0:05 and let's get started into understanding
0:07 the world of insurance before we delve
0:10 into the other details that together
0:12 comprise this whole universe. So the
0:16 first question is what is insurance
0:20 at a very broad level insurance is
0:23 nothing but a method of handling risks
0:26 risks which could result in potential
0:30 losses. So one of the things you realize
0:33 is that and and in some sense insurance
0:36 has been developed as an answer to
0:38 address these problems of risk which is
0:40 inherently a part of life. There is no
0:43 nothing that is free of risk. In effect
0:45 there is really nothing called a
0:48 risk-free environment. We assume under
0:50 certain scenarios certain environments
0:52 are risk-f free. However, please
0:54 remember that those are based on certain
0:57 assumptions. For example, we assume that
1:00 when a government borrows nationally, in
1:02 particular, for example, when government
1:05 of India borrows in India, there can be
1:07 no default and therefore we assume the
1:09 the environment that that setup is a
1:11 risk-free environment or the borrower is
1:14 a risk-free borrower. However, there are
1:17 instances thankfully not in India but
1:19 globally we've seen enough instances
1:21 where governments have borrowed in the
1:24 domestic market and yet been not been
1:26 able to pay up or or repay the
1:28 borrowings in the domestic market which
1:31 means that even the borrowing even the
1:33 government is not really a risk-free borrower
1:35 borrower
1:37 if I extend this there is no part of
1:40 life which will actually be risk- free
1:43 everything there is a risk so risk has
1:46 developed as an answer to the problem of
1:49 handling risks. Now risks are something
1:51 which are an inherent part of life.
1:52 There is no part of life which is
1:55 independent or can be assumed to can can
1:57 be realistically taken to be free of
2:00 risks. Now we assume certain aspects to
2:02 be risk-f free. What do I mean that
2:04 based on our basis our assumptions or
2:07 based on our assumptions there is no
2:10 risk involved. However,
2:11 the inherent assumptions that we make
2:13 are itself
2:16 kind of a question to be asked. Is is
2:18 there going to be a risk in that? Is
2:20 there a risk of those assumptions
2:23 failing? Just to give you an example,
2:26 when a government borrows nationally. So
2:28 for example when government of India
2:32 borrows from the Indian markets the
2:34 assumption is that there is no risk of
2:37 default because remember government of
2:39 India has the right to print money and
2:43 therefore repay however strictly
2:44 speaking government of India could also
2:47 default. Now thankfully it has never
2:49 happened in India but we've seen enough
2:51 cases in other parts of the world in
2:53 other countries where governments have
2:56 not been able to sustain their
2:58 liabilities or their debt by just
3:00 printing money and hence they have had
3:03 to default. So therefore effectively
3:04 there is really nothing called a
3:07 risk-free environment. What what we talk
3:08 about in a risk-free framework is based
3:11 on a certain set of assumptions that
3:12 failures will not happen. Now in
3:15 particular in the insurance sector risk
3:18 is defined as a condition in which there
3:21 is a possibility of an adverse deviation
3:24 from the desired outcome. Actually risk
3:27 in a in a sense is nothing but deviation
3:29 from the desired outcome. Now the
3:31 deviation in some sense could be both
3:34 positive or negative. What do I mean by
3:36 that? So let's say you are expecting a
3:38 certain amount of average return on an
3:40 investment. Now the actual return may be
3:43 higher or lower than that. If the return
3:46 is higher it is still a deviation but
3:48 remember the deviation is a posit in a
3:49 positive framework or a positive
3:51 direction and therefore you are happy
3:53 with it. On the other hand if the
3:55 deviation is on the negative side which
3:57 means the actual outcome is lower than
3:59 what you are expecting. You'll end up
4:01 having a negative deviation or an
4:03 adverse deviation which res which then
4:06 potentially results in a loss. You also
4:08 need to re understand and realize the
4:12 fact that just because there is a risk
4:14 does not automatically ensure that there
4:16 will be a loss. Risks are nothing but
4:19 the expectation of potential loss and
4:22 therefore risk may not always fractify.
4:24 So that's one thing you have to keep in
4:26 mind when you consider a specific
4:28 payment essentially which is called the
4:31 premium by one party. So by the buyer of
4:34 the policy, the counterparty, the second
4:37 party or the insurance company agrees to
4:40 indemnify the first party up to a
4:43 certain limit for some specified loss
4:45 that may or may not occur. And that may
4:46 not occur is important because if it
4:49 does not occur then essentially there is
4:51 no payout to be made yet the premium is
4:53 essentially paid out right or paid out
4:55 by the second party the insurance
4:56 company. That's how it will typically
5:00 work. Insurance is therefore it also a
5:02 technique which provides for collection
5:05 of small amounts of premium from many
5:08 individuals and firms. So the policy
5:09 base is actually a diversified policy
5:12 base. There are many many individuals
5:14 many many organizations from which small
5:16 relatively small amounts and when I say
5:18 relatively small amounts small with
5:21 respect to the total value of the
5:23 benefit or the cover that the insurance
5:25 company offers which is called the sum
5:27 assured. So they take a very large
5:30 diversified base and at any one point in
5:33 time the idea is that this base is so
5:36 diversified that only a very few of
5:38 these people will actually be impacted
5:40 and therefore would need a cover or a
5:42 reimbursement. So a very large number of
5:45 them will not really need the cover or a
5:46 reimbursement at a particular point in
5:49 time. The in other words there is fairly
5:52 low levels of concentration risk because
5:53 if everybody was chosen from the same
5:56 geography or the same segment you would
5:57 have very high levels of concentration
5:59 risk. So here one of the things that is
6:01 done is the concentration risk is kind
6:03 of reduced as far as possible. It is
6:06 large and it is uncertain but now how do
6:08 you protect them themselves? So they are
6:10 now able to protect themselves by buying
6:13 protection which is payment of a small
6:16 amount which is the premium today and
6:18 and that's kind of a definite cost that
6:20 you pay out which this will allow the
6:22 holder the right to exercise if it is
6:25 needed. If not the money is sunk cost
6:27 but yes if it is needed then the holder
6:29 can exercise it to kind of get you know
6:31 the cover that they need. [Music]
