Companies can recover amount by selling damaged property at auction.
5. Proximate cause: This principle is based on the concept that the compensation will be paid only if the cause of event is insured. If caused of insurance is not done insurer is not bound to compensate.
6. Principle of contribution: This principle emphasizes that a person can not get an insurance policy from more than one insurance company for a single property. This principle focuses on that insurance is only for compensation and not for profit.
7. Mitigation of loss: This principle concentrates that as far as possible insured should take proper measured to protect subject matter of insurance on the occurrence of an unexpected event.

Life Insurance

Life insurance provides safety against the risk of humans. Life insurance is a contract between an insurance company and the insured where the insurer undertakes the risk of compensation of financial loss either at the termination of the policy period or at the death of the insured. For this purpose insurance company charge a certain amount of premium. However, life insurance is not a contract of indemnity because no one can measure the life of a human being in terms of money. Since life insurance involves both protection and investment, therefore, it comprises about 80% of total insurance business

Types of Life Insurance: Life insurance policies are divided into various types on different basis. They are as follows:

1. Whole life policy: In whole life policy, the sum assured will be paid only on the death of insured to the legal nominee. The whole life policy consists of
   • ordinary whole life policy,
   • limited payment whole life policy,
   • convertible whole life policy,
2. Endowment policy: In endowment policy, sum assured will be paid either at the termination of the policy period or on the death of the insured whichever is earlier. The endowment policy consists of
   • ordinary endowment policy,
   • pure endowment policy,
   • double endowment policy,
   • joint endowment policy
   • anticipated endowment policy and
   • deferred endowment policy.
3. Term policy: This is short term from 3 to 7 months, life insurance policy Sum assured amount would be paid only on the death of insured The term policy consists of
   • straight term policy,
   • renewal term policy,
   • convertible term policy and
   • decreasing term policy

Procedures for life insurance: For involving in a life insurance policy contract, it is essential to full some official documentation and formalities both by insurer and insured. Some of the common procedures of affecting life insurance policy are

1. submission of proposal form
2. submission of medical examination report
3. submissions of agents reports
4. submission of agent certificate
5. acceptance of the proposal,
6. payment of first premium and
7. issue of insurance policy

Fire Insurance Concept:

Fire insurance is a contract between an insurer and insured to indemnify loss of property due to fire and other reasons as it is involved in insurance contract. For this purpose insurer charges certain rate of premium. Fire insurance is also known as insurance of indemnification. The necessity of fire insurance was felt for the first time in England in 1966 when one-third of houses of London City were destroyed by a great fire. At present, it becomes one of the most important parts among other insurance policies

Types of Fire Insurance: Fire insurance policy may be classified into various types on different basis. They are as follows:

1. On the basis of risk covered:
   • In comprehensive policy, insurers undertake the risk of indemnification not only property loss by fire but also other reasons as specified in the contract.
   • In blanket policy assets of various locations are taken into account.
   • In consequential policy covers not only material loss but also the consequence of loss in future business.
   • Sprinkle policy provides protection against loss of property caused by the accidental leakage of water. gas or other materials.
2. On the basis of indemnity:
   • In valued policy, the amount of sum assured is predetermined.
   • In average policy, the amount of sum assured is determined with reference to the actual value of property assured.
   • In specific policy, the insured can claim only assured sum when property lost by fire.
   • In reinstatement policy, the Insurer only replaces the damaged property to insured.
3. On the basis of stock of goods:
   • Floating policy covers stocks located in different places of an insured.
   • In declaration policy, insured undertakes insurance policy for the maximum amounts of stock that may remain during policy period.
   • In adjustable policy, insured undertakes insurance policy for the maximum amounts of stock that may remain during policy period.
   • Excess policy covers the stocks of different nature of items.
   • In Maximum value with discount policy, premium paid to the insurer on the basis of maximum value of stock in any month during policy period.

Procedures of Fire Insurance: For completion of fire insurance policy, it is essential to complete some formal documents and formalities. The generally accepted procedures of fire insurance are

1. selection of insurance company,
2. submission of proposal form,
3. evidence of respectability,
4. survey of property,
5. acceptance of proposal
6. issue of cover note and
7. issue of fire insurance policy.

Marine insurance

Marine insurance is the insurance of sea journey, marine insurance is a contract between insurer and insured where insurer undertakes the responsibility of indemnification of loss of shipment and other properties in sea transportation, in return of certain amount of premium. The concept of marine insurance has been developed due to more risk of loss in sea journey.

In marine business, three parties have interest i.e. owner of the ship, owner of the cargo and transportation company. Therefore, marine insurance policy covers the following:

• Hull insurance: In hull insurance, value of ship is only taken into account for insurance.
• Cargo insurance: In cargo insurance, value of goods and services carried in the ship is included in insurance.
• Freight Insurance: Freight insurance covers the carrying charge of the ship.
• Liability insurance: Liability insurance includes liability hazard such as collision, running down or other accident.

Types Marine Insurance: The following are the policies taken into account in marine insurance policy:

1. Time policy: Time policy is taken for a definite time like on week, one month and so on.
2. Voyage policy: Voyage policy is taken for a voyage from a point to another point of destination.
3. Mixed policy: Mixed policy covers both time and distance.
4. Valued policy: In valued policy, value of subject matter of insurance is agreed while entering into contract.
5. Unvalued policy: In unvalued policy, value of subject matter of insurance would be determined while loss occurred.
6. Floating policy: In floating policy, one policy is accepted for shipment and continues till the shipment of goods is made to the amount of insurance policy.
7. Blanket policy: Blanket policy covers the risk of various types of properties in lump sum.
8. Block policy: Block policy covers risks other than sea voyage like the risk of carrying goods from place of origin to port.
9. Port policy: Port policy covers the risk of unloaded goods within the fencing of port X. P.P.R. policy: P.P.R. policy focuses to insurable interest.
10. Currency policy: In currency policy, sum assured is stated in foreign currency

Procedures of binding in Marine Insurance: For completion of marine insurance policy, it is essential to complete some formal documents and formalities. The general accepted procedures of marine insurance policy are

1. selection of insurance company,
2. submission of marine declaration form,
3. acceptance of proposal,
4. issue of cover note and
5. issue of insurance policy