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Insurance is a kind of risk management tool in which the potential loss which can happen to an insurer are being transferred to another entity which is called as insurance company who insures the insurer. Insurance enables individuals, businesses and other entities to save themselves from any hardships caused due to financial loss, life loss, property loss etc. at a reasonable affordable rate. In this system the insurer deposits a periodic premium to the insurance company which estimates the potential loss from the risk involved and accordingly in case the loss actually happens, the insurance company reimburses the lost money to the insurer. The common example of losses are death of a family person, damage to the building due to fire, accident on the road, damage to material during shipment etc. Thus, insurer gets considerable financial aid for the loss happened. In the present environment there are various types of risks but insurance is used to cover only few specific types of risks. Hence, it is important to understand the types of risk before understanding insurance.
Speculative Risk: It is a type of risk in which profit and loss both are possible. For e.g. when someone puts a bet on a horse race then he can win as well as lose. Similarly, decision of new market entry, product failure, advertising results etc. involves speculative risks.
Pure Risk: It is a type of risk in which there are chances of loss or being neutral, hence there are no chances of being in profit. Its results are never beneficial. For example, premature death, occupational disability, damage to property etc. There are three types of risks: Personal risk, Property risk and Liability risk (Vaughan&Vaugha, 2003).
Insurers only insure the pure risks but all the pure risks are not insured. For example, unemployment is a type of risk which leads to financial loss to a person as well as his family. But, it is not being insured by the companies. It is because, the companies can’t figure out the potential loss by this risk. Also, it will depend on the market conditions and the qualification of the person. There are many variables in this regard and the insurance company can’t quantify all of them. Hence, there are some conditions which need to be satisfied before a pure risk in eligible for getting insurance cover, which have been mentioned below:
1) There must be a large number of exposure units: It will help the insurer to estimate the extent of losses expected for the group of people/ units. These people are not required to have same risk, but they should have similar risk. The insurance company can then spread the cost of loss over all the insured people belonging to that group.
2) The loss must be of accidental and unintentional: Insurance is a tool to cover the losses due to risk and not a profit making tool. Hence, it should not happen that insured person intentionally and deliberately get into the loss and then ask for the premium although he could have avoided that risk. If the company starts paying international loss then moral hazards will increase so the insurance company would have enough money to help the person who naturally faced the loss. Law of large numbers is also based on random numbers, so chances of that loss should be accidental as well for the application of the formula.
3) The loss must be determinable and measurable: The insurance company should be able to reasonable estimate the cause, place, time and amount of loss from a given risk. It will also help the company to calculate the premium in sync with the expected losses.
4) There should not be a catastrophic loss: It would mean that a large number of insured people should not incur losses at the same time. Then it will be difficult for the insurance company to reimburse everybody.
5) The chances of loss should be calculable: The insurance company can estimate the premium only when it has reasonable understanding about the frequency of loss occurrence and the severity of the loss. It will also allow the company to pay for all claims and to handle all expenses.
6) The premium should be economically feasible. A large premium will not attract people and instead they will try to handle the risk themselves. Also, the premium should be in sync with the severity of loss. The chances of loss must be low and then premium will also be low.
Hence, the risk which qualifies all the six points mentioned above can come under the category of insurable risk.
With the advent of globalization all the industries across the world impact each other directly or indirectly. The business environment has become very dynamic and all the industries face cyclical movements. The cyclical nature means that an industry finds a boom in its business at one time and a slowdown at other time. In 2001 IT industry faced a major slowdown and in 2007 finance industry faced the major setback. Same is the case with insurance industry. When market conditions are good insurance companies get low of business and their profits increase but in the adverse market conditions the companies start facing losses or their profitability reaches to rock bottom. Insurance industry has a great dependence on other industries as people buy insurance only to cover their risks and they need to have considerable disposable income to pay the premiums. It needs to be noted that insurance is not considered as a necessity by the public and hence they purchase it when they have enough disposable income. In this way the market conditions of insurance industry can be classified as:
Hard market conditions: It is a state when insurance company find it difficult to get business and their target customers consider that insurance is quite expensive and hence they defer their insurance purchase decisions. It is considered to be the seller’s market as the insurance companies enjoy high premiums on their policies.
In this market following characteristics may be found:
1) Premium increase may be more than loss experienced by the insured people and thus people will find it costly to purchase the insurance.
2) There are chances that insurance companies restrict their insurance cover from few certain lines of coverage like medical malpractice or day care centres etc. They may also start restricting their services from geography.
3) New coverage restrictions may be applied by the insurance company and hence insurance conditions will become more stringent.
Soft market conditions: It is a buyer market wherein insurance premiums are less, high availability of coverage and flexible contract conditions are there. In this market the competition is very high and hence insurance company has to provide some extra benefits to attract the customers. A new entrant will follow a flexible policy which will lead to soft market environment for the people. In this market following characteristics may be found:
1) Insurance is relatively affordable as competition is high and companies reduce the premium amount on the policies.
2) More coverage for the insured people can be found as insurance agents will try to sell their policy on more flexible conditions to attract the customers from other competitors. They may design new lines of coverage or insurance products to meet additional needs of buyers.
3) Companies may launch more innovative products as per the need of the market and to differentiate themselves from other companies.Order Now