Question

Explain how and why the following characteristics of pure risk influence the availability of insurance from the point of view of SUPPLIERS of insurance. a) iThe size of the possible loss ii) The measurability of losses iii The predictability of losses iv The degree of correlation between losses vMoral hazard vi Morale hazard vii) Legal purpose vii Moral purpose (25 marks) b) Explain (with examples) how "words' can be included in insurance contracts to 'shape' is cs ull恥300 y products. 11 neia salle, the will 11 1p.fk:SS訓顴01: lli y « il san cis «wilci lii un aik e

Answer 1

The availability of insurance from suppliers point of view considering the following factors :

1) The size of possible loss: The possible loss must be accidental in nature, and beyond the control of the insured. If the insured could cause the loss, the element of randomness and predictability would be destroyed.At the same time, the potential loss must be severe enough to cause financial hardship if it is not insured against. Insurable risks include losses to property resulting from fire, explosion, windstorm, etc.; losses of life or health; and the legal liability arising out of use of automobiles, occupancy of buildings, employment, or manufacture.

2) the measurability of losses :There must be some way to determine whether a loss has occurred and how great that loss is. This is why insurance contracts specify very definitely what events must take place, what constitutesloss, and how it is to be measured. Loss control is an extremely important technique for treating loss exposures in a risk management programme since; it is designed to reduce both loss frequency and loss severity. Loss-control measures attack risk by lowering the chance that a loss will occur, or by reducing its severity if it does occur. As C. Arthur Williams, Jr. and Richard M. Hems point out, “loss control has the unique ability to prevent or reduce losses for both the individual firm and society while permitting the firm to commence or continue the activity creating the risk”.Unlike the technique of avoidance of loss exposure, loss control deals with an exposure that the firm does not wish to abandon. The purpose of loss control activities is to change the characteristics of the exposure so that it is more acceptable to the firm.

3) The predibility of risk:Insurance is a game of statistics, and insurance providers must be able to estimate how often a loss might occur and the severity of the loss. Losses that occur more frequently or have a higher required benefit normally have a higher premium. Life and health insurance providers, for example, rely on actuarial science and mortality and morbidity tables to project losses across populations.

4) The degree of correlation between losses: All insurance schemes operate based on the law of large numbers. This law states there must be a sufficient large number of homogeneous exposures to any specific event in order to make a reasonable prediction about the loss related to an event. A second related rule is that the number of exposure units, or policyholders, must also be large enough to encompass a statistically random sample of the overall population. This is designed to prevent insurance companies from only spreading risk among those most likely to generate a claim, as might occur under adverse selection.