How Insurance Works

InsuranceInsurance

Providing Protection to allProviding Protection to all Whether Big or SmallWhether Big or Small

Insurance may be defined in two ways:

Functional Terms.

Legal Terms.

In legal terms, insurance is a contractual agreement whereby one party agrees, for a consideration called premium, to compensate another party for losses. Thus an insurance transaction involves the following:

Insurer: The party agreeing to pay for the losses of the insured.

Insured: The party who insured his risk with the insurer.

Premium: the payment to the insurer received from the insured for indemnifying the losses.

Policy: is the contract between the insurer and insured that sets the contractual obligation between the two.

Exposure to loss: The insured’s possibility of incurrence of loss is called the insured’s exposure to loss.

INSURANCE PREMIUM RECEIVED

IS POOLED IN A FUND

To pay the Expenses of management

To Pay Agency Commission

To pay the claims

Surplus money is invested in Govt. securities as per

norms)

How Insurance Works

The mechanism of insurance is very simple. People who are exposed to the same kind of risks come together and agree that, if any one of them suffers a loss, the others will share the loss and make good to the person who lost.

In other words, the risk is spread among the community and the likely big impact on one or few is reduced to smaller manageable impacts on all.There are certain principles also, which make it possible for insurance to remain a fair arrangement.

The first being sharing of risk as it is difficult for any one individual to bear the consequences of the risks that he is exposed to. It will become bearable when the community shares the burden.

The second is that the peril should occur in an accidental manner. The occurrence of loss has to be random, accidental, and not the deliberate action of the insured person(s).

The manner in which the loss is to be shared can be determined beforehand. average, may suffer losses.

The following illustrations make the concept of insurance clear. Example 1In a particular colony there are 600 houses each having a worth of Rs 30000. Every year there is a probability of 3 houses getting burnt. The resultant loss per house is Rs 30000 and total loss being Rs 90000. If all the 600 home owners pool Rs 150 each to the pool the unfortunate people whose houses were burnt can be easily paid.

Example 2There are 10000 persons in a city who all are aged 40 and are healthy. It is expected that of these , 10 persons may die during the year . If the economic value of the loss suffered by the family of each dying person is taken to be Rs. 30000 , the total loss would work out to Rs. 3,00,000/- . If each person in the group contributed Rs. 100/- a year , the common fund would be Rs.10,00,000/-. This would be enough to pay Rs. 30,000/- to the family of each of the ten persons who die . Thus, 10000 persons share the risk of 10 persons.The surplus if any after payment of claims remains in the fund which is utilized to meet future excess losses or returned back to policyholders in one or the other form.

Human being – Is it an asset?

A human being is an income-generating asset. One’s manual labour, professional skills are the assets. Human asset can also be lost like other assets due to causes like -early death , fatal sickness and death caused by accidents.

Insurance -Is it a Business?

Insurance companies are called insurers. The business of insurance is to Bring together the persons with common insurance interests (sharing the same risks)Collect the share or contribution (called premium) from all of them andPay out compensations (called claims) to those who suffer.

Rights and responsibilities of the insurer

Right to collect premium from the insured Right to specify the rules and conditions that govern the promise made under the policy Responsibility to pay for the losses occurred and claimed by the insured

Rights and responsibilities of insured

Obligation to pay premium to the insurer Right to collect payment from the insurer if a covered loss occurs Obligation to comply with the terms and conditions prescribed by

insurer:

In an insurance contract, one should remember that a right created for one party represents a duty for the other party. In the event of default of premium or non-compliance of conditions by insured, an insurer may cancel the insurance or refuse to pay claims/payment of losses.

Is insurance a contract? What is its nature?

A contract of insurance is a contingent contract. The general principles of law of contract must be complied with for a contract of insurance to be valid.

Contract of insurance comes into existence where there is an offer (from the person facing the risk) and the underwriter or the insurer accepts it by issuing the policy. The contract of insurance (in order to be a valid contract) can be entered into only by person(s) competent to contract.

A contract of insurance other than life insurance contract is a contract of indemnity. The insurer undertakes to indemnify the insured for loss or damage arising as a result of risk specified. In case of life insurance, if a person dies the insurance company can only give a specified claim amount as compensation to the survivors, it cannot indemnify the loss of lost life . Since the person who is dead cannot be brought back.

Classification of Insurance

Types of Insurance

Life Insurance Non-life Insurance

General Insurance •Marine Insurance•Fire Insurance•Personal Accident Insurance•Vehicle Insurance

Miscellaneous Insurance •Fidelity Guarantee Insurance•Crop Insurance•Burglary Insurance•Flood Insurance etc.•Cattle Insurance•Cash in Transit Insurance

Insurance (Non-Life Insurance)

• Fire, marine insurance and other contracts are contracts of indemnity.

• In fire insurance, insurable interest must be present both at the time of affecting the policy and also at the time of occurrence of loss also. In marine insurance. It must be present only at the time of loss . It is not necessary at the time of affecting the policy.

• In the case of marine and fire insurance, policy cannot be surrendered by the assured before its maturity.

• In the case of fire and marine insurance, insurance contain only the protection element.

Assurance (Life Insurance

• It is not a contract of indemnity. Since life lost cannot be returned .

• Insurable interest must be present only at the time of taking out the policy, but need not be present at the time of maturity of the policy.

• A life insurance policy can be surrendered by the assured before its maturity.

• Life Insurance contains both the elements of security and investment.

Role Of Insurance In Financial System

It accepts the risk from people and corporate bodies who are exposed to them.

It collects small amounts of premium, which are pooled together to be called an insurance fund . This fund is used for investment purpose.

It organizes compulsory insurance in certain areas as per the provisions of the law.

It sells voluntary insurance covers through its sales force .

It settles claims arising out of insured losses . Neither the insurance company nor the insured are allowed to make profits out of insurance . If insurance company gets a surplus after meeting claims , it distributes it among policyholders in form of bonus or reduction in premium

It follows the principles of Indian Contract Act which help to prevent its misuse or abuse.

Functions of Insurance

It provides protection

It provides certainty

It helps prevention of losses

It helps capital formation

It shares risk

Characteristics of Insurance

Risk Sharing and Risk Transfer Co-operative DeviceCalculates risk in advancePayment of claim at the Occurrence of Contingency.Amount of PaymentLarger Number of Insured Persons Insurance must not be confused with charity or

gambling

Risk and Insurance

Insurable risks have certain common features. They are

enumerated below: -

Financial value Homogeneous exposures. Insurance is concerned only with pure risks Fortuitous (by fortune) Insurable interest Not against public policy Risk of being fined by the police

Classes of Risk and their Insurability

Financial and Non – financial Risks

Static and Dynamic Risks

Fundamental and Particular Risks

Pure and Speculative Risks

Effects Of Risks On The Economic Well Being Of A Person

Impact on a large section of the people or a geographical area.

Capacity to produce loss and suffering to people. Have financial consequences. Uncontrollable once they occur. Are Predictable. No possibility of any gain.

The Insurer And The Insured To Have Mutual Goals

Insurance companies motivate people to cover risks

Marketing of insurance

Risk

Insurer

Reinsurer

Insured

Chain of Risk Transfer

Structure Of Insurance Devices/products

Characteristic features of an insurance device or contract

Purpose of the device Who is eligible to insure? After buying the insurance, can the policy be transferred? When and what claim is payable under the terms of the

policy? Is every loss a claim?

Legal Principles of Insurance Principle of utmost good faith i.e. mutual trust.

Principle of insurable interest. Insurable interest is the legal relationship with the subject matter.

Transferability of policy by the instrument of assignment .

Principle of indemnity i.e. insured can claim for the quantum of loss incurred only. He cannot make profit out of an insurance contract

Principle of contribution i.e. All insurers will contribute a portion of total loss if the property has been insured with more than one insurer. This is not valid to a life insurance contract .

Principle of subrogation operates which says that after paying the claim the insurer will step into the shoes of insured regarding the property