Page 47 - DCOM309_INSURANCE_LAWS_AND_PRACTICES

Insurance Laws and Practices

Notes Gamblers, by creating new risk transfer, are risk seekers. Insurance buyers are risk avoiders,
creating risk transfer in terms of their need to reduce exposure to large losses.
Gambling or gaming is designed at the start so that the odds are not affected by the players’
conduct or behaviour and not required to conduct risk mitigation practices. But players can
prepare and increase their odds of winning in certain games such as poker or blackjack. In
contrast to gambling or gaming, to obtain certain types of insurance, such as fire insurance,
policyholders can be required to conduct risk mitigation practices, such as installing sprinklers
and using fireproof building materials to reduce the odds of loss due to fire. In addition, after a
proven loss, insurers specialise in providing rehabilitation to minimise the total loss.

Insurance, the avoiding, mitigating and transferring of risk, creates greater predictability for
individuals and organisations.

Notes Both gambling and insurance transfer risk and reward.

3.4.2 Insurance and Hedging Compared

In this section, we will compare and contrast between insurance and hedging. The concept of
hedging refers to transferring the risk to the speculator through purchase of future contracts. An
insurance contract, however, is not the same thing as hedging. Although both techniques are
similar in that risk is transferred by a contract, and no new risk is created, there are some
important differences between them.

First, an insurance transaction involves the transfer of insurable risks, because the requirement
of an insurable risk generally can be met. However, hedging is a technique for handling risks
that are typically uninsurable, such as protection against a decline in the price agriculture
products and raw materials.
A second difference between insurance and hedging is that insurance and hedging is that insurance
can reduce the objective risk of an insurer by application of the law of large numbers. As the
number of exposure units increases, the insurer’s prediction of future losses improves, because
the relative variation of actual loss from expected loss will decline thus, many insurance
transactions reduce objective risk.

In contract, hedging typically involves only risk transfer, not risk reduction .The risk of adverse
price fluctuation is transferred because of superior knowledge of market conditions. The risk is
transferred, not reduced, and prediction of loss generally is not based on the law of large
numbers.

Self Assessment

Fill in the blanks:
10. Insurance buyers can only spend up to the limit of what carriers would accept to insure;
their loss is limited to the amount of the ……………………………….
11. The concept of hedging is to transferring the risk to the speculator through purchase of
…………………………. contracts.
12. The risk of adverse price …………………………… is transferred because of superior
knowledge of market conditions.

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