to provide compensation to the insured upon the happening of a specified event
or loss. This promise can be obtained by paying a small charge upfront
compensation for the loss or damage caused by event(s) beyond the control.
Insurance Company works?
providing financial protection from risks. These risks include death of bread
earner (life insurance), hospitalization expenses (health insurance), damage to
assets (car insurance) etc. The insurance company’s role includes –
a) pricing of the premium
b) determining the coverage i.e. compensation
c) inking the insurance contract
d) collection of premium
e) administering the claim/promise
Companies make Profit?
collected + Investment income on premium collected – Selling expenses – Claims
paid & provisioned – Operating expenses
collected = Rs. 10 lacs (say, 100 users on avg paid Rs. 10,000 each as premium)
income = Rs. 80,000 (8% interest p.a. on Rs. 10 lacs)
expenses = Rs. 1,50,000 (15% commission paid on Rs. 10 lacs)
paid & provisioned = Rs. 6,50,000 (say, 13% of users made claims averaging
Rs. 50,000 each)
expenses = Rs. 2,00,000 (20% of Rs. 10 lacs)
Hence, the profit earned by the insurance company is Rs. 1.8 lacs (Rs. 10
lacs + Rs. 0.8 lacs – Rs. 1.5 lacs – Rs. 6.5 lacs – Rs. 2.0 lacs).
would have been very different had 23% of the users made a claim instead of
only 13%. In this scenario, the insurer would have made a loss of Rs. 4.7 lacs.
Thus, the insurer too has to carry risk on its books and has to manage the
delicate balance between risk forecasting and pricing the policy.
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