Unit 3: Fundamentals of insurance
Risk Management and Insurance notes · PTU syllabus (BCOP 622-18)
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Unit summary
Insurance is the most common way to transfer risk, but not every risk is insurable. This unit covers the definition and characteristics of insurance, requirements of an insurable risk, adverse selection, insurance vs gambling vs hedging, essentials and principles of insurance contracts, and life, general, health, marine and automobile insurance.
After this unit you can
- Define insurance and explain its characteristics
- Explain the requirements of an insurable risk and adverse selection
- Distinguish insurance, gambling and hedging and explain the principles of insurance contracts
- Describe life, general, health, marine and automobile insurance
PTU syllabus topics
- Definition and basic characteristics of insurance
- requirements of an insurable risk
- adverse selection
- insurance vs. gambling vs. hedging
- essentials and principles of insurance contracts
- life
- general
- health
- marine and automobile insurance
Insurance
No, transfers an existing risk
Protection from loss
Gambling
Yes, creates new risk
Chance of gain
Hedging
No, offsets an existing risk
Reduce price risk
Topic 1
Definition and characteristics of insurance
Insurance is the pooling of fortuitous losses by transfer of such risks to insurers, who agree to indemnify insureds for such losses, provide other pecuniary benefits on their occurrence, or render services connected with the risk (American Risk and Insurance Association).
Pooling of losses
Losses of a few shared by many
Payment of fortuitous losses
Unforeseen, accidental
Risk transfer
From insured to insurer
Indemnification
Restore to the pre-loss position
Contract
Legal agreement with premium as consideration
Law of large numbers
Predictable losses for the pool
Topic 2
Insurable risk and adverse selection
- 1
Large number of exposure units
Law of large numbers applies
- 2
Accidental and unintentional loss
- 3
Determinable and measurable loss
- 4
No catastrophic loss to the pool
Or reinsured
- 5
Calculable chance of loss
- 6
Economically feasible premium
- Adverse selection: people with higher-than-average risk are more likely to buy insurance (e.g., those with health problems buying health cover). Control: underwriting, medical tests, waiting periods, exclusions, differential premiums, group insurance, mandatory cover.
- Moral hazard (dishonesty after insurance) controlled by deductibles, co-payments and investigation.
Topic 3
Insurance vs gambling vs hedging; contract essentials and principles
Risk
Existing pure risk transferred
New speculative risk created
Purpose
Restore loss (indemnity)
Gain at another's expense
Social value
Productive — reduces uncertainty
Unproductive
Legal status
Enforceable contract
Wagering agreement void (Section 30, Contract Act)
Risks
Pure, insurable risks
Speculative price risks (commodities, currency)
Mechanism
Pooling, law of large numbers
Offsetting positions in derivatives
Counterparty
Insurer
Market participants
Essentials of a valid insurance contract
- Offer and acceptance (proposal and policy), consideration (premium), competent parties, legal object, free consent — plus insurance-specific features: aleatory (unequal exchange), unilateral, conditional, contract of adhesion (ambiguity interpreted in favour of the insured), personal.
Principles
Utmost good faith
Full disclosure of material facts
Insurable interest
At inception (life) / at time of loss (property); marine — at loss
Indemnity
No profit from loss (not for life)
Subrogation
Insurer steps into insured's rights
Contribution
Pro-rata sharing among insurers
Proximate cause
Dominant effective cause (Leyland Shipping v. Norwich Union)
Loss minimisation
Insured must act prudently
Topic 4
Life, general, health, marine and automobile insurance
| Type | Key features |
|---|---|
| Life insurance | Term, endowment, whole life, ULIP, pension; contract of assurance; nominee; surrender value; Section 45 — no repudiation after 3 years |
| General — fire | Standard Fire and Special Perils policy; Bharat Griha/Sookshma/Laghu Udyam Raksha; add-ons (earthquake, terrorism) |
| Health insurance | Hospitalisation, day care, pre/post hospitalisation; cashless via TPAs; waiting periods; portability; Arogya Sanjeevani standard policy |
| Marine insurance | Marine Insurance Act, 1963; cargo (ICC A, B, C clauses), hull, freight; open cover and open policy; voyage, time, mixed policies |
| Automobile insurance | Motor Vehicles Act, 1988 — third-party liability compulsory; comprehensive = third party + own damage; no-claim bonus (20–50%); add-ons (zero depreciation, engine protect) |
- Other general insurance: liability (public, product, professional, D&O), engineering, crop (PMFBY), travel, cyber, credit.
Example
Marine cargo: ICC (A) is all-risks (subject to exclusions); ICC (C) covers only major casualties like fire, stranding, collision — a cheaper but narrower cover.
Key terms
- Insurable risk
- Risk meeting conditions such as accidental, measurable, non-catastrophic loss
- Adverse selection
- Higher-risk persons seeking insurance more than others
- Aleatory contract
- Contract where values exchanged may be unequal
- Proximate cause
- The dominant, effective cause of a loss
- Third-party insurance
- Liability cover compulsory for motor vehicles
Quick revision
- Insurance: pooling, fortuitous loss, transfer, indemnity.
- Insurable risk: many units, accidental, measurable, non-catastrophic, calculable, affordable.
- Adverse selection vs moral hazard.
- Insurance ≠ gambling ≠ hedging.
- Lines: life, fire, health, marine (ICC A/B/C), motor (third party compulsory).
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.Define insurance.
- Q2.State the requirements of an insurable risk.
- Q3.What is adverse selection?
- Q4.Distinguish insurance and gambling.
- Q5.What is a contract of adhesion?
- Q6.What is compulsory under motor insurance?
Long-answer questions
- Q1.Explain the characteristics of insurance and requirements of an insurable risk.
- Q2.Distinguish insurance, gambling and hedging and explain adverse selection.
- Q3.Explain the essentials and principles of insurance contracts.
- Q4.Explain life, health, marine and automobile insurance.
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