Case1. A Ltd. Co. is an insurance company. It provides certainty of payment in case of losses incurred to the person who purchases the insurance policies. One of its product is motor insurance policy, in which the company pays for the damages, theft etc., of the car/motor vehicle for a small amount of payment. Suppose Mr. X, has a car worth SR 50,000. He gets the car insured with A Ltd. Co. for a payment of SR 1000 as premium.
The following insurance terminologies have been explained with the help of case 1.
Insurer: The Company which agrees to pay for the payment of loss is known as insurer. In the above example, A Ltd. Co. is the insurer, which agrees to pay the amount of loss if there is any accident of the car or the car is stolen.
Insured: The person who purchases the insurance policy is known as insured. Mr. X who gets his car insured for SR 1000 is the insured in the above example. In case of accident or loss he shall be getting the amount of loss from A Ltd. Co (insurer).
Premium: The amount paid by the insured to the insurance company is known as Premium. SR 1000 paid by Mr. X to A Ltd. Co. is the amount of premium.
Policy: The contract between insurer and insured is known as policy. The contract between A Ltd. Co and Mr. X, for an agreement that A Ltd. Co. will pay the amount of loss to Mr. X, and Mr. X will pay SR 1000 to X Ltd. is the policy.
Exposure to Loss: The insured’s possibility of loss is called the insured’s exposure to loss. In the above case if Mr. X drives his car frequently on a crowded highway, without proper dividers, at very high speed the exposure to loss is high. On the other hand if Mr. X drives his car occasionally at slow speed only to his office, the loss exposure in this situation is low.
Loss: The word loss, in insurance means being without what earlier was their in possession. It also means reduction in economic value or loss of the economic value of insured item. If the car of Mr. X meets an accident, the car is damaged and its value is reduced, to bring the car in the same position or of same value it needs to be repaired. On the other hand if the car is stolen the total value is lost, and the insured must be given the full value of the car to purchase a new car.
Insurable Loss: Insurable losses are those that occur with chance. For example, there may or may not be an accident for the insured car, the car may or may not be stolen, so it is insurable loss. But the reduction in the value due to passage of time and use of the car i.e., depreciation is not an insurable loss.
Direct Loss: In case of an accident, the car is damaged and it is known as direct loss.
Indirect Loss: The loss which is consequential is known as indirect loss. Suppose, Mr. X uses his car as taxi, that is for commercial purpose taking public from one place to another and earns income. In case of an accident the car is damaged on the one hand and on the other hand because of the accident the car could not be run and there is loss of income also.
Chance of Loss: Suppose there are 2000 cars insured with the insurance company (A Ltd. Co.), and on an average out of 2000 cars, 10 cars meet accident every year, the chance of loss in this situation is, 10/2000, i.e., 0.005.
Peril: The reason because of which there is reduction in the value is known as peril, in other words we can say that the cause of loss. If the car of Mr. X is stolen the peril was theft. If fire destroys a house the peril is the fire.
Hazard: It is the condition or situation that affects the chances of loss. It increases the possibility of loss. It may increase the frequency of loss or the severity of loss. For example, if Mr. X takes his car on hilly area, the chances of accident increases, and the expected amount of loss is also high. If Mr. X employs an untrained driver, then the hazard further increases.
Moral hazard: If the insured causes the loss deliberately, to get the insurance claim it is an example of moral hazard. Again if in the above case Mr. X takes an accident consciously to get a claim it is an example of moral hazard.
Morale hazard: It refers to the attitude of indifference to loss created by the purchase of an insurance contract. The attitude why should I care? I am insured, is an example of the morale hazard. If Mr. X leaves his car keys in the car carelessly, it is an example of morale hazard.
Risk: uncertainty concerning the occurrence of a loss. For example, in the above case the risk of accident is present, as uncertainty is present.
Pure risk: as a situation in which there are only the possibilities of loss or no loss, example, In the above example, there can be either accident (loss) or no accident (no loss).
Speculative risk: is a situation in which either profit or loss both is possible. Example, In business the possibility of earning profit or suffering loss, both are present.
Fundamental risk is a risk that affects the entire economy or large numbers of persons or groups within the economy. Example, the risk of natural disaster, the risk of inflation (price rise).
Particular risk: is a risk that affects only an individual and not the entire community. Example, car theft.