Class 11-chapter 11
Chapter-11
Risk and insurance
Meaning of Business Risk
Business risk means the possibility that a business may face loss or may not earn the expected profit because the future is uncertain. It arises from factors that affect the normal working of a business, such as changes in customer demand, increase in production costs, competition, changes in government rules, or natural events. Since these factors cannot be fully controlled by the business, profit is never guaranteed. Business risk exists in every type of business, whether small or large. The chance of failure, loss, or lower income due to uncertain business conditions is known as business risk.
Meaning of Insurance
Insurance is a method of protection against financial loss caused by unexpected events such as accidents, illness, fire, theft, or death. It works on the principle of risk sharing, where many people contribute a small amount of money called a premium to an insurance company. In return, the insurance company promises to compensate the insured person if a specified loss occurs. This system helps reduce the burden of sudden expenses that individuals or businesses may not be able to bear alone.So, insurance is the process of transferring the riks of loss from insired to the insurer.
Insurance provides a sense of security and peace of mind by ensuring financial support during difficult times. It helps people plan their future with confidence, knowing that they are protected from major risks. Different types of insurance, such as life, health, and property insurance, serve different needs, but all aim to provide safety, stability, and financial protection when unexpected problems arise.
Some basic terms of insurance
1. Insurer
The insurer is the insurance company that provides insurance coverage. It agrees to compensate the loss suffered by the insured in return for a premium.
Example: Nepal Life Insurance Company is an insurer.
2. Insured
The insured is the person or organization whose life or property is protected by insurance. The insured pays the premium to get protection against risk.
Example: A person who insures his house or life is the insured.
3. Insured Amount (sum assured)
The insured amount is the fixed amount of money that the insurer agrees to pay to the insured or nominee in case of loss, damage, or death. This amount is decided at the time of taking the policy.
4. Insurance Premium
The insurance premium is the amount of money paid by the insured to the insurer at regular intervals (monthly, quarterly, or yearly) to keep the insurance policy active.
5. Insurance Policy
An insurance policy is a written legal contract between the insurer and the insured. It contains all the terms and conditions, rights, and responsibilities of both parties.
Importance of Insurance in Business
-
Protection against loss
Insurance protects a business from financial losses caused by fire, theft, accident, or natural disasters. -
Business continuity
It helps the business continue operations even after unexpected damage or loss. -
Risk sharing
Insurance spreads business risk among many policyholders, reducing the burden on one business. -
Financial security
It provides financial stability and reduces uncertainty in business income. -
Encourages expansion
With insurance protection, business owners can confidently invest and expand operations. -
Protection of employees
Insurance covers workers against accidents, injury, or death, improving employee safety. -
Improves creditworthiness
Banks and financial institutions prefer to lend to insured businesses. -
Legal requirement
Some types of insurance are compulsory by law, such as workers’ compensation insurance. -
Peace of mind
Insurance reduces stress and allows business owners to focus on growth. -
Supports long-term growth
By reducing risk, insurance helps ensure the long-term survival of the business.
General Principles of Insurance
Insurance works on some basic rules called general principles of insurance. These principles make sure insurance contracts are fair and smooth for both the insurer and the insured.
The main principles are:
1. Insurable Interest
Meaning:
The person taking insurance must have a financial interest in the subject matter insured. This means the person will suffer a financial loss if damage or loss happens.
Example:
- You can insure your own house, not your neighbor’s house.
- A person can insure their own life or the life of their spouse.
Importance:
- Prevents gambling through insurance
- Makes insurance legal and valid
2. Utmost Good Faith
Meaning:
Both the insurer and the insured must tell the truth and disclose all important facts while entering the insurance contract.
Example:
- While taking health insurance, hiding a serious disease is wrong.
- The insurer must clearly explain policy terms.
Importance:
- Builds trust
- Avoids disputes later
- False information can cancel the policy
3. Contract of Indemnity
Meaning:
Insurance compensates only for actual loss suffered, not profit.
Example:
- If your insured bike worth Rs. 2,00,000 is damaged and loss is Rs. 50,000, you will get Rs. 50,000 only, not more.
Importance:
- Prevents profit from loss
- Keeps insurance fair
👉 Note: Life insurance is an exception (it is not a contract of indemnity).
4. Principle of Subrogation
Meaning:
After paying compensation, the insurer gets the right to recover the loss from the third party responsible for the damage.
Example:
- Your car is damaged due to another driver’s fault.
- Insurance company pays you first, then recovers money from that driver.
Importance:
- Prevents double compensation
- Reduces insurer’s loss
5. Principle of Contribution
Meaning:
If the same property is insured with more than one insurer, all insurers share the loss proportionately.
Example:
- A factory is insured with two companies.
- Loss is Rs. 1,00,000.
- Both insurers pay according to their coverage amount.
Importance:
- Ensures fair sharing of risk
- Prevents extra gain to insured
6. Proximate Cause
Meaning:
The insurer pays only if the loss is caused by the nearest and direct cause insured in the policy.
Example:
- Fire causes damage → covered → claim paid
- Fire causes theft later → theft may not be covered
Importance:
- Helps decide claim validity
- Avoids confusion in multiple causes
7. Mitigation of Loss
Meaning:
The insured must take reasonable steps to reduce loss after the accident.
Example:
- If fire starts, calling fire brigade immediately
- Not leaving damaged goods unattended
Importance:
- Reduces loss amount
- Encourages responsibility
Conclusion
These principles ensure that insurance contracts are fair, legal, and useful. They protect both the insured and the insurer and help in smooth settlement of claims.
Major Types of Insurance
1. Life Insurance
It provides financial protection to the family in case of the death of the insured person. The insurer pays the sum assured to the nominee. Examples: Term insurance, endowment policy.
2. Health Insurance
It covers medical expenses like hospital bills, surgery, and treatment costs during illness or accidents. Example: Mediclaim policy.
3. Fire Insurance
It protects property and goods against loss or damage caused by fire, explosion, or lightning. Used by: Factories, shops, warehouses.
4. Marine Insurance
It covers loss or damage of goods during transportation by sea (and sometimes air or land). Used in: Import–export business.
5. Motor Insurance
It provides coverage against damage or loss of vehicles due to accidents, theft, or natural disasters. Compulsory in many countries.
6. Property Insurance
It covers buildings, machinery, and other assets against risks like fire, theft, or natural calamities.
Types of Life Insurance
Life insurance policies are designed to provide financial security to the family of the insured and also encourage savings. On the basis of nature and benefits, life insurance policies are classified into Whole Life Policy, Endowment Policy, and Term Policy.
1. Whole Life Policy
A whole life policy provides insurance coverage for the entire lifetime of the insured. The sum assured is paid only on the death of the insured.
(a) Ordinary Whole Life Policy
In this policy, the insured pays premium throughout his/her life. The insurance company pays the sum assured only after the death of the insured.
(b) Limited Payment Whole Life Policy
Here, premium is paid only for a limited number of years (for example 20 years), but the insurance cover continues for the whole life.
(c) Convertible Whole Life Policy
This policy can be converted into another policy, such as an endowment policy, after a certain period.
2. Endowment Policy
An endowment policy provides both life protection and savings. The sum assured is paid either on death during the policy term or on survival till maturity.
(a) Ordinary Endowment Policy
The sum assured is paid on death before maturity or on completion of the policy period.
(b) Pure Endowment Policy
The sum assured is paid only if the insured survives till the maturity period. No payment is made on death before maturity.
(c) Double Endowment Policy
If the insured survives till maturity, double the sum assured is paid. If death occurs earlier, only the original sum assured is paid.
(d) Joint Life Endowment Policy
This policy covers two persons under one policy, usually husband and wife. The benefit is paid on death or maturity.
(e) Anticipated Endowment Policy
A part of the sum assured is paid at fixed intervals during the policy term, and the remaining amount is paid at maturity.
(f) Deferred Endowment Policy
The policy benefits start after a fixed future period, mainly used for future needs like retirement.
3. Term Policy
A term policy provides insurance cover for a fixed period only. It offers pure risk coverage and no maturity benefit.
(a) Straight Term Policy
If death occurs during the policy term, the sum assured is paid. If the insured survives, nothing is paid.
(b) Renewable Term Policy
The policy can be renewed after expiry without medical examination.
(c) Convertible Term Policy
This policy can be converted into a permanent policy such as endowment or whole life.
(d) Decreasing Term Policy
The sum assured reduces gradually over the policy period. It is mainly used to cover loans.
📌 Conclusion
Thus, different types of life insurance policies serve different needs such as protection, savings, and investment. Selection of policy depends on income, age, and future financial goals.
Types of Life Insurance (for 5 Marks)
1. Whole Life Policy
Provides insurance cover for the entire life of the insured. The sum assured is paid after death.
Ordinary Whole Life Policy: Premium is paid throughout life; payment is made only on death.
Limited Payment Whole Life Policy: Premium is paid for a limited period, but cover continues for life.
Convertible Whole Life Policy: Can be converted into another policy after a certain time.
2. Endowment Policy
Provides both insurance protection and savings. Payment is made on death or maturity.
Ordinary Endowment Policy: Sum assured is paid on death or on maturity.
Pure Endowment Policy: Payment is made only if the insured survives till maturity.
Double Endowment Policy: Double sum assured is paid on maturity; single on death.
Joint Life Endowment Policy: Covers two lives; payment on death or maturity.
Anticipated Endowment Policy: Part payments are made at intervals during the policy term.
Deferred Endowment Policy: Benefits start after a fixed future period.
3. Term Policy
Provides insurance for a fixed period only. No maturity benefit.
Straight Term Policy: Payment only if death occurs during the term.
Renewable Term Policy: Can be renewed after expiry without medical test.
Convertible Term Policy: Can be converted into a permanent policy.
Decreasing Term Policy: Sum assured decreases over time, mainly used for loans.
Essentials of Insurance Contract
For a risk to be insurable, it must fulfill the following conditions:
1. Large Number of Exposure Units
Insurance works on the principle of law of large numbers.There should be many similar units exposed to the same risk so that the insurer can predict losses accurately.
Example: Thousands of vehicles insured against accidents.
2. Accidental and Unintentional Loss
The loss must be sudden, unexpected, and beyond the control of the insured. Intentional losses are not covered by insurance.
Example: Fire due to short circuit (covered), burning property deliberately (not covered).
3. Determinable and Measurable Loss
The loss should be clearly measurable in terms of money, time, or place.This helps the insurer calculate compensation.
Example: Damage to a car worth Rs. 3 lakhs.
4. No Catastrophic Loss
The loss should not affect many people at the same time.Huge disasters create heavy losses for insurers.
Example: Normal house fire (insurable), nuclear war loss (not insurable).
5. Calculable Chance of Loss
The probability of loss must be estimable with statistical data.Without calculating risk, premium cannot be fixed.
Example: Life insurance premiums are based on mortality tables.
6. Economically Feasible Premium
The premium must be reasonable and affordable.If the premium is too high, people will not buy insurance.
Example: Health insurance premium should be affordable for common people.
🔑 Conclusion
Only those risks that are accidental, measurable, calculable, non-catastrophic, and economically feasible can be insured. These conditions ensure the smooth functioning of insurance business.
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