[00:00.00]A financial definition of insurance
[00:02.93]Throughout human history,unexpected economic losses have occurred.
[00:07.52]Such losses would continue to occur whether or not a system of insurance had ever been devised.
[00:13.14]But through the operation of an insurance system,losses can be predicted before they occur.
[00:19.28]The predictability of losses in advance is basic to an insurance system's operations.
[00:24.56]Because an insurance system allows losses to be predicted in advance,it allows the cost of losses to be financed and redistributed in advance.
[00:33.04]The first definition of insurance that we will examine is the financial one.
[00:37.62]In this instance,insurance is a financial arrangement that redistrbutes the costs of unexpected losses.
[00:45.24]The insurance arrangement involves the transfer of many different exposures to loss to one insurance pool,
[00:51.59]which combines the numerous exposures.
[00:54.52]An insurance system accomplishes the redistribution of the costs of losses by collecting a premium payment from every participant in the system.
[01:03.01]In exchange for the payment of the premium,the insured receives a promise from the insurance system to be compensated in the event of a loss.
[01:11.08]In most insurance systems only a small percentage of those insured suffer losses.
[01:16.70]Thus,an insurance system redistributes the costs of losses from the unfortunate few members who experience them,
[01:23.04]to all the members of the insurance pool(including those who suffer losses) who have paid premiums.
[01:28.79]Diagram 1 illustrates the way in which a fire insurance pool redistributes the costs of losses.
[01:35.66]Assume that each member of the pool is exposed to loss of his home by fire.
[01:40.41]Each member willingly contributed a premium-$800-to the insurance pool in exchange for the promise of payment in the event of fire.
[01:49.71]Assume that homeowner #4644 loses his house in a fire.
[01:55.20]He will collect $100,000, the insured value of his house,from the insurance pool.
[02:01.23]If there were no insurance pool,the unfortunate victim would lose $100,000.
[02:06.98]But instead,all the members of the pool have each paid $800 to provide funds to pay for losses.
[02:14.01]Thus,each insured has paid a part of the $100,000 loss experienced by one member.
[02:20.56]The $800 premium each insured paid in advance was calculated from the losses predicted by the insurance system.
[02:28.11]When the year began it was not predicted that home #4644 would burn but,rather,that 33 houses from among the 5,000 insured would burn.
[02:38.67]From this prediction came the decision to charge each homeowner $800 for his or her insurance.
[02:45.30]An insurance system is able to operate because all the insureds are willing to substitute a relatively small certain outlay,
[02:52.85]the insurance premium,for a relatively large uncertain loss.
[02:57.40]It is generally assumed that most people find the possibility of suffering a large loss unpleasant to contemplate.
[03:04.22]Therefore,people are willing to pay an insurance premium to be relieved of the uncertainty about a loss,
[03:11.14]as well as to be compensated if the loss actually occurs.
[03:15.45]Thus,even if no loss occurs during a year,as will be the case for most insureds,
[03:21.40]value has still been received in the form of a reduced or eliminated unpleasant mental state,the anxiety about a loss.
[03:30.05]Legal principles of insurance
[03:33.08]HEADING A
[03:34.75]It is sometimes said that insurance is like gambling.
[03:38.25]In betting,for example,one gives a sum of money to a bookmaker who agrees to pay out on the bet if the horse one has backed wins the race.
[03:47.58]The law however has found a means of distinguishing between gambling contracts,
[03:52.33]which it will not enforce,and insurance contracts,which it will.
[03:56.90]For a contract to be one of insurance the insured person must have an insurable interest in the subject matter of the insurance.
[04:05.39]That is,he must stand to lose financially if the event insured against happens.
[04:11.53]In life insurance,for example,a man or woman obviously has an interest in his or her own life and can therefore insure it and also the life of a husband or wife.
[04:23.47]But one cannot insure the life of anybody else unless their death would result in financial loss to oneself.
[04:30.65]Similarly,with property,insurance may only be effected if one stands to lose financially by its loss or destruction.
[04:38.73]Clearly the owner of the property would lose but so also might other people,
[04:44.11]such as a building society which has lent money on the security of a house or a dry cleaner who has taken in clothes for cleaning.
[04:53.17]HEADING B
[04:54.56]Further,in insurances on property or against liabilities the law applies the principle that the policyholder must not make a profit if the event insured against happens.
[05:06.49]The insurance contract is said to be one of indemnity,to make good the insured's loss and no more.
[05:13.86]Suppose,for example,that property is insured for more than its value and is destroyed as a result of an event insured against.
[05:22.17]The insured's recovery will be limited to the actual value.
[05:26.30]Again,if the property has been insured twice over and is destroyed,the insured will not be entitled to recover in all more than its total value.
[05:36.56]And if insured property is destroyed in circumstances which give the insured a right to claim both against his own insurer
[05:44.14]and against some other person who was responsible for the damage,the insured must allow the insurer to have the benefit of the right to claim against the other person.
[05:54.19]HEADING C
[05:55.29]Contracts of insurance form a special class of contract in that the law requires both parties to them,
[06:01.90]the insured and the insurer,to exercise the utmost good faith towards each other.
[06:08.20]In particular when anyone applies for insurance(he is known as the proposer) he must tell the prospective insurer every fact that he knows,
[06:18.46]or ought to know which would influence a prudent insurer in deciding whether to grant the insurance and,if so,on what terms.
[06:27.34]To take an example,a proposer for life insurance must reveal if he has recently had a heart attack as this may be a sign that he is more likely to die prematurely.
[06:37.79]Similarly if a motorist is seeking to insure his car and has had a number of recent road accidents,
[06:43.80]he must reveal that fact so that the insurer can decide whether to charge him an above-normal premium because he appears to be especially prone to accidents.
[06:52.73]If any fact of the kind described is not disclosed by the proposer,or if any fact is misstated,even unintentionally,
[07:00.65]the insurer is entitled to refuse to pay a claim under the policy.
[07:04.83]Insurers maintain that this is only right because the proposer knows the facts and the insurer does not.
[07:11.26]The insurer needs to be put in a fair position to decide whether to accept an insurance and on what terms. |