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W01_C01_What is Insurance | Introduction to Insurance | YouTubeToText
YouTube Transcript: W01_C01_What is Insurance
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Core Theme
Insurance is fundamentally a risk management tool designed to handle potential losses by pooling premiums from many individuals to cover the uncertain adverse outcomes experienced by a few.
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and let's get started into understanding
the world of insurance before we delve
into the other details that together
comprise this whole universe. So the
first question is what is insurance
at a very broad level insurance is
nothing but a method of handling risks
risks which could result in potential
losses. So one of the things you realize
is that and and in some sense insurance
has been developed as an answer to
address these problems of risk which is
inherently a part of life. There is no
nothing that is free of risk. In effect
there is really nothing called a
risk-free environment. We assume under
certain scenarios certain environments
are risk-f free. However, please
remember that those are based on certain
assumptions. For example, we assume that
when a government borrows nationally, in
particular, for example, when government
of India borrows in India, there can be
no default and therefore we assume the
the environment that that setup is a
risk-free environment or the borrower is
a risk-free borrower. However, there are
instances thankfully not in India but
globally we've seen enough instances
where governments have borrowed in the
domestic market and yet been not been
able to pay up or or repay the
borrowings in the domestic market which
means that even the borrowing even the
government is not really a risk-free borrower
borrower
if I extend this there is no part of
life which will actually be risk- free
everything there is a risk so risk has
developed as an answer to the problem of
handling risks. Now risks are something
which are an inherent part of life.
There is no part of life which is
independent or can be assumed to can can
be realistically taken to be free of
risks. Now we assume certain aspects to
be risk-f free. What do I mean that
based on our basis our assumptions or
based on our assumptions there is no
risk involved. However,
the inherent assumptions that we make
are itself
kind of a question to be asked. Is is
there going to be a risk in that? Is
there a risk of those assumptions
failing? Just to give you an example,
when a government borrows nationally. So
for example when government of India
borrows from the Indian markets the
assumption is that there is no risk of
default because remember government of
India has the right to print money and
therefore repay however strictly
speaking government of India could also
default. Now thankfully it has never
happened in India but we've seen enough
cases in other parts of the world in
other countries where governments have
not been able to sustain their
liabilities or their debt by just
printing money and hence they have had
to default. So therefore effectively
there is really nothing called a
risk-free environment. What what we talk
about in a risk-free framework is based
on a certain set of assumptions that
failures will not happen. Now in
particular in the insurance sector risk
is defined as a condition in which there
is a possibility of an adverse deviation
from the desired outcome. Actually risk
in a in a sense is nothing but deviation
from the desired outcome. Now the
deviation in some sense could be both
positive or negative. What do I mean by
that? So let's say you are expecting a
certain amount of average return on an
investment. Now the actual return may be
higher or lower than that. If the return
is higher it is still a deviation but
remember the deviation is a posit in a
positive framework or a positive
direction and therefore you are happy
with it. On the other hand if the
deviation is on the negative side which
means the actual outcome is lower than
what you are expecting. You'll end up
having a negative deviation or an
adverse deviation which res which then
potentially results in a loss. You also
need to re understand and realize the
fact that just because there is a risk
does not automatically ensure that there
will be a loss. Risks are nothing but
the expectation of potential loss and
therefore risk may not always fractify.
So that's one thing you have to keep in
mind when you consider a specific
payment essentially which is called the
premium by one party. So by the buyer of
the policy, the counterparty, the second
party or the insurance company agrees to
indemnify the first party up to a
certain limit for some specified loss
that may or may not occur. And that may
not occur is important because if it
does not occur then essentially there is
no payout to be made yet the premium is
essentially paid out right or paid out
by the second party the insurance
company. That's how it will typically
work. Insurance is therefore it also a
technique which provides for collection
of small amounts of premium from many
individuals and firms. So the policy
base is actually a diversified policy
base. There are many many individuals
many many organizations from which small
relatively small amounts and when I say
relatively small amounts small with
respect to the total value of the
benefit or the cover that the insurance
company offers which is called the sum
assured. So they take a very large
diversified base and at any one point in
time the idea is that this base is so
diversified that only a very few of
these people will actually be impacted
and therefore would need a cover or a
reimbursement. So a very large number of
them will not really need the cover or a
reimbursement at a particular point in
time. The in other words there is fairly
low levels of concentration risk because
if everybody was chosen from the same
geography or the same segment you would
have very high levels of concentration
risk. So here one of the things that is
done is the concentration risk is kind
of reduced as far as possible. It is
large and it is uncertain but now how do
you protect them themselves? So they are
now able to protect themselves by buying
protection which is payment of a small
amount which is the premium today and
and that's kind of a definite cost that
you pay out which this will allow the
holder the right to exercise if it is
needed. If not the money is sunk cost
but yes if it is needed then the holder
can exercise it to kind of get you know
the cover that they need. [Music]
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