by Insurance is a system that helps individuals and businesses protect themselves against financial loss. Loss occurs due to uncertain events that may or may not happen in the future. These uncertain events are known as risks. The immediate cause of loss is called a peril. Understanding perils is very important in insurance because insurance companies decide coverage, premium, and claim settlement based on perils. Not all perils are insurable. Only those perils which are uncertain, accidental, and measurable can be covered under insurance. Therefore, the concept of peril forms the foundation of insurance contracts.
Perils
A peril is the actual cause of loss or damage to insured property or person. For example, fire is a peril that causes damage to a house, and accident is a peril that causes injury to a person. In insurance, perils are clearly mentioned in the policy document. Insurance companies cover only specified perils, and losses caused by uncovered perils are not compensated.
Perils can be classified into different types. Natural perils include earthquake, flood, cyclone, and storm. Man made perils include theft, burglary, riot, strike, and war. Personal perils affect human life and health, such as death, accident, and disease. Property perils affect assets like buildings, machinery, and vehicles.
Perils may also be classified as insured perils and uninsured perils. Insured perils are those which are covered by the insurance policy, while uninsured perils are excluded from coverage. For example, fire insurance covers fire but may not cover loss due to war.
In short, peril is the event that triggers the loss. Without a peril, there is no claim in insurance.
Risk:
Risk is the possibility of loss or damage arising from an uncertain future event. Insurance exists mainly to manage risk. Every individual faces various risks in life related to health, property, income, and life. Risk creates fear and financial insecurity. Insurance provides protection by sharing the financial burden of loss. However, not all risks can be insured.
Risk refers to uncertainty regarding the occurrence of loss. It is the chance that actual results may differ from expected results. In insurance, risk means the possibility of financial loss only, not profit. For example, a house may catch fire, or a person may meet with an accident.
Risks can be classified into pure risk and speculative risk. Pure risk involves only the possibility of loss or no loss, such as death or accident. These risks are insurable. Speculative risk involves the possibility of profit or loss, such as business investment, and these risks are not insurable.
Risk can also be classified as personal risk, property risk, and liability risk. Personal risk includes risk of death, disability, and illness. Property risk relates to loss or damage of assets due to fire or theft. Liability risk arises when a person is legally responsible for injury or damage to others.
Insurance deals mainly with pure risks by transferring them to the insurer in exchange for a premium.
Mechanism for Transfer of Risk:
The main purpose of insurance is to transfer risk from an individual to an insurance company. Risk transfer reduces financial burden and mental stress. Individuals cannot predict losses, but insurance companies can manage risks using scientific methods. Through insurance, many people facing similar risks come together and contribute small amounts. This system makes it possible to compensate losses suffered by a few members. Thus, the mechanism of risk transfer is central to the concept of insurance.
Risk transfer means shifting the financial loss arising from risk from the insured to the insurer. This is done through an insurance contract. The insured agrees to pay a fixed amount called premium, and the insurer agrees to compensate the loss if it occurs.
The mechanism works on the principle of pooling of risks. A large number of people exposed to similar risks insure themselves. Premiums collected from all policyholders form a common fund. When loss occurs to any insured person, compensation is paid from this fund.
Insurance companies use the law of large numbers to predict losses. By analyzing past data, insurers estimate the probability of loss and fix premiums accordingly. This allows insurers to spread losses over a large group.
Risk transfer is beneficial because individuals cannot bear heavy losses alone. Insurance converts uncertain large losses into certain small payments. However, only financial risk is transferred, not the emotional or physical loss. This mechanism ensures economic stability and security.
Concept of Insurance – Hazards
Hazards are conditions or situations that increase the chances of loss due to a peril. While peril is the cause of loss, hazard increases the probability of loss. Insurance companies closely study hazards before accepting a proposal. Hazards affect premium rates and policy terms. Understanding hazards helps insurers reduce losses and control risk. Therefore, hazards play an important role in insurance underwriting and risk assessment.
Hazards are factors that increase the likelihood or severity of loss. They do not cause loss directly but make the occurrence of peril more probable. For example, storing petrol in a house increases the chance of fire loss.
Hazards are classified into three types. Physical hazards relate to physical conditions, such as faulty wiring, slippery floors, or poor construction. Moral hazards arise due to dishonest behavior of the insured, such as intentional loss or false claims. Morale hazards arise from careless attitude, such as negligence after taking insurance.
Insurance companies try to reduce hazards by inspections, safety guidelines, and policy conditions. Higher hazards lead to higher premiums or rejection of insurance proposal. For example, a factory without fire safety measures may be charged a higher premium.
