PART 1
UNDERSTANDING INSURANCE BASICS
WHAT AN INSURER DOES
BASIC
PRINCIPLES BASIC PRINCIPLES
•
The advantage of obtaining insurance is that it allows the pooling of risks
and d th b bilit f t b i th ti t f l d re
duces the pro
b
ability o
f one par
ty
bearing the entire cos
t o
f a loss
• Insurance policies originated in 17th century London coffee houses which
became the place for sharing information on agreements of pooled risks
between merchants, ultimately leading to the formation of Lloyds of
London
• In the aftermath of The Great Fire of London, Nicholas Barbon an English
physician opened “The Fire Office” to insure London’s brick homes, and
establi h d i li i k h d bli
s
h
e
d insurance poli
cies as we
know t
hem to
day
• Toda
y y( ) , an insurance contract is a contract in which one part
y
(the insurer
)
accepts significant insurance risk from another party (the policyholder) by
agreeing to compensate the policyholder if a specified uncertain future
event (the insured event) adversely affects the policy holder. (AASB 4)
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WHAT AN INSURER DOES
Diff t d th fi i l d t Differences
to assurance an
d other financial pro
duc
t
s
• Insurance pools the risk of uncertain future events. This is different
to assurance models which pool the risk of events which will
happen such as death, retirement or paying interest happen such as death, retirement or paying interest
• The actual cost of providing the general insurance product is not
known at the time of selling the product at the time of selling the product
• The product being sold only has intangible attributes such as
selling a promise to pay and the likelihood of a claim occurring selling
a promise to pay and the likelihood of
a claim occurring
• The product is often a ‘grudge’ purchase and a ‘need’ rather than a
‘want’
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WHAT AN INSURER DOES
BASIC PRINCIPLES BASIC PRINCIPLES
SIMPLIFIED CONCEPT SIMPLIFIED CONCEPT
– RISK OF A LARGE AND INFREQUENT LOSS RISK OF
A LARGE AND INFREQUENT LOSS
Every year 1 in every 1,000
houses suffers a fire at a
cost of $100,000.
An individual risks having to finance
$100,000 if it is their turn for the
1:1000 loss.
A group of 1,000 householders
pooling together pay only $100
each to rebuild the house each each to rebuild the house each
year. Even after 10 years the
individual has only paid $1,000 to
protect their risk of $100,000.
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protect their risk of $100,000.
WHAT AN INSURER DOES
BASIC PRINCIPLES
SIMPLIFIED CONCEPT
– RISK OF SMALL FREQUENT LOSSES
BASIC PRINCIPLES
SIMPLIFIED CONCEPT RISK OF SMALL FREQUENT LOSSES
Every year 100 in every
1,000 houses suffers a
burglary at a cost of $1,000.
An individual risks having to finance
$1,000 if it is their turn for the 1:10
loss.
A group of 1,000 householders
pooling together pay $100 each to
reimburse the cost of goods stolen. reimburse the cost of goods stolen.
Over 10 years the individual has
paid $1,000.
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WHAT AN INSURER DOES
PRODUCTS
SHORT TAIL LONG TAIL
• Claims may not even be
SHORT TAIL LONG TAIL
•
Claims usually known and
• Claims may not even be
reported within 12 months
• Settlement can take 3-4 years
• Greater complexity in
• Claims usually known and
settled within 12 months
• Less complexity in
managing claims
• Greater complexity in
managing claims
• Higher risk in predicting final
settlement
managing claims
• Less risk in predicting final
settlement
• Generally based around settlement
• Generally based around
medical and legal outcomes
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