a) To explain: Pooling of losses characteristic of insurance. Introduction: Insurance contracts are based on the principal of pooling of losses, that is, losses incurred from any individual contract are irrelevant for the purpose of business since they are inevitable and are considered only in context of entire population of insurance contracts. The business of insurance uses the law of large numbers for its operations which states that an individual event may be unpredictable but when there is a series of large numbers the over-time probability patterns result in rather predictable outcomes. Insurance companies charge premium from customers after considering expected outflow of claim obligations and desired profit margins, these expected claim obligations are calculated based on actuarial evaluation for the entire set or group of insurance contracts. Essentially, all the possible and probable losses are pooled together and compared with overall premium receivable so that the company can run a sustainable business. b) To explain: Payment only for random losses characteristic of insurance. Introduction: Random losses refer to those un-foreseen circumstances resulting in damages and which occur randomly without any intention on part of the concerned party, there occurrence cannot be know prior to the event. Insurance contracts are entered by the insurance company to earn premium and by the customer for safeguarding against losses incurring from un-favorable circumstances, occurrence of which cannot be predicted with certainty. When there is an intention and action by the customer to incur losses in order to gain insurance compensation, the contract entered is rendered void. For instance, a person cannot damage insured property and claim damages from the insurance company, as such actions are not done in good faith, which is a basic requirement for any insurance contract. In such circumstances, the insurance company incurs no liability for providing damages as the customer has committed insurance fraud. c) To explain: Risk transfer characteristic of insurance. Introduction: Risk refers to the possibility of occurrence of losses or damages resulting from un-favorable circumstances likelihood of which is not known. The entire business model of insurance sector revolves around the transfer of risk from premium paying customer to the premium receiving insurance companies. An insurance contract protects the purchaser of insurance policy against unforeseen circumstances by transferring the risk of incurring damages to the insurance company by paying a ‘premium’ on the policy as per the terms of contract. d) To explain: Indemnification characteristic of insurance. Introduction: Indemnification refers to the process of providing compensation to the insuree, for any damage or loss sustained, being as per the terms of the insurance contract. Insurer enters into an insurance contract with the customer and takes over the risk on terms and conditions as decided in the insurance contract, that is, the insurer takes the responsibility of making good on damages or losses sustained by the insuree on account of events which are covered in the insurance contract. If such mentioned events transpire the insurer is legally bound by the contract to provide agreed compensation as decided in the terms of the contract to the insuree, such an act is known as indemnification.

Chapter 2 Solutions