Evolution of the role of an insurance broker

When we run down the memory lane, we remember those days when a broker was
considered a glorified postman delivering policies and endorsements from the
insurer to the customer. As time passed, brokers realized that they needed to
exceed the expectations of their customers to remain in business. Some caught on
to that the role of an insurance broker has evolved from being that of a
matchmaker between the insurer and the client to a risk consultant providing
various value-added services. These services include loss control, claims
management, contract reviews, safety program recommendations and other risk
management services that go beyond the structuring and placement of insurance
cover. Initially, when the concept of insurance broking was introduced in the
market by IRDA, most of the people considered the role of a broker very similar to
that of an insurance agent. Over a period of time, their views have changed and
this evolution is in tandem with the changing risk landscape.
• How do you rate the importance of insurance brokers in today’s market?
43% of the survey participants consider insurance brokers to be important in
today’s market while 35% view them as very important. Brokers have become
important in today’s market because their clients are benefiting from their clear
and unbiased advice, which may otherwise be hard to come by. They feel brokers
reduce the time, mind space and search costs incurred by insurance buyers when
they have to look at multiple insurers for placement of the policy.
It is also observed that larger companies having insurance portfolio greater than 25
lakhs consider the role of a broker as very important.
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RISK is defined as:

“Risk is the possibility of loss or damage”.

“Risk is the measure of profitability and severity of adverse effects”.
“Risk is the potential for realization of unwanted negative consequences of an
event”.
Risk is defined as uncertainty of financial loss. If the event were certain to happen, then
there be no loss if the event were certain not to happen, then also there is no loss. It is the
uncertainty about the time of loss that worries the mankind.

In any transaction, when there is a possibility of loss or peril, it may be termed as a risky
transaction.
Meaning of Risks:
The risk may mean that there is a possibility of loss or damage. It may or may not
happen. In business the risk may be defined as the danger of loss from unforeseen
circumstances.
According to Life Insurance Corporation of India, risk may be defined as “a condition
where there is a possibility of an adverse deviation from a desired outcome that is
expected or hoped for; there is no requirement that the possibility be immeasurable, only
that it must exist”. When an event is stated to be possible, it has a possibility between
zero and one, it is neither impossible nor definite. The degree of risk may or may not be
measurable.
The concept of risk may be distinguished from peril and hazard. A peril is the
cause of loss for example fire, wind, storm, hail or theft. Hazard is a condition that may
create or increase the chance of a loss arising from a given peril or under a given
condition.

There are two types of RISKS namely PURE RISK and SPECULATIVE RISK.
In pure risk there is always loss only. By happening of the event, the person is certain to
have an economic loss. In speculative risk, there can be loss or gain. Trade risk is a
speculative risk.

Whereas speculative risks are managed by management techniques, RISK

MANAGEMENT manages pure risk.
Avoidance: Here the risk is altogether avoided. E.g.: Do not get a motorcycle to young
boy. Prevention: being very careful prevents Risk. Eg: Proper maintenance of the vehicle.
Reduction: Again by proper maintenance of the vehicle, loss can be reduced. Retention:
Where the loss is minimum and can be met by own resources, Transfer: When the person
is not in a position to manage the loss by anyone of the above methods, the risk is
transferred to someone else.
Here comes the concept of Insurance. It is the function of Insurance, to enable individuals
to protect such losses. In Insurance language, RISK means financial loss only.

Individually every person irrespective of his financial status cannot provide against all the
losses he may incur. It is not only costly but also speculative. Hence all the individuals
who are exposed to same type of risk or common risk come together and transfer their
loss to an organization or a corporate body. This is done by a cooperative endeavor. All
people contribute towards a common fund. It is not possible to predict as to which
individual suffers the loss. But it is always possible to forecast the quantum of loss the
entire group may suffer. The loss of few is compensated by the contribution of many
individuals.

The characteristics of pure risk or insurable risk;

The risk may be one that may or may not happen. The risk must be pure and not
speculative. This is because of the fact that it is not possible to know various factors
which may result in trade loss The loss caused must be capable of being measured in
terms of money only Risk should not be of illegal nature E.g.: stolen property cannot be
insured Risk should not be opposed to any public policy. Risk should not be catastrophic
in nature

Types of Risk
Risk can be categorized as to why the risk exists, and to whom it affects.
Pure risk is a risk in which there is only a possibility of loss or no loss—there is
no possibility of gain. Pure risk can be categorized as personal, property, or legal
risk.
Personal risks are risks that affect someone directly, such as illness, disability, or
death. Property risk affects either personal or real property. Thus, a house fire or
car theft is examples of property risk. A property loss often involves both a direct
loss and consequential losses. A direct loss is the loss or damage to the property
itself. A consequential loss (aka indirect loss) is a loss created by the direct loss.
Thus, if your car is stolen, that is a direct loss; if you have to rent a car because of
the theft, then you have some financial loss—a consequential loss—from renting a
car.
Legal risk (aka liability risk) is a particular type of personal risk that you will be
sued because of neglect, malpractice, or causing willful injury either to another
person or to someone else's property. Legal risk is the possibility of financial loss
if you are found liable, or the financial loss incurred just defending yourself, even
if you are not found liable. Most personal, property, and legal risks are insurable.
Speculative risk differs from pure risk because these is the possibility of profit or
a loss. This characterizes most financial investments. Most speculative risks are
uninsurable, because they are undertaken willingly for the hope of profit.
Pure risk is insurable, because the law of large numbers can be applied to forecast
future losses, and, thus, insurance companies can calculate what premium to
charge based on expected losses. On the other hand, speculative risks have more
varied conditions that make estimating future losses difficult or impossible. Also,
speculative risk will generally involve a greater frequency of loss than a pure risk.
For instance, people do many things to protect their lives, or their property, but
people willingly engage in speculative risks, such as investing in the stock market,
to make a profit; otherwise, a person can avoid most speculative risks simply by
avoiding the activity that gives rise to it.

Peril and Hazard

Risk is the chance of loss, and peril is the direct cause of the loss. If a house burns
down, then fire is the peril. A hazard is anything that either causes or increases the
likelihood of a loss. For instance, gas furnaces are a hazard for carbon monoxide
poisoning. A physical hazard is a physical condition that increases the possibility
of a loss. Thus, smoking is a physical hazard that increases the likelihood of a
house fire and illness.

Pure or Static Risk

The second category of risk is known as pure or static risk. Pure (static)
risk is a situation in which there are only the possibilities of loss or no
loss, as oppose to loss or profit with speculative risk. The only outcome
of pure risks are adverse (in a loss) or neutral (with no loss), never
beneficial. Examples of pure risks include premature death, occupational
disability, catastrophic medical expenses, and damage to property due to
fire, lightning, or flood.

It is important to distinguish between pure and speculative risks for three

reasons. First, through the use of commercial, personal, and liability
insurance policies, insurance companies in the private sector generally
insure only pure risks. Speculative risks are not considered insurable,
with some exceptions.

Second, the law of large numbers can be applied more easily to pure
risks than to speculative risks. The law of large numbers is important in
insurance because it enables insurers to predict loss figures in
advance. It is generally more difficult to apply the law of large numbers
to speculative risks in order to predict future losses. One of the
exceptions is the speculative risk of gambling, where casinos can apply
the law of large numbers in a very efficient manner.

Finally, society as a whole may benefit from a speculative risk even

though a loss occurs, but it is harmed if a pure risk is present and a loss
occurs. For instance, a computer manufacturer's competitor develops a
new technology to produce faster computer processors more cheaply.
As a result, it forces the computer manufacturer into bankruptcy.
Despite the bankruptcy, society as a whole benefits since the
competitor's computers work faster and are sold at a lower price. On
the other hand, society would not benefit when most pure risks, such as
an earthquake, occur.

Types of Pure (Static) Risk

The major types of pure risk that are associated with great economic and
financial insecurity include;
1. Personal risks
2. Property risks
3. Liability risks.

Personal risks are risks that directly affect an individual.

They involve the possibility of loss or reduction of income, of extra
expenses, and the elimination of financial assets.

There are four major personal risks;

o Premature death
o Old age
o Poor health
o Unemployment.
Premature death risk is defined as the risk of the death of the head of a household
with unfulfilled financial obligations. These can include dependents to support, a
mortgage to be paid off, or children to educate.

Old age is a risk of insufficient income during retirement. When older

workers retire, they lose their normal amount of earnings. Unless they
have accumulated sufficient assets from which to draw on, they would
be facing a serious problem of economic insecurity.

Risk of poor health includes both catastrophic medical bills and the loss
of earned income. The cost of health care has increased substantially
in recent years. The loss of income is another major cause of financial
instability. In cases of severe long term disability, theiris a substantial
loss of earned income, medical bills are incurred, employee benefits may
be lost, and savings depleted.
The risk of unemployment is another major threat to most families.
Unemployment can be the result of a industry cycle downswing,
economic changes, seasonal factors and frictions in the labor market.
Regardless of the cause, unemployment can create financial havoc in
the average families by way of loss of income and employment benefits.

Liability risks are another important type of pure risk that many people
face. More than ever, we are living in a litigious society. One can be
sued for any frivolous reason. One has to defend himself when sued,
even when the suit is without merit.

Dynamic risk: This results from the changes in economics like demand and supply,
changes in consumer tastes. But such risks benefit the society over a long term.
Static risk: These arise due to dishonesty of few individuals. They cause unequal
distribution of wealth, asset or possession of property.

Fundamental risk: These are not personal in nature. These come out of political and
social phenomenon like unemployment, wars etc.,

Particular risk: Here the loss is due to individual events like fire, accidents etc.,.The
solution lies in going for insurance.