Types of Loss Exposures

Type of Loss Exposures:
There are three kinds of loss exposures
1.Property Loss Exposures
2.Liability Loss Exposures
3.Personal and Personnel loss Exposures


Property Loss Exposure: Any condition or situation that presents the possibility that a property loss will happen. There are two kind of property Real Property—Land, buildings and other structures attached to the land or embedded in it. Personal Property All tangible or intangible property that is not real (furniture, jewellery, machinery, inventory, equipment, patents, copyrights…)
            When a family or business faces a loss of property, it not only causes direct loss but also causes indirect loss in the form of decrease or complete loss of revenue, increase in expenses, both commonly called as Net Income Loss. Insurer also covers for Net Income Loss.         
Example: When a home is damaged to a large extent due to fire accident, the owner has to spend to restore the building, at the same time during renovation he needs to look for an alternative residence, which would incur him an extra expense. If the owner is operating any kind of business in the premises, he looses the income that used to generate from that business too. Therefore the Net Income Loss would equal to amount used to restore the building + the amount spend on alternative residence during renovation + Business income loss.


Liability Loss Exposure: Any condition or situation that presents the possibility of a claim alleging legal responsibility of a person or business for injury or damage suffered by another party. Some liability claims result in lawsuit. A Liability Loss is a claim for monetary damages because of injury to another party or damage to another party’s property.
                  In the above example, if the Insured is covered for Liability loss exposure then the Insurer should pay for the losses incurred by people other than family members (employees, relatives…). Losses include medical expenses, rehabilitation costs, and pain and suffering experienced by guests, employees and other injured in the fire.


Personal and Personnel Loss Exposures:


Personal Loss Exposure: Any condition or situation that presents the possibility of a financial loss to an individual or a family by such causes as death, sickness, injury, or unemployment. 
Personnel Loss Exposure: Any condition or situation that presents the possibility of a financial loss to a business because of the death, disability, retirement, or resignation of key employees.


Ideally Insurable Loss Exposures: Insurers generally prefer to provide insurance for the potential financial consequences of loss exposures that have the following characteristics.

Ø      Loss Exposure Involves Pure, Not speculative, Risk:  Insurance should help the insured to restore his financial condition but not to gain from the loss he faced. The purpose of Insurance is not served if the loss exposure involves speculative risk and the insured gains from it. Therefore only those loss exposures are covered by the Insurers whose losses are definite and can be calculated.  

Ø      Loss Exposure Is Subject to Accidental Loss From the Insured’s Standpoint:  The event that triggers the loss should be fortuitous, or at least outside the control of the beneficiary (Insured) of the insurance.

                      If the losses are not accidental (if intentionally done by the     insured), the insurer cannot calculate an appropriate premium because the chance of a loss could increase as soon as policy issued. If the loss exposure involves only accidental losses, the insurer can better estimate future losses and calculate an adequate premium for the exposure. The loss that is not accidental is a case of insurance fraud. 

Ø      Loss Exposure Is Subject to Losses That are Definite in Time and That are Measurable: Insurer covers only those losses, which have definite time, and place of occurrence and the amount of loss must be measurable in monetary terms. For example the sudden bursting of a water pipe that causes water damage in the insured’s bathroom is an occurrence that has definite time and place. But if a slow leak in the pipe causes decay and rotting of the insured’s bathroom floor over several years. The resulting loss does not have a definite time of occurrence and is generally not insurable. 

Ø      Loss Exposure is One of a Large number of Similar, But Independent, Exposures: If there are similar kinds of loss exposures, it would make easy for Insurers to determine appropriate premiums using Law of Large Numbers. Each loss affects the profitability of the Insurer; therefore if the insurer tries to insure an unusual loss exposure, he might have to cover an indefinite loss, as it is difficult for him to estimate the loss and the premium to be charged. Therefore most insurers are reluctant to insure unusual loss exposures.  

Ø      Loss Exposure is not Subject to a Loss That Would Simultaneously Affect many other Similar Loss Exposures; Loss Would Not be Catastrophic: If most of homes or businesses of a city are insured by a particular insurer then a Catastrophe (hurricanes, windstorm, hail….) could cause losses to sizable proportion of insureds at the same time. This might affect the profitability of the Insurer or Insurer may not have sufficient funds to pay for all the claims of the all the insureds. The tendency of insurers to avoid insuring catastrophic losses does not mean that hurricane damage to property is not insurable. If each of many Insurers issued relatively small number of policies in the city that is prone to hurricane, no one insurer would face the financial ruin.   

Ø      Loss Exposure Is Economically Feasible to Insure: Loss Exposures involving only small losses as well as those involving a high probability of loss are generally considered uninsurable. For example disappearance of office supplies from a Company could require the insurer to spend more to issue claim checks than it would pay for the claims, therefore Insurer avoids covering these kinds of loss exposures. Insurers also do not cover for wear and tear of an automobile because autos are certain to incur damage over time.

  

A Transfer System

 A Transfer System:
Insurance is a system that enables a person, a family or an organization (Insured) to transfer the cost of losses to an Insurer. By transferring the cost of losses to Insurers, Insured exchange the possibility of large loss for the certainty of a much smaller periodic payment called Premium.

 Insurance Policy: A contract that states the rights and duties of both Insured and the Insurer regarding the transfer of costs of losses.

Covered Losses: The events for which Insurance pays.

Sharing the Cost of Losses:
Insurance also involves in Sharing the Cost of Losses. The Insurer pools (Combine into a common fund) premiums paid by insureds. When ever Insured incur covered loss then the claim is settled from these pooled funds, thereby spreading (sharing) the costs of losses among all the insureds. Insurer estimates future losses and expenses based on the past loss experience and determines the amount that should be collected from insureds as premiums.
                  
Exposure unit: A measure of the loss exposure assumed by the insurer, used in pricing insurance.

Law of Large Numbers:  A mathematical Principle stating that as the number of similar but independent exposure units increases, the relative accuracy of predictions about future outcomes (losses) based on these exposure units also increases.

A Risk Management System

Risk Management: The process of making and implementing decisions to handle loss exposures.

Individuals, Families and Organizations face loss exposures every day. Some of them can be retained but some of them may lead to serious financial consequences. Few loss exposures can be controlled by Loss Prevention Measures such as safety goggles and helmets for construction workers to reduce the frequency of injuries and few may be controlled by Loss Reduction Measures such as placement of fire extinguisher in the home or workplace to reduce the severity of fire loss.
           Some of the loss exposures are neither easy to retain nor avoid nor control, in this case the best risk management technique to overcome these kind of uncertain losses would be To Transfer the costs of losses to another party (Insurer).

What is Insurance?

Life is full of Risks - some are preventable or can at least be minimized, some are avoidable and some are completely unforeseeable, therefore every house hold or business needs Insurance to protect assets against unforeseen events that could cause financial hardship. Sometimes Insurance is also needed to satisfy a Contractual Obligation (homeowner's commitment to purchase insurance on home to protect the mortgage company's investment in case the home is destroyed or damaged).

Insured: A person, a business or an organization whose property, life or legal liability is covered by an Insurance Policy.(Named Insured or Additional Named Insured on the policy) 

Insurer: An Insurance company.

Loss Exposure: Any condition or situation that presents the possibility of loss.

Insurance is four things:

1.      A Risk Management Technique that enables a person or an organization to deal with loss exposures and their financial consequences.

2.      A Transfer System in which one party-the Insured transfers the chance of financial loss to another party-the Insurer.

3.      A Business which includes various operations that must be conducted in a way that generates sufficient revenue to pay claims and provide a reasonable profit for its owners.

4.      A Contract between the Insured and Insurer that states what potential costs of loss the insured is transferring to the Insurer and expresses the insurer’s promise to pay for those costs of loss in exchange for a stated payment by the insured.