RISK MANAGEMENT AND INSURANCE

Objectives

⚫ Introduce students to fundamental concepts of

insurance and risk management
⚫ Introduce students to the use of insurance
documents
⚫ Provide students with ways of how to negotiate and
arrange an insurance policy/certificate for
export/import goods carriage by sea in international
trade and how to make claim procedure to receive
indemnity from insurer as well.
References

⚫ Rejda, G. E., Principles of Risk Management and Insurance,

13th ed. (Boston: Pearson, 2017)
⚫ Insurance in Business (Vietnamese textbook), Prof.Dr
Hoàng Văn Châu, 2009
⚫ Harrington, S. E. and Niehaus, G. R., Risk Management and
Insurance, 2nd ed. (New York: McGraw-Hill/Irwin, 2004);
⚫ Gupta, P. K., Principles and Practice of Non Life Insurance
(New Delhi: Himalaya Publishing House, 2009);
⚫ Gupta, P. K., Fundamentals of Insurance (New Delhi:
Himalaya Publishing House, 2008);
⚫ Hudson, N. G. and Madge, T., Marine Insurance Clauses, 4th
ed. (Conrwall: MPG Books, 2005).
References

⚫ Institute Cargo Clauses 1982

⚫ Incoterms 2020, ICC
⚫ Vietnam Insurance Law, 2015
Content

⚫ Chapter 1: Basic concepts in insurance

⚫ Chapter 2: Fundamental legal principles
⚫ Chapter 3: Marine insurance
⚫ Chapter 4: Insurance company’s operation
⚫ Chapter 5: Introduction to risk management
Assessment

⚫ 10% attendance
⚫ 30% mid-term test (Oral presentation)
⚫ 60% final exam (Oral test)
 Chapter 1
Basic concepts in
insurance
Main content

1. Risk
2. Introduction to insurance
3. Types of insurance
1. RISK

1.1 Concept of risk

1.2 Classification
1.3 Burden of risk on society
1.4. Methods of handling risk
Air crash disaster
CAN THO BRIGDE BROKE DOWN
FTU 9th FLOOR ON FIRE
1. Risk

1.1 Risk concept

⚫ “At its most general level, risk is used to describe any
situation where there is uncertainty about what outcome
will occur.” (Gupta, 2009, p.3)
⚫ “The term risk may refer to the expected losses associated
with a situation.” (Harrington and Niehaus, 2004, p.2)
⚫ The term Risk is used to describe all the accidental
happenings which produce a monetary loss
⚫ Risk is defined here as uncertainty concerning the
occurrence of a loss
1. Risk

One situation is riskier than another if it has

greater:
⚫ Expected losses;
⚫ Uncertainty.
Example: 2 houses A and B

⚫ Have same value: 10,000,000 VND

⚫ Assume: a meteor might hit the earth in the
coming week and house A is in the potential
impact area
 Probability of House A being hit by meteor: 0.1
and House B is 0
 Expected loss of House A is more than house B:
0.1x10,000,000 = 1,000,000 VND
Example: 2 houses A and B

⚫ If the owner of house A want to sell the house:

the price will reduce at least 1,000,000
 Greater risk brings higher expected loss
• Uncertainty: by the end of the week, house A
may worth 10,000,000 VND or 0 VND => impose
cost on the owner, the price may go down more.
=> Risk is costly
Risk is costly

⚫ Direct expected losses: loss caused directly

when a risk happens
⚫ Indirect expected losses: arise as a
consequence
=> What is the different between risk and loss?
1. Risk

1.2 Types of Risk

1.2.1 Business Risk and Personal Risk (Harrington
and Niehaus, 2004, p.4-6)
⚫ Possible reductions in business value from any
source is considered business risk
⚫ Personal risk includes the risks faced by
individuals and families
 Business Risk

Price Risk Credit Risk Pure Risk

Damage to
Output Input price assets
price risk risk
Legal
liability
Commodity Exchange Interest
price risk rate risk rate risk Worker
injury

Employee
benefits
 Personal Risk

Medical Physical Financial

Earnings Liability Longevity
expenses assets assets

Death Auto Auto Stocks

Disability Home Home Bonds

Aging Others Others

Unemployment
1. Risk

1.2.2 Pure Risks and Speculative Risks (Gupta,

2009, p.6)
⚫ Pure Risks: situations are those where there is a
possibility of loss or no loss. There is no gain to
the individual or the organization
⚫ Speculative Risks are those where there is a
possibility of gain as well as loss. The element of
gain is inherent or structured in such a situation
1. Risk

Pure risks are generally insurable while

speculative ones are not.

Pure Risk

Personal Risk Liability Risk Property Risk

1. Risk

⚫ Property risks are the risks to the person in

possession of the property being damaged or
lost. The property includes immovable and
movables.
⚫ Liability risks are the risks arising out of the
intentional or unintentional injury to the people or
damages to their properties through negligence
or carelessness. Liability risks generally arise
from the law.
1.3. Burden of risk on society

⚫ Larger emergency fund

⚫ Loss of certain goods and services
⚫ Worry and fear
1.4 Methods of Handling Pure Risks

⚫ Avoidance: avoid the risks or circumstances

which may lead to losses.
- You can avoid the risk of being mugged in a
high- crime rate area by staying out of the area
- A business firm can avoid the risk of being sued
for a defective product by not producing the
product
=> However, not all risks should be avoided
• Loss control: consists of certain activities that reduce both the
frequency and severity of losses
• Objectives:
⚫ Loss prevention: aims at reducing the probability of loss so that
the frequency of losses is reduced:
– Auto accidents can be reduced if motorists take a safe-driving
course and drive defensively
– The number of heart attacks can be reduced if individuals
control their weight, stop smoking, and eat healthy diets
⚫ Loss reduction: reduce the severity of a loss after it occurrs:
– A department store can install a sprinkler system so that a fire
will be promptly extinguished
⚫ Retention: to retain in full or part of the risk
⚫ Transfer: to transfer the risk to another individual or
organization. Risks can be transferred to non
insurance parties and insurance companies.
2. Introduction to insurance

⚫ 2.1. Definition
⚫ 2.2 Nature of insurance
⚫ 2.3 Basic concepts
⚫ 2.4 Classification
2. Introduction to insurance

2.1 Definition
⚫ Insurance is a contract whereby, in return for
the payment of premium by the insured, the
insurers pay the financial losses suffered by
the insured as a result of the occurrence of
unforeseen events.
2. Introduction to insurance

2.2 Nature of insurance

⚫ Provides financial protection against a loss
arising out of happening of an uncertain event.
⚫ Risk transfer
⚫ The business object in the insurance sector is
risk
⚫ Insurance works on the basic principle of risk-
sharing.
Risk sharing

⚫ Pooling of loss: spreading of losses incurred by

the few over the entire group and prediction of
future losses base on the law of large number
⚫ Law of large number: the greater number of
exposures, the more closely will the actual
results approach the probable results that are
expected from an infinite number of exposures.
=> Risk is shared among?
Example

⚫ Houses in a village: 1000

⚫ Value of 1 house: 4,000,000,000 vnd
⚫ Houses burning in a year: 5
⚫ Total annual loss due to fire: 20,000,000,000 vnd
⚫ Contribution of each house owner: 30,000,000 vnd

All 1000 house owners are exposed to a common risk, i.e. fire
PROCEDURE

⚫All owners contribute 30,000,000 vnd each as premium to the

pool of funds
⚫Total value of the fund = 30,000,000,000 vnd (i.e. 1000 houses
* 30,000,000)
⚫5 houses get burnt during the year
⚫Insurance company pays 4,000,000,000 vnd out of the pool to
all 5 house owners whose house got burnt
EFFECT OF INSURANCE
Risk of 5 house owners is spread over 1000 house owners in the
village, thus reducing the burden on any one of the owners.
2. Introduction to insurance

2.3 Terms
2.3.1 Insurer/ underwriter
The party to an insurance arrangement who
undertakes to indemnity for losses.
 The right and responsibility of insurer?
2. Introduction to insurance

2.3.2 Insured
⚫ an insured or policyholder is the person or
entity buying the insurance and receiving
indemnity on happening of unforeseen events
=> The right and responsibility?
2. Introduction to insurance

2.3.3 Subject matter of insurance

⚫ an object of an insurance policy and is the
reason for issuing the policy.
⚫ The person, group, or property for which an
insurance policy is issued
2. Introduction to insurance

2.3.4 Value of subject matter of insurance (V)

⚫ The term “value” refers to the value of the property,
on the same basis used in indemnifying losses
- Replacement cost. equal to the amount it would cost to
fully repair or replace the property if it must be
reconstructed or purchased new.
- Actual cash value: equal to the replacement cost minus
any depreciation
 The difference between replacement cost and actual cash
value?
Question

Contract signed FOB term, when she check the

insurance policy, the insurance value is equal to CIF
price, is there any conflict?
2. Introduction to insurance

2.3.5 Amount of insurance to value (A)

⚫ A certain amount of insurance coverage that the
insured requires in the insurance policy, it can be a
part or an entire of insurance value
 What is the linkage/ relationship between A and V?
 How much money you will receive?
 Can we buy an over insurance coverage?
 If we purchase an insurance policy for 110% CIF,
does it means that we buy an over insurance
coverage?
2. Introduction to insurance

2.3.6 Liability limits

⚫ The largest total amount the insurance company will
pay for covered losses.
2.3.7 Insurance rate ( R )
⚫ a factor used to determine the amount to be charged
for a certain amount of insurance coverage, called
the premium.
2.3.8 Premium
⚫ Payments to the insurance company to buy a policy
and to keep it in force.
2.3.9 Re - insurance
Practice where an Insurance company (the insurer)
transfers a portion of its risks to another (the re-
insurer).
=> The risks of insurance company?
=> The rules of re – insurance
+ Risk sharing
+ Develop scope of coverage
+ Legal right
⚫ If the original one goes into bankruptcy?
 The cut through clause.
 If the re-insurance company goes into
bankruptcy?
 What kind of lesson?
2.3.10 Double insurance
⚫ Situation in which the same risk is insured by two
overlapping but independent insurance policy.
=>Is it possible to obtain double insurance and
make claim to all insurers?
 How much money that insured can received from
all insurers?
2.3.11 Co – insurance
Insurance held jointly by two or more insurers.
2.3.12 insurable risk
⚫ Large Number of Expose Units
⚫ Accidental and Unintentional Loss
⚫ Determinable and Measurable Loss
⚫ Calculable Chance of Loss
⚫ Economically Feasible Premium
2.4 Types of insurance

⚫ According to operating method

– Social insurance: carried out or mandated by a
government to provide economic assistance to the
unemployed, the elderly, or the disabled.
– Commercial insurance
2.4 Types of insurance

⚫ According to the nature of insurance

– Life insurance: insurance that pays out a sum of
money either on the death of the insured person or
after a set period.
– Non-life insurance: typically defined as any
insurance that is not determined to be life insurance
 Difference between life insurance and bank
savings?
2.4 Types of insurance

⚫ According to subject matter insured

– Personal insurance
– Property insurance
– Liability insurance
⚫ According to Vietnamese law (in certain cases)
– Compulsory
– Voluntary
 Chapter 2:
Fundamental Legal Principles
Outline

1. Insurance is a repayment of a random loss

2. Utmost Good Faith
3. Insurable Interest
4. Indemnity
5. Subrogation
 1. Insurance is a repayment of
a random loss
– The timing or occurrence of the loss must be
uncertain.
– For example, you can't know your house is going
to be destroyed in three weeks by a demolition
team and still get home owner's insurance.

Exception: life insurance?

the deductible is covered by the insurance policy.

51 Pham Thanh Ha (MA)

 3.2. Utmost Good Faith

⚫ A higher degree of honesty is imposed on both

parties to an insurance contract than is imposed
on parties to other contract

52 Pham Thanh Ha (MA)

 3.2. Utmost Good Faith

➢ The insurer: Let the buyer beware

➢ The insured: Declaration of all material Information
about the subject mater of insurance

53 Pham Thanh Ha (MA)

 3.2. Utmost Good Faith

➢ What is Material Information ?

Those that would influence an underwriter as to
whether he should or should not accept the risk

➢ Breach of duty of utmost good faith?

➢ Is it easy to being totally honest to someone?

54 Pham Thanh Ha (MA)

Example

⚫ The insured misrepresent that she had no traffic

violation convictions in the prior three- year period.
After an accident, a check of her record revealed that
she had two speeding tickets in that period. The
insurer denied coverage.
 3.3. Insurable Interest

⚫ Insurable Interest : The legal right enjoyed by the

owner of a property to insure .
⚫ The insurance will become null and void, without the
insurable interest.
⚫ What are the Purposes?
- Prevent gambling
- Reduce moral hazard: both in property and life
insurance
- Measure the amount of loss in property
56 Pham Thanh Ha (MA)
 3.3. Insurable Interest

- Can you purchase a life insurance policy on the life of

another person?
- When must an insurable interest exist?
+ In life insurance, the insurable interest requirement must be
met only at the inception of the policy, not at the time of
death.
+ In property insurance? => CIF term

57 Pham Thanh Ha (MA)

 3.4. Indemnity

⚫ The principle of Indemnity states that under the policy of

insurance, the insured has to be placed after the loss in
the same financial position in which he was immediately
before the loss.
The insurer agrees to pay no more than the actual amount of
the loss.
⚫ What are the purposes?
- Prevent the insured from profiting from a loss
- Reduce moral hazard

58 Pham Thanh Ha (MA)

⚫ Basic method to for indemnifying the
insured is based on the actual cash value
of the damage at the time loss.
 Methods to determine actual cash value:

60
61
 3.5. Subrogation

⚫ Transfer of rights and remedies from the insured to

the insurer who has indemnified the insured in
respect of the loss.
⚫ Subrogation means substitution of the insurer in
place of the insured for the purpose of claiming
indemnity from a third person for a loss recovered by
insurance.

62 Pham Thanh Ha (MA)

⚫ Example: a negligent motorist fails to stop at a red
light and smashes in to Marry”s car, causing damage
in the amount of $5000. If she has collision insurance
on her car, her company will pay the physical
damage loss to the car and then attempt to collect
from the negligent motorist who caused accident.
⚫ Alternatively, Marry could attempt to collect directly
from the negligent motorist for the damage to her car.
⚫ Purpose of subrogation?
- Prevent the insured from collecting twice for the
same loss
- Hold the negligent person responsible for the
loss
- Hold down insurance rates