Insurance by its operations reduces financial uncertainties and gives confidence to policyholders, individuals and all levels of businesses to venture out into arena personal and business endeavours content that their multifaceted risks are under professional management that hedge them from going out of operation. This is settled upfront in what is known as no premium no cover in the local insurance parlance. Granting of cover is precedent on payment of premium.
So, fitted into the cover starting blocks is that in exchange of premiums, insurers promise to compensate policyholders should unpredictable events occur. According to Global Federation of Insurance Associations, “These unpredictable losses of individual losses of individual policyholders become more predictable or measurable when aggregated and diversified into a pool or portfolio of risks. Individuals do not know if their car will be stolen this year, but the insurer is able to estimate with a high degree of accuracy how many claims will be made on its portfolio of car insurance policies.”
The insurance arrangement of reducing financial uncertainty is at the core of insurance, the transfer of risk with the aim of reducing financial uncertainty and making a potential future loss more manageable. GFIA lays out the picture of insurance workstation, “Insurers take over the risks faced by policyholders and aggregate them into a “risk pool” that offers protection against a potential negative event. Insurers charge a premium in exchange for the transfer of risk and the promise to pay in the event of a loss. The insurance premium is determined by the specific profile of the risks insured.”
From the moment the premium is paid a transformation takes place lifting the burden of the uncertain event from individual shoulder and placed in the custody of increasing number of individuals (policyholders) with the same risk. As the purpose of insurance plays out, risk is transferred, and concerns for financial uncertainty reduces, the insurers who now have placed the risk in a pool of same risk can confidently manage the potential of future loss.
Giving more insight, the association said, “Insurance transforms a risk from being one faced entirely by a single individual or entity to one collectively shouldered by a large number of policyholders (spreading of the risks). From financial point of view, insurance transforms a potentially large, unaffordable or even catastrophic future loss into a much smaller, predictable one in the form of regular premium payments. Insurance is also an important vehiclefor old-age security – providing both products for long-term saving and coverage of biometric risk (eg, longevity risk).
Noting the key features of insurance and its singular capacity to bear risks of other economy players, GFIA says that the insurer can add other pools of different risks to its overall portfolio, allowing it to diversify the aggregate risks of its motor insurance customers with home insurance risk, travel insurance risk, etc. This pooling and diversification makes it more efficient for insurers to hold risks than for individuals to do so.
What follows is the nitty gritty of insurance, risk management, the heart of insurance. GFIA forges ahead with its input, “For most businesses, risk isa by-product of doing business and something to be avoided or minimised. For insurers, risk management and protection is the core product being provided to customers. Therefore, risk management has always been at the heart of the insurance industry and impacts how it designs products, how it prices products and how it manages investments and its internal governance.
Action by insurers begin from the time premiums are charged to cover the cost of claims when they need to be paid to customers. On the strength of this, “The inflow of new premiums and the accumulation of assets backing insurers’ long-term products are invested, sometimes for a very long period. As a result, insurers are generally not as exposed to liquidity risks as some other financial services sectors.”
