Insurance is a form of protection against a possible risk. It is a method which helps in shifting risks to the insurer in consideration of a nominal cost. The aim of all insurance is to compensate the owner against loss arising from a variety of risks, which he anticipates, to his life, property and business. Insurance allows individuals, businesses and other entities to protect themselves against significant potential losses and financial hardship at a reasonably affordable rate. If the potential loss is small, then it doesn’t make sense to pay a premium to protect against the loss. Insurance is a form of risk management in which the insured transfers the cost of potential loss to another entity in exchange for monetary compensation known as the premium.
Insurance works by pooling the risk. Pooling risk simply means that a large group of people who want to insure against a particular loss pay their premiums into the insurance bucket, or pool. If the number of insured individuals is so large, then the insurance companies can use statistical analysis to project what their actual losses will be within the given class. They know that all insured individuals will not suffer losses at the same time or at all. This allows the insurance companies to operate profitably and at the same time pay for claims that may arise. For instance, most people have vehicles insurance but only a few actually get into an accident. We pay for the probability of the loss and tor the protection that we will be paid for losses in the event they occur. Insurance does not increase the total of risks and of losses, but merely combines. averages, and distributes them equally among all the insured. This eliminates the chance element to the individual by converting it into a regular cost to all members of the group. Modern insurance is conducted either by enterprisers for profit, or by mutual companies; but in any case in large measure the losses in insurance are mutually shared, as the premiums (plus interest earned) equal the total losses plus operating expenses and profit, if any is made. Each insured gets a contract of indemnity for the payment of a sum that will help cover the losses of others. Such an exchange is mutually beneficial. The premium comes from marginal income; the loss, if it occurs, would fall upon the parts of income having higher value to the insured. The less urgent needs of the present are sacrificed in order to protect the income that gratifies the more urgent needs of the future. In insurance each party gives a smaller value for a greater; each makes a gain. The greater security in business stimulates effort. This effect is quite the opposite of that of gambling.
On the basis of function we can define insurance in the following ways.
According to Prof. R.S.Sharma, “Insurance can be defined as a cooperative device to spread the loss caused by a particular risk over a number of persons who are exposed to it and who agree to ensure themselves against the risk.”
According to Reigel and Miller, “the function of insurance is primarily to decrease the uncertainty of events.”
In the words of John Megi, “Insurance is a plan where in persons collectively share the losses of risks.”
Thomsan defines, “Insurance is a provision which a prudent man makes against fortuitous or inevitable contingencies, loss or misfortunes. It is a form of spreading risk.”
“Insurance is a cooperative form of distributing a certain risk over a group of persons who are exposed to it.” – Ghosh and Agarwal
In simple terms, “insurance is a protection against financial loss arising on the happening of an unexpected event.”
On the basis of the functional definitions the following are the main features of insurance.
- Insurance is a cooperative device by which risks are distributed among large of number of individuals.
- It provides securities against losses or risks.
- A common fund is raised among members to meet the losses.
- It is a plan under which the losses of uncertain events are secured.
Legally insurance can be defined as follows
Insurance is a contract between two parties whereby one party agrees to undertake the risk of another in exchange for consideration known as premium and promises to pay a fixed sum of money to the other party on happening of an uncertain event (death) or after the expiry of a certain period in case of life insurance or to indemnify the other party on happening of an uncertain event in case of general insurance.
The party bearing the risk is known as the “insurer” or “assurer” and the party whose risk is covered is known as the ‘insured’ or ‘assured’. According to Chief Justice Tindal, “Insurance is a contract in which sum of money is paid by the assured in consideration of the insurers incurring the risk of paying a large sum upon a given contingency.
According to these definitions all contracts of insurance except life insurance contracts, are contract of indemnity.
Concept of Insurance
The basic objective of insurance is to transfer the risk of a person to the insurance company which has easily spread it over a large number of persons who are insuring similar risks. The concept behind insurance is that a group of people exposed to similar risk come together and make contributions towards formation of a pool of funds. In case a person actually suffers a loss on account of such risk, he is compensated out of the same pool of funds. Contribution to the pool is made by a group of people sharing common risks and collected by the insurance companies in the form of premiums.
It is a promise of compensation for specific potential future losses in exchange for a periodic payment. Insurance is designed to protect the financial well-being of an individual, company or other entity in the case of unexpected loss. Some forms of insurance are required by law, while others are optional. When parties agree the terms of an insurance policy, a contract created between the insured and the insurer. In exchange for payments from the insured (called premiums), the insurer agrees to pay the policyholder a sum of money upon the occurrence of a specific event. In most cases, the policy holder pays part of the loss (called the deductible), and the insurer pays the rest. Examples include car insurance, health insurance, disability, life, and business.
Insurance is a guaranty of partial or complete indemnity against a financial loss that will result if an event of a specified kind occurs.
The following are the parties involved in an insurance contract.
- Insured: The person seeking some surety against the possible loss is called ‘insured’.
- Insurer: The person contracting to indemnify against the loss is the insurer:
- Insurance Policy: The written contract of insurance the policy
- Premium: The price paid by the insured in fulfilment of his part of the contract is the premium;
- Indemnity: The amount paid when a loss has been incurred is the indemnity.
- Beneficiary: The person to whom the indemnity is paid is the beneficiary (who may or may not be the insured).
Classes of insurance
In relation with the nature of loss we can classify insurance into two classes.
- Property insurance and
- Personal insurance.
Property insurance is that which indemnifies for loss of one’s possession in specified ways, such as by fire, by the elements at sea (marine), by hail, lightning, or cyclone, by death (of valuable animals), by robbery, and by breakage (as of window-glass).
Personal insurance is that which indemnifies the beneficiary for loss of income as the result of various happenings to persons, the chief being death, accident, sickness, invalidity, old age, and unemployment.
Types of Insurance
Insurance provides indemnity, or reimbursement, in the event of an unanticipated loss or disaster. There are different types of insurance policies in the world cover almost anything that one might think of. Likewise there are numerous companies who are providing customized insurance policies. Insurance is mainly of two types: Life insurance and general insurance. General insurance means Fire, Marine and Miscellaneous insurance which includes insurance against burglary or theft, fidelity guarantee, insurance for employer’s liability, and insurance of motor vehicles, livestock and crops.
The Insurance Act, 1972 and the General Insurance Business (Nationalization) Act, 1972 govern Fire and Marine Insurance, while the Indian Marine Insurance At, 1963 governs marine insurance in our country. These laws contain provisions relating to the constitution, management and winding up of insurance companies and the conduct of insurance business of all types.
Features of Insurance
- Contract: Insurance is a contract between insurer and the insured. The insured makes an offer and the insurer accepts this offer through the contract. It is always made in writing.
- Consideration: Insurance is a contract whereby one party takes over the risk of other party and promises pay a certain sum of money to the insured or to his nominee a certain sum of money on happening of an event for a consideration. This consideration is called premium.
- Cooperative endeavor: Large number of persons transfers their risk to an association which is formed for this purpose. So we can say that the insurance is cooperative endeavor of large number of individual who are ready to share risks.
- Protection of monetary risks: Insurance covers only monetary risks. That means the risks which can be measured in terms of money.
- Good faith: In insurance utmost good faith is required on the part of all parties.
- Contract of indemnity: All contract of insurance except life insurance is a contract of indemnity.
- Not gambling: It is not gambling because the insurer is assured to get his loss of indemnity if the event concerned is happening.