Functions and Benefits of Insurance 保險的功能及好處

Primary Function: Risk Transfer 主要功能：風險轉移

The primary function of insurance is risk transfer. The insured pays a certain, budgetable premium and passes the financial consequences of a possible loss to the insurer. In effect, the insured swaps an uncertain, possibly large loss for a small, certain cost.

Note that insurance transfers the financial consequences of a loss, not the event itself. Buying fire insurance does not stop a fire from happening. If a fire does occur, the insurer pays under the policy terms, so the insured is protected financially.

As a rule, only pure risks (where the outcome is either loss or no loss) can be transferred through insurance. Speculative risks, such as trading shares where a gain is also possible, are normally not insurable.

The Common Pool and the Law of Large Numbers 共同基金與大數法則

The insurer collects premiums from a large number of people facing similar risks and puts them into a common pool. The pool pays the claims of the few who actually suffer a loss. In short, the premiums of the many pay for the losses of the few.

The law of large numbers states that the more similar exposure units there are, the closer actual losses will be to expected losses. So the more homogeneous risks an insurer accepts, the more accurately it can forecast total claims and set premiums that are adequate and reasonable.

An individual cannot predict whether they will suffer a loss, but an insurer can make a fairly reliable prediction for the group as a whole. This is what makes insurance workable.

Equitable Premiums 公平保費

Each insured should pay an equitable premium that reflects the degree of risk they bring to the common pool. Higher-risk insureds should pay more, and lower-risk insureds less.

For example, a restaurant using open flames for cooking normally presents a higher fire risk than a stationery shop, and a timber-built warehouse a higher risk than a reinforced concrete building. The insurer assesses such factors through underwriting and adjusts the premium accordingly, adding a loading or giving a discount.

Equitable premiums stop low-risk insureds from subsidising high-risk ones, which keeps the pool sustainable. They also encourage insureds to improve their risk, for example by installing sprinklers in return for a premium discount.

Benefits of Insurance 保險的好處

For individuals and businesses: insurance reduces worry about loss and gives peace of mind. There is no need to hold large reserves against accidental loss, so money can go into developing the business. People become more willing to start businesses and invest. Insurance also makes credit easier to obtain: a bank will normally insist that a mortgaged property is insured before it grants the loan.

Loss prevention and control: insurers survey risks, give loss-prevention advice and offer premium discounts for good precautions. The industry also supports fire prevention, security and other loss-control work.

For society and the economy: pooled premiums form large funds that insurers invest, providing long-term capital for the economy. The industry creates jobs. Insurance services sold to overseas clients bring in invisible earnings. Compensation paid to victims and their families reduces the burden on public welfare.

Hong Kong specifics: some insurance is compulsory by law. The Employees' Compensation Ordinance (Cap. 282) requires employers to insure their liability for work injuries, and the Motor Vehicles Insurance (Third Party Risks) Ordinance (Cap. 272) requires motor vehicle users to have third party cover, so that victims can be compensated. Remember, though, that insurance cannot remove the chance of a loss happening, and it cannot guarantee that a business will succeed.