Insurance as a risk mitigation tool:

Slide 1: To understand about risk and insurance and risk let’s start with a case study.

Sachin and Sourav are friends studying in the same private tuition and regularly go home
together. Sachin always carries an umbrella and Sourav does not. One day, it suddenly
started raining. Sachin used his umbrella to protect him and his belongings from rain. After
reaching Sachin’s home, Sourav found that Sachin’s father was carefully reading a bunch of papers
and signing some documents. When Sourav asked Sachin’s mother what uncle is doing, she said,
“Actually, your uncle is reading and finalising papers for purchase of an insurance policy”.

Slide 2: “What is an insurance policy,” Sourav enquired.

Sachin’s mother explained, “Insurance offers protection against unforeseen risks, just like a raincoat
or umbrella protects against rain”.

Every day we hear stories about mis fortunes and accidents that someone has suffered.
Some of these includes:

 Getting ill all of a sudden

 House and belongings getting destroyed by fire
 Large scale loss of life due to storm, fire, earthquake, tsunamis
 Motor vehicles parts getting stolen

Life is full of uncertainties and protecting oneself, and one’s family from such uncertain
events has been one of the biggest concerns of man for centuries.

Slide 3: “So, what is a risk?”, Sourav asked.

Risk is a term that we use to refer to the chance of suffering a loss as a result of uncertain
events. For example, if you drench yourself in rain, you may fall sick. There is a risk of illness. Due to
rain, there could be a short circuit of electricity. There is a risk of theft of our car which is parked in
the garage and there is also the risk of an accident while crossing the road. So risk is an inherent part
of our life. Whether and when loss would be caused because of risk and how much loss is caused
cannot be foreseen, known or controlled at all times. While we cannot avoid most of these risks, by
purchasing insurance, we can transfer the risk to the insurance company.”

Slide 4: We face many such risks in our day to day life including risk to our life, health,
property and so on. We don’t know whether and when something unfortunate will happen.
It may not be always possible for us to prevent such happenings. For example, we cannot
prevent a storm or somebody’s death from occurring.

Slide 5: Luckily, to mitigate such risks we have something called Insurance. The concept of
insurance is based on a very simple idea that even though an event like a death or a fire
which comes as a huge economic blow to someone cannot be completely prevented but
when we take the society as a whole, during any given period only a few of such incidents
occurs and a few suffers.

If small contribution is collected from everyone in the community and pooled to create a
common fund, the amount so pooled can be used to compensate to the few unfortunate
members who have been subject to the loss.

Insurance is basically the mechanism of risk transfer and sharing by pooling of risks and
funds among a group of individuals who are exposed to similar kind of risks for the benefit
of those who suffer loss on account of the risk.

Slide 6: Sourav asked, “How does this happen”?

Sachin’s mother explained, “Suppose the downpour is heavy resulting in a flood, our car could get
immersed in water. It could damage a few vital parts necessitating repairs. Since we have insured
our car, the insurance company will reimburse the expenses of repairs, thereby reducing the impact
of loss because of damage to the car.”

Just like “Had you taken an umbrella you could have protected yourself from getting wet”. Similarly,
insurance helps us to protect ourself and our family against unforeseen events.

Slide 7: Let’s take an example to understand how insurance mitigates the risk with the help
of a simple sum.

In a village, there are 400 houses, each valued at Rs. 20,000. Every year, on an average, 4
houses get burnt, resulting into a total loss of Rs. 80,000.

Number of houses 400

Value of each house Rs. 20,000
Houses that get burnt every year (average) 4
Total loss (4 houses X Rs. 20,000) Rs. 80,000
Contribution to be made by 400 house Rs. 200
owners to compensate for loss of Rs.
80,000 = Rs. 80,000 / 400

If all the 400 owners come together and contribute Rs.200 each, the common fund would
be Rs. 80,000. This is enough to pay Rs. 20,000 to each of the 4 owners whose houses got
burnt. Thus, the risk of 4 owners is spread over 400 houses/ house-owners of the village.