Today we are going to talk about insurance. Our session will be split in two parts. Firstly, we are going to achieve a basic understanding what is an insurance by getting familiar with the following set of ideas like: risk, identification of the risk, risk evaluation, risk management process, common pool principle. Second part of our discussion will be dedicated to analyze the benefits insurance provide to us – individuals, to businesses and to our society as a whole. So let’s begin! Now try to remember the last time you or your parents were buying something at “Carphone Warehouse”, “PC World” or “Argos”.
And then suddenly a weird thing happened: the person at the till asked a question: “Would you like an insurance with this item? ” What was your parents’ reaction? Or maybe recently you were buying something online on eBay? Do you remember at the checkout point there was an option to tick a box called “postage insurance”? And do not worry if your answer to my previously asked questions is “no” and you do not have a clue what the insurance is all about. Maybe it sounds complicated but actually it is really simple stuff. All you have to do is participate in our discussion and I promise you will hear all the answers!
Insurance as a risk transfer mechanismSo imagine you have brought a brand new mobile phone costing i?? 300. We all know that if we want our new purchase to look nice and work properly we have to take care of it. We understand that it is not clever to use it as an opener for a bottle of Coca-Cola, because that will damage the surface of our new purchase. We are aware, that we cannot take our mobile phone to swim together with us in a swimming pool as it will be the first and last swim for this electronic device (unless your model is waterproof).
Finally if you take a bus, tube or a train and go to see your friends, you normally check zips of your clothes or handbag because you are aware that bad people may steal your mobile phone. So all the negative situations we have identified in the previous paragraph that may damage your mobile phone or possibility of losing it (if you will not take a proper care) are called risks. You may ask how your brain recognizes risks to your mobile phone. By watching movies, listening to the radio or talking with our friends we are aware that it is a frequent situation when people lose mobile phones and it may happen to you too.
Moreover the moment when we realise we have lost or broken our mobile phone is a severe event because this mobile phone is a valuable thing to us. Finally the process when your brain realizes the frequency and severity of bad thing happening to your mobile phone is called a risk evaluation. Is it important? Yes it is! We all want to keep our mobile phone in a good condition and working well because we have paid a lot of money for it! So we all agreed that risks are part of our life, that they exist, but… What do we not know?! Any ideas?… Right! We do not know when something bad is going to happen to our mobile phone.
So how could we deal with this unpredictability of risks. The way of getting some level of certainty is called risk management. Now you may start to think things are getting to complicated. But hey! Risk management is what we do every single day! In other words we normally take care of our mobile phone in two ways: physically and financially. If you intentionally leave your mobile phone at home then this is an example of physical risk management. It means you avoid the possibility of it being damaged or stolen when you carry it with you. Another way of physical risk management is called reduction.
You may reduce the risk of your mobile phone being damaged by putting it into case or cover. So as you see people have agreed to use certain words like elimination or reduction when they talk about physical risk management and now you too understand meaning of these terms. So far so good? Fantastic! 🙂 Let’s move on! As you already know we can manage the risk not only physically but also financially! So if you are a forward looking person and retain some of your pocket-money in your piggy bank (in case something bad happens to you mobile phone so you can buy a new one straight away).
That is a one way of financially managing the risk. Another way is when you transfer the financial consequences of the risk occurring. That is where insurance comes in. So people transfer the risk of losing or damaging their mobile phone to insurance companies which are taking that risk. How it works in practice? Imagine you know, that there is always one person in you class who loses the mobile phone in a year. But as we stated previously because of the unpredictability of risks nobody knows who will be unlucky this year. So thirty of you decide to pay i?? 10 each and collect a pool of i?? 300.
These money will be paid out to that person who’s mobile phone will be lost, damaged or stolen. This key idea where contributions of the many pays for the losses of the few is known as common pool principle. Of course operations of insurance companies are much more complicated. And the things you can insure are not only mobile phones but all the other things you use in your daily life like: laptop, digital camera, ipod, video game consoles (XBox360, PSP2). If you were injured by playing football, riding a bike or skateboard expenses for your medical treatment will be compensated if you have brought an insurance policy before the accident.