Insurance

CH2: INS. & RISK

Intended Learning Outcome (ILOs):

After studying this chapter you should be able to:

1-Explain the basic characteristic of insurance.

2-Explain the law of large numbers.

3-Describe the characteristics of an ideally

insurable risks.

4-Describe the major types of insurance.

5-Explain the social benefits & costs of insurance.

MHA, C1

T1

CH2: INS. & RISK

Definition of ins.: "Insurance is the pooling

of fortuitous (potential) losses by transfer of

such risks to insurers (the pool), who agree

to indemnify insureds for such losses, to

provide other pecuniary benefits on their

occurrence, or to render services connected

with the risk, the pool combines them &

transfers the cost (premium) back to the

exposed to risk (insureds).

MHA, C1

T2

CH2: INS. & RISK

Basic Characteristics of Ins.:

1-Pooling of Losses:

Pooling involves spreading losses incurred by

the few over the entire group

Risk reduction is based on the Law of Large

Numbers

According to the Law of Large Numbers, the

greater the number of exposures, the more

closely will the actual results approach the

probable results that are expected from an

infinite number of exposures.

MHA, C1

T3

CH2: INS. & RISK

Basic Characteristics of Ins.:

 Example of Pooling:

 Two business owners own identical buildings

valued at $50,000

 There is a 10 percent chance each building will be

destroyed by a peril in any year

 Loss to either building is an independent event

 Expected value and standard deviation of the loss

for each owner is:

Expected loss  0.90 * $0  0.10 * $50,000  $5,000

Standard deviation  0.900  $5,000  0.10$50,000  $5,000

2

2

 $15,000

MHA, C1

T4

CH2: INS. & RISK

 Example, continued:

 If the owners instead pool (combine) their loss

exposures, and each agrees to pay an equal share

of any loss that might occur:

Expected loss  0.81* $0  0.09 * $25,000  0.09 * $25,000  0.01* $50,000

 $5,000

Standard deviation  0.810  $5,000  (2)(0.09)$25,000 ...