INSURANCE AS A RISK

MANAGEMENT
TECHNIQUE
Module – V
Definition of an insurance contract
• An insurance contract is an agreement between the insurer, i.e., the
insurance company, and the insured, i.e., the policyholder, in which
the insurer agrees to compensate the insured for any future loss
suffered by him, and he does so by accepting a premium. In India,
insurance contracts are governed by the Insurance Act of 1938 and
other rules and regulations issued by the Insurance Regulatory and
Development Authority of India (IRDAI).
• Meaning- A contract under which one party (the issuer) accepts
significant insurance risk from another party (the policyholder) by
agreeing to compensate the policyholder if a specified uncertain
future event (the insured event) adversely affects the policyholder.
Objective of insurance contract
• Insurance Contracts establishes the principles for the recognition,
measurement, presentation and disclosure of Insurance contracts
within the scope of the Standard. The objective of IFRS 17 is to ensure
that an entity provides relevant information that faithfully represents
those contracts. This information gives a basis for users of financial
statements to assess the effect that insurance contracts have on the
entity's financial position, financial performance and cash flows.
Essential Elements of an Insurance Contract?
• An insurance policy is a contract between the named insured and the insurance carrier. It's important to
note that, for an insurance contract to be considered legally binding, it should comprise certain
elements that are necessary for any contract to be legally binding. Here is a breakdown of all the
important elements that make an insurance contract legally binding.

• Offer and Acceptance

• Competent Parties
• For an insurance contract to be legally binding, the individual obtaining it must have attained the legally
required age as well as be legally competent. The contract won't hold if the insured is intoxicated or
insane or operating illegally.
Consideration
This element of an insurance contract refers to the exchange of value that comes with a contract. For instance, with an
insurance policy, the insured agrees to pay the insurance premiums, and in exchange, the insurer agrees to pay future
claims.

Consent
Both parties should get into the contract willingly. During the contract signing, no coercion, fraud, intimidation, or
misrepresentation should be involved.

Legal Purpose
Insurance contracts must adhere to the law. Therefore, a business that's involved in illegal activities can't be covered by an
insurance policy.

Insurable Interest
The insured must be exposed to losses in case the insured peril occurs. For instance, you can't get a homeowners policy on
a home you don't own and be compensated if it burns down.
Principle of insurance contract
• Utmost Good Faith
• For the insurance contract to hold, all parties involved in the insurance contract must
be transparent in their actions without any misrepresentation, omission, or deception.
Every party should have a clear understanding of the pertinent pacts.
• Full Disclosure
• This means all parties involved must fully disclose all the pertinent material facts. The
must be no twisting of facts, omissions, or misrepresentation when the insured is
filling out an insurance application form or when the insurer is providing the policy.
• Principle of Indemnity
• Under this principle, the insured can't receive more compensation than the losses they
suffered due to a covered peril. Insurance is meant to help you regain your financial
position before the covered peril strikes.
Full Disclosure
This means all parties involved must fully disclose all the pertinent material facts. The must be no twisting of facts, omissions, or
misrepresentation when the insured is filling out an insurance application form or when the insurer is providing the policy.
Principle of Indemnity
Under this principle, the insured can't receive more compensation than the losses they suffered due to a covered peril. Insurance is
meant to help you regain your financial position before the covered peril strikes.
Subrogation
Subrogation means that the insurance can seek compensation from third parties liable for your loss. If you are in a car crash and
the other driver is at fault, your insurer can seek to be reimbursed by the other driver's insurer. Conditions
Conditions are factors that determine if the insurer will pay the claim. The most important factor is that you're paying your
premiums. But many others factors come into play when a claim is made.
Warranties
These are promises outlined in the insurance contract. They define conditions leading to a claim and the insurer's obligations after
a claim.
Exclusions
These are conditions under which the insurer won't pay a claim.
Limitations
This list outlines the maximum compensation an insurer will pay for a given loss, as well as any conditions under which the
insurer will be required to pay more or less.
Proximate Cause
This refers to how the loss occurred. The insurer has the right to know the circumstances under which the loss occurred to
determine if the loss was due to a covered peril.
Below are the types of general insurance policies-

• Health Insurance
• Motor Insurance
• Home Insurance
• Travel Insurance

• Health Insurance:

• Health insurance plays a very big role to reduce the cost of medical expenses. Health insurance helps you
by giving cover for a medical emergency. Expenses that you must pay due to accidents or illnesses are
covered in health insurance. Events such as pre and post hospitalisation, illness, health check-ups, etc. are
covered in a health insurance policy.
• You can also buy cover for organ donation, maternity benefit, etc. The premium is based on age, lifestyle,
coverage type, health history, etc. play role in the premium.
• There are two types of health insurance- individual health insurance policy and family floater policy.
Motor Insurance:
You can get your car or bike insured with motor insurance. The insurer will cover the damage or loss to your motor.
The damage can be due to natural or man-made calamities.
Events such as accidents, damages, theft, vandalism, flood, fire, etc. are covered in a motor insurance policy. You
can also purchase riders with the policy. There are different types of motor insurance riders, such as zero
depreciation cover, breakdown assistance, etc.
For example, you are driving to your office. However, a bike hits your car. There are some damages to your car that
will cost Rs. 10,000. You can save money on your car’s expense as the insurer will have to pay for it.
Home Insurance:
Our house has some of the most expensive valuables. A home insurance policy protects your house and its
valuables from the damages caused due to natural or man-made calamities. You can get insurance for events such
as loss or damage of valuables, fire, etc.
For example, you buy a home insurance policy with a cover of Rs. 50 Lakhs. However, someone robbed your house.
In such a situation, you can claim for the loss. The insurer will have to pay you for the loss.
Household appliances, computers, mobile phones, furniture, etc. are covered in home insurance.
Travel Insurance:
You can purchase travel insurance when you are traveling in the country or outside. A basic health cover will not
help you with any medical expenses if you are out of the country. However, you can pay them with travel insurance.
In case you are hospitalized or lose your baggage, you can claim for its expense.
Travel insurance can cover events such as loss of baggage and passport, medical emergencies, flight delays,
accidental deaths, etc.
– Insurance Cost & Fair Pricing
• Insurance Cost:Insurance cost refers to the amount of money an individual or entity pays to an insurance company in
exchange for coverage against certain risks.
• Several factors influence insurance costs, including:
• Risk factors: Insurance companies assess the likelihood of an event occurring and its potential cost. For example, a
person's age, health status, occupation, and driving record can affect insurance premiums.
• Coverage amount: Higher coverage limits typically result in higher premiums.
• Deductibles: A deductible is the amount the policyholder must pay out of pocket before the insurance company
covers the remaining costs. Higher deductibles often lead to lower premiums.
• Location: Geographic factors such as crime rates, weather risks, and the cost of healthcare services in a particular area
can impact insurance rates.
• Type of coverage: Different types of insurance (e.g., auto, health, homeowners) have varying costs based on the risks
they cover.
• Insurance companies use actuarial tables and statistical models to calculate insurance costs based on these factors.
• Fair Pricing:
• Fair pricing in insurance involves charging policyholders premiums that accurately reflect the risks associated with insuring
them.
• Pricing is considered fair when it balances the insurer's need for profitability with the policyholder's need for affordable
coverage.
Expected claim costs
• Expected claim costs refer to the anticipated amount of money an insurance company expects to pay
out in claims over a certain period, typically based on historical data, actuarial analysis, and risk
assessment. This figure is crucial for insurers in determining appropriate premium levels to cover
potential claims while ensuring profitability. Here's how expected claim costs are calculated:
1. Data Analysis: Insurance companies analyze historical claim data to understand patterns, trends, and
probabilities associated with different types of claims. They examine factors such as frequency (how
often claims occur) and severity (the cost of individual claims).
2. Actuarial Analysis: Actuaries play a key role in estimating expected claim costs. They use statistical
models and mathematical techniques to assess risk and forecast future claim payments. Actuaries
consider various factors, including demographics, geographic location, policy features, and economic
trends.
3. Risk Assessment: Insurers assess the risk profiles of policyholders to estimate the likelihood and
potential cost of future claims. They consider factors such as age, health status, occupation, driving
record (for auto insurance), property value (for homeowners insurance), and other relevant
information.
Contractual provisions that limit Insurance
Coverage.
• Contractual provisions that limit insurance coverage are clauses or terms within an insurance policy that specify
circumstances under which coverage may be restricted or excluded. These provisions help insurers manage risks and clarify
the scope of coverage for policyholders. Here are some common contractual provisions that limit insurance coverage:
1. Exclusions: Exclusion clauses specify risks or events that are not covered by the insurance policy. Common exclusions may
include pre-existing conditions (in health insurance), intentional acts, war, nuclear hazards, and certain types of natural
disasters. By excluding specific risks, insurers can limit their exposure to potential losses.
2. Limitations on Coverage Amounts: Insurance policies often include limitations on the maximum amount payable for
certain types of claims or losses. For example, a homeowner's insurance policy may have sub-limits for jewelry, electronics,
or certain types of property. Policyholders should be aware of these limitations when assessing their coverage needs.
3. Deductibles: A deductible is the amount the policyholder must pay out of pocket before the insurance coverage kicks in.
Higher deductibles can help insurers control claim costs and may result in lower premiums for policyholders. However,
policyholders should consider their ability to afford the deductible in the event of a claim.
• Policy Conditions: Insurance policies typically include conditions that policyholders must meet to maintain coverage. For
example, an auto insurance policy may require the insured to notify the insurer promptly after an accident or to cooperate
fully in the claims investigation process. Failure to comply with policy conditions could result in coverage limitations or
denial of claims.