Insurance , Legal and Regulatory CII

CHAPTER 1
RISK AND INSURANCE

Learning objectives:

• list the main components of risk (menjelaskan komponen utama risiko)
• describe how risk is perceived (menggambarkan bagaimana resiko dipersepsikan)
• state the function of risk management (menetapkan fungsi risk management)
• describe the process of risk management (menggambarkan proses risk management)
• demonstrate how insurance relates to risk (menunjukkan hubungan asuransi dengan risiko)
• identify the categories into which risks are divided (mengidentifikasi kategori pembagian risiko)
• compare insurable and uninsurable risks (membandingkan risiko yang dapat diasuransikan dan tidak)
• describe the relationship between frequency, severity, risk and insurance (menggambarkan hubungan antara frequency, severity, risiko dan asuransi)
• distinguish the terms perils and hazard as they relate to insurance (membedakan istilah perils dan hazard yang berkaitan dengan asuransi)
• describe how insurance operates as a risk transfer mechanism (menggambarkan bagaimana pelaksanaan mekanisme pengalihan risiko)
• describe how the common pool operates (menggambarkan bagaimana pelaksanaan common pool)
• describe how insurance benefits policyholders and society (menjelaskan bagaimana manfaat asuransi untuk pemegang polis dan masyarakat)
• describe what is meant by co-insurance, dual insurance, and self insurance (menjelaskan apa yang dimaksud dengan co-insurance, dual insurance dan self insurance)
• describe the main classes of insurance (menjelaskan kelas kelas utama asuransi)

The Concept of risk

The word 'risk' is used in a number of different ways in the insurance market place and we need to look at each of these in turn.  (penggunaan kata risiko dipasar asuransi berbeda beda dab kita perlu melihat satu persatu)

Firstly we will examine the term in its everyday sense and here we find our first problem. (pertama kita akan memeriksa istilah risiko dalam pengertian sehari hari dan disini kita menemukan masalah pertama)

There is no universally recognized definition for the term. (tidak ada definisi yang universal untuk istilah ini)

Risk perception

If you were to ask anyone what the term 'risk' means to them you are likely to receive a wide variety of answer - everything from the owner of the business being concerned about the possibility of recession to worries parents concerned about all kinds of dangers faced by their children,

Yet others may identify the risks inherent in running a business, perhaps the demand for their products or obsolescence issues.

The list of risks that we face is almost endless (tidak ada habisnya)

In a personal sense we all take decisions based upon an assessment of risk. 

Most of this is carried out normally.

We assess the likelihood of rain occurring and decide whether to take an umbrella with us when we leave our home in the morning.

There may be some data involved ( a weather forecast from a reliable source) or we may have merely looked out he window to make the judgment about the likelihood of rain.

This informally may be acceptable in 'low risk' situations where the ultimate calamity is something like wet clothing, but in many contexts we need better measurement tools, especially where the potential for loss is significant.

Risk measurement and the means of attempting to deal with the risks we face are collectively termed risk management. 

In a commercial context this is often a well-defined and scientific process, attempting to "What are the chances of the risk becoming a reality?" We will deal with these issues in greater detail later in the course. In a personal sense most individuals make less precise calculations, often preferring instead to simply protect against those things that seem capable of inflicting some kind of financial disaster, such as fire or theft.

Definitions of risk

Consider the following statements, each giving a different slant to the term 'risk':

• The possibility of an unfortunate occurrence (kemungkinan dari kejadian yang tidak menguntungkan)
• Doubt concerning the outcome of a situation (keraguan dari hasil suatu keadaan)
• Unpredictability (yang tidak dapat diperdiksi)
• The possibility of loss (kemungkinan kerugian)
• The chance of gain (such as hoped for benefit from a gamble or investment strategy (kesempatan untuk mendapatkan keuntungan (seperti mengharapkan keuntungan dari perjudian atau investasi)

Other meanings of the term 'risk'

Although this section is devoted to risk in its generic sense, there are three other ways in which the term is used in the market place:

• The first refers to the perils or contingency that is insured - the fire risk, the theft risk and so on. (pertama merujuk pada peril atau bahaya yang diasuransikan - risiko kebakaran, risiko pencurian dan seterusnya)
• The second use of the term relates to the thing (or liability) actually insured. (Penggunaan istilah yang kedua berkaitan dengan sesuatu (atau kewajiban) yang sebenarnya diasuransikan
• When an underwriter quotes for 'a risk', an even wider definition is implied. Then underwriter will mean both the thing insured, such as the property itself, and the range of contingencies or scope of cover required. (ketika seorang underwriter mengaksep risiko, maka ada 2 hal yang diasuransikan, seperti property itu sendiri dan scope jaminan yang diminta) 

Attitude to risk (perilaku atau sikap)

Each person's attitude to risk is different. 

Therefore, we all respond to risk in a different way.

Some people are willing to carry certain risks themselves and are termed risk-seeking, while others lean more towards being risk-averse, feeling happier minimizing the risk to which they are exposed (perhaps by transferring the risk, as in insurance). (beberapa orang bersedia mengambil risiko tertentu sendiri dan disebut dengan pencari risiko, sementara yang lain lebih condong menghindari risiko, merasa lebih bahagia meminimal kan risiko yang mereka hadapi (mungkin dengan mengalihkan risiko, seperti asuransi)

Very few individuals are in a position to evaluate, with any accuracy, the risks to which they are exposed. (sangat sedikit individu pada posisi untuk melakukan evaluasi dengan akurat risiko yang mereka hadapi)

However, as well as now see, many companies attempt to achieve this as part of their risk management process. (namun banyak perusahaan mencoba mencapai ini sebagai bagian dari proses manajemen risiko mereka.

Risk Management

Risk management is important for a number a reason:

• It reduces the potential for loss by identifying and managing hazards (mengurangi potensi kerugian dengan mengidentifikasi dan mengelola hazards)
• It gives shareholders a greater degree of confidence in a company's ability to manage its risks. (memberikan pemegang saham tingkat kepercayaan yang lebih besar dalam kemampuan perusahaan mengelola risiko)
• It provides a disciplined approach to quantifying risks (memberikan pendekatan disiplin untuk mengukur risiko)

The decision to transfer risks (for example, by insurance) is an important final stage in the risk management process. (keputusan untuk mengalihkan risiko (contoh, dengan asuransi) tahapan akhir yang paling penting dalam proses management risiko.

Function of risk management

• Risk Identification
• Risk analysis
• Risk control

Categories of risk

Financial and non-financial risks

Some of the risks that we face are not capable of financial measurement.

They may have a financial aspect to them, but it is incidental.

The real risk arises from decisions and actions motivated by other considerations.

Take for example the choice of a marriage partner or our enjoyment of a holiday.

For a risk to be insurable the outcome of adverse events must be capable of measurement in financial terms.

Some examples of financial risks:

• Accidental damage to a motor car
• Theft of property.
• Loss of business profits following a fire
• Legal limit to pay compensation for personal injury to others

Pure and speculative risks

There are many situations in life when we speculative with a view to making some kind of gain. 

Obvious examples are the National Lottery or other forms of gambling. 

There are also situations such as investing in the stock market or starting up a new business that fall into this category.

Insurance does not apply to speculative risks.

Pure risks are those where is the possibility of a loss but not of gain., and where the best what we can achieve is a break-even situation.

Some examples of pure risks:

• The risk of fire
• The risk of machinery breakdown
• The risk of injury of employees at work

Particular and fundamental risks

There are some risks that occur on such a vest that are uninsurable.

These are called fundamental risks.

Take for example the risk of earthquake in a region known to be prone to such risks, or famine, economic recession or a more general risk - that of war.

We can define fundamental risks as those that arise from social, economic, political or natural causes and are widespread in their effect.

As we seen, non-financial and speculative risks are uninsurable as a matter of principle.

In contrast, the problem with fundamental risks is that it is often a lack of willingness or capacity on the part of insurers that causes such risks to be uninsurable.

It is not an easily defined category and there seem to be, on the face of it, many exceptions to the general rule.

Just think of the terrorism cover provided on the WTC, or the fact that marine insurers will often grant war risks cover for vessels and cargo, or even the fact it is possible to be insured for earthquake cover in California.

Nevertheless, the fact remains that those risks that tend to affect whole countries, regions or communities are classified as fundamental and therefore, generally, uninsurable.

Two risks automatically categorized in this way for non-marine policies are war risks and nuclear risks.

In contrast to fundamental risks, particular risks are localized or even personal in their cause and effect. Sometimes the cause may be more widespread (s storm over a whole region), but the effect is locallised or even related to an individual.

Not all properties in the region will have been damaged.

Some examples of particular risks:

• A factory fire
• A car collision
• Theft of personal possession from a home

Types of risk that can be insured

It is important that you understand that not every risk is insurable.

For a risk to be insurable, in addition to being financial, pure and, generally speaking, particular, the following features must also apply:

• A fortuitous event
• Insurable interest
• Public policy
• Homogeneous exposures

Summary of insurable and uninsurable risks

From what we seen in the preceding sections, we can summarize risks that are generally insurable and those that are not as follows:

Insurable risks                    Uninsurable risks

Financial                                    Non-financial

Pure                                            Speculative

Particular                                    Fundamental (generally)

Fortuitous event                          Deliberate act

Insurable interest                        No insurable interest

Not against public liability         Against the public interest

Homogeneous exposure              One-Offs (generally

Component of risk

• Uncertainty
• Level of Risk
• Peril and hazard

Level of risk

Risk is usually assessed in terms of frequency (how often it will happen) and severity (how serious it will be if it does happen)

High frequency and low severity

In a large number of different risk situations, there is a high frequency and low severity of loss where there are a large number of small losses and relatively few large losses

Figure below could relate to compare private car policies, where there are many losses for damage to the insured's own vehicle at a fairly modest level, but relatively few very costly third party personal injury claims.

This relationship between high frequency and low severity losses is not limited to property damage. In fact, research into industrial injury incidents has shown a very similar pattern.

The Heinrich Triangle, developed in 1931 (given in figure below), shows that, at that time, for every one major in jury at work, there were 30 minor ones and 300 non-injury incidents. The triangle crated as the result of looking at several thousand incidents at work and similar studies have given similar results. The pattern shows few serious incidents and very many minor ones.

Similar research has been carried out in the area of motor accidents (by Frank E Bird in 1969) using the statistics from 2 million accidents and near misses. Critically from an insurer's perspective, the relationship between serious and minor incidents in an important one, as we shell see.

Low frequency and high severity

In some cases there is a low frequency and high severity of loss, illustrated in below.

A small number of evens would result in very high costs. Accidents involving aircraft are good examples of this type of risk profile because, when a loss occurs, the cost could be substantial. However, technological advances help to reduce the frequency of accidents.

Significance of frequency and severity

The different frequency and severity profiles are important to insurers. This is because they wish their businesses to be, as far as possible, free from great peaks and troughs of claim payments made from one year to the next. Smooth trends in trading patterns tend to encourage investors to support an insurer.

An insurer will often base its decisions on how much of a risk it can prudently accept on factors relating to frequency and severity. Insurers have various ways of dealing with a risk that is offered to them where the amount involves exceeds their normal acceptance limits.

Peril and hazard

The concepts of peril and hazard together from the final aspect of risk. This aspect relates to the causes of losses:

• A perils can be defined as that which gives rise to a loss
• A hazard can be defined as that which influences the operation or effect of the peril.

At first, the distinction between the two may not be that obvious. However, the following example should help.

Here are some other examples of peril:

• The overflow of water tanks: this is the event insured against, which may give rise to loss.
• Lightning: when it occurs, this natural peril can result in damage

And some other examples of hazard:

• High value sports cars: the hazards in this motor insurance example are the potential for high speed, which in turn increase the risk of accidents, and the high value and attractiveness that increases the risk of theft
• A safari holiday: the climate, the existence of local diseases and the likelihood of injury all increase the possible extent of loss and are, therefore, hazards in travel insurance.

Hazard breaks down into tow further parts: it can be physical or moral.

Physical hazard relates to the physical characteristics of the risk and includes any measurable dimension of he risk. Example are:

• Security protection at a shop
• The construction of the property
• The age of a proposer and type of car for motor insurance

Moral hazard arises from that attitude and behaviour of people. In insurance, this is usually the conduct of the person insured. However, the conduct of the insured's employees and that of society as a whole are also aspects on moral hazard. Example include the following:

• Carelessness
• Dishonesty
• Social attitudes

The Need for Insurance

Insurance has been around for a very long time. It has its origins in the different kinds of situation where financial protections is required against the possibility of suffering some misfortune or loss.

We have already stated that the primary function of insurance is to act as a risk transfer mechanism; that is, to transfer a risk from one person, the insured, to another, the insurer. Transferring the risk to an insurer does not in itself prevent losses from occurring, but it provides a form of financial security and peace of mind for the insured. The large unknown financial risk that an individual faces of their home burning down, for example, is transferred to the insurer and replaced by the much smaller and certain cost of the premium.

Pooling of Risk

The basic concept of insurance is that the losses of the few who suffer misfortune are met by the contribution of the many who are exposed to similar potential loss. An insurance company gathers together relatively small sums of money from people who want to be protected financially form similar kinds of perils. The insurer sets itself up to operate a pool. In fact, as we shall see, insurers operate a number of separate pools for each different class of insurance. Contributions, in the form of premiums from many insured, go into this pool. From the pool, payments are made to compensate the losses of the few.

These contributions, or premiums, must be large enough, in total, to meet the losses in any one year. In addition, they must cover the costs of operating the pool and provide an element of profit for the insurer. The insurer endeavours to make sure that the premium which each insured pays in proportionate to the risk which they introduce to the pool (see Equitable premium)

• Law of large numbers 
• Equitable premiums

Benefits of Insurance

• It release capital within companies that can be used in the business.
• Enterprises are encouraged to start or expand
• Employees are kept in work
• Losses are reduced in size and number
• The nation benefits from the investment made by insurers
• The nation benefits from so-called invisible exports

Risk Sharing

There are two way of sharing the risk:

• Co-insurance
• Reinsurance

Dual insurance

Essentially this term is used when there are two or more policies in force which cover the same risk. The insured may have done this accidentally. For example, they may have bought a travel policy for their holiday that includes some cover for personal effects that are already covered under the all risks section of their household contents policy.

Self Insurance

The term self-insurance means that an individual or company has decided not to use insurance as the risk transfer mechanism, but to carry the risk themselves by means of funding. So self-insurance would describe a situation where, for example, a company that had many sales shops and a predictable regular pattern of small claims for glass breakages, sets aside a regular sum each month to fund these losses.

Classes of insurance

General (non-life) insurance

• Property insurance
• Fire, special perils and all risk policies
• Theft
• Engineering/breakdown
• Glass
• Livestock
• Money
• Pecuniary insurance
• Fidelity guarantee
• Legal expenses
• Credit
• Business interruption
• Motor Insurance
• Liability insurance
• Employers' liability
• Public liability
• Products liability
• Directors' and Officers' liability
• Professional liability
• Marine and aviation insurance
• Marine
• Aviation
• Combined or packaged policies
• Household
• Travel
• Commercial package
• Trader's combined
• Health insurance
• Personal Accident
• Sickness
• Private medical insurance
• payment protection indemnity
• Critical illness