Introduction to Insurance and Risk Management
Domain 1 checks whether you can separate risk from insurance and apply a risk-management sequence to a small business or family. Expect definition-based questions plus a simple numerical comparison.
Core rules
- Risk is uncertainty about a financial loss; a peril is the cause (fire, accident); a hazard raises the chance or size of loss (poor wiring, smoking).
- Pure risks (fire, theft, liability) can be pooled; speculative risks (share trading) are generally not insurable.
- Insurers pool many independent exposures; the law of large numbers makes actual claims more predictable as the pool grows.
- Risk-management steps: identify, measure, choose a technique (avoid, reduce, retain, transfer), implement, monitor.
- Insurance transfers the financial consequence; it does not stop the peril.
Worked example
A shop worth ₹20,00,000 faces a 1% annual fire-loss probability. Expected loss = 0.01 × 20,00,000 = ₹20,000. A policy costs ₹25,000 with a ₹10,000 deductible. The owner pays ₹25,000 and retains the first ₹10,000 of any loss; the insurer pays the rest up to the sum insured. Reasoning: the premium exceeds expected loss because the insurer adds expenses, capital and profit, but the owner gains certainty against a ruinous large loss.
Traps that cost marks
- Saying insurance “removes” risk; it transfers financial loss.
- Treating speculative risk as insurable.
- Confusing hazard (condition) with peril (cause).
- Mixing moral hazard (dishonest behaviour after cover) with adverse selection (bad risks seeking cover).