UNIT – III

INSURANCE

What is Insurance

In D.S. Hamsell words, insurance is defined “as a social device providing financial
compensation for the effects of misfortune, the payment being made from the accumulated
contributions of all parties participating in the scheme”

In simple terms “Insurance is a co-operative device to spread the loss caused by a particular
risk over a number of persons, who are exposed to it and who agree to insure themselves against
the risk”

Thus, the insurance is

(a) A cooperative device to spread the risk;

(b) the system to spread the risk over a number of persons who are insured against the risk;

(c) the principle to share the loss of the each member of the society on the basis of probability
of loss to their risk; and

(d) the method to provide security against losses to the insured

Insurance may be defined as form of contract between two parties (namely insurer and insured
or assured) whereby one party (insurer) undertakes in exchange for a fixed amount of money
(premium) to pay the other party (Insured), a fixed amount of money on the happening of certain
event (death or attaining a certain age in case of life) or to pay the amount of actual loss when it
takes place through the risk insured (in case of property)

Terminology used in definition of Insurance

- Insurer or insurance company – The agency involved in Insurance business is

known as insurer

- Insured/ Assured – The person who gets his property/life insured is known as
insured

- Policy - The agreement or contract which is put in writing is known as a Policy

 - Premium – The consideration in return of which the insurer undertakes to make
goods the loss or give a certain amount in case of life insurance is known as premium

ASSURANCE AND INSURANCE

The two words were used synonymously at one time, but there is fine distinction between
the two. ‘Assurance’ is used in those contracts which guarantee the payment of a certain sum on
the happening of a specified event which is bound to happen sooner or later, for example attaining
a certain age or death. Thus life policies comes under ‘assurance’.

Insurance, on the other hand, contemplates the granting of agreed compensation of the happening
of certain events stipulated in the contract which are not expected but which may happen, for
example risk relating to fire, accident or marine.

NATURE OF INSURANCE

Following are the main characteristics of insurance which are applicable to all types of
insurance (life, fire, marine and general insurance).

1. Sharing of Risks - Insurance is a device to share the financial losses which may occur to
individual or his family on the happening of certain events
2. Co operative Device – Insurance is a co-operative device to spread the loss caused by a
particular risk over a large caused by a particular risk over a large number of persons who are
exposed to it and who agree to insure themselves against the risk.
3. Value of Risk – Risk is evaluated at the time of insurance. There are several methods of
valuing the risk. Higher the risks, higher will be premium
4. Payment on Contingency -If the contingency occurs, payment is made; payment is made only
for insured contingency. If there is no contingency, no payment is made. In life insurance
contract, payment is certain because the death or the expiry of term will certainly occur. In
other insurance contract like fire, marine, the contingency may or may not occur
5. Amount of Payment of Claim - The amount of payment depends upon the value of loss
occurred due to the particular insured risk. The insurance is there upto that amount. In life
insurance insurer pay a fixed sum on the happening of an event or within a specified time
period.
 Example – In fire insurance, if fire occurs and half the property is destroyed, but the whole
property is insured, then payment of claim will be made only for that half building that is
destroyed not the whole amount of insured.

6. Insurance is different from Charity - In charity, there is no consideration but insurance is

not given without premium
7. Large number of Insured Person - Insurance is spreading of loss over a large number of
persons. Larger the number of persons, lower the cost of insurance and amount of premium
and incase lower the number of persons, higher the cost of insurance and amount of premium.
8. Insurance is different from Gambling - In gambling, there is no guarantee of gain, by
bidding the person expose himself to risk of losing. Whereas in insurance, by getting insured
his life and property, he protect himself against the risk of loss.

FUNCTIONS OF INSURANCE
The functions of insurance can be studied into two parts (i) Primary Functions, and (ii) Secondary
Functions.
Primary Functions:
(i) Insurance provides certainty:

Insurance provides certainty of payment at the uncertainty of loss. The uncertainty of loss can be
reduced by better planning and administration. But, the insurance relieves the person from such
difficult task. Moreover, if the subject matters are not adequate, the self-provision may prove
costlier.

There are different types of uncertainty in a risk. The risk will occur or not, when will occur, how
much loss will be there? In other words, there are uncertainty of happening of time and amount of
loss. Insurance removes all these uncertainty and the assured is given certainty of payment of loss.
The insurer charges premium for providing the said certainty.

(ii) Insurance provides protection:

The main function of the insurance is to provide protection against the probable chances of loss.
The time and amount of loss are uncertain and at the happening of risk, the person will suffer loss
in absence of insurance. The insurance guarantees the payment of loss and thus protects the assured
from sufferings. The insurance cannot check the happening of risk but can provide for losses at
the happening of the risk.

(iii) Risk-Sharing:

The risk is uncertain, and therefore, the loss arising from the risk is also uncertain. When risk takes
place, the loss is shared by all the persons who are exposed to the risk. The risk-sharing in ancient
time was done only at time of damage or death; but today, on the basis of probability of risk, the
share is obtained from each and every insured in the shape of premium without which protection
is not guaranteed by the insurer.

Secondary functions:

Besides the above primary functions, the insurance works for the following functions:

(i) Prevention of Loss:

The insurance joins hands with those institutions which are engaged in preventing the losses of the
society because the reduction in loss causes lesser payment to the assured and so more saving is
possible which will assist in reducing the premium. Lesser premium invites more business and
more business cause lesser share to the assured.

So again premium is reduced to, which will stimulate more business and more protection to the
masses. Therefore, the insurance assist financially to the health organisation, fire brigade,
educational institutions and other organisations which are engaged in preventing the losses of the
masses from death or damage.

(ii) It Provides Capital:

The insurance provides capital to the society. The accumulated funds are invested in productive
channel. The dearth of capital of the society is minimised to a greater extent with the help of
investment of insurance. The industry, the business and the individual are benefited by the
investment and loans of the insurers.

(iii) It Improves Efficiency:

The insurance eliminates worries and miseries of losses at death and destruction of property. The
carefree person can devote his body and soul together for better achievement. It improves not only
his efficiency, but the efficiencies of the masses are also advanced.

(iv) It helps Economic Progress:

The insurance by protecting the society from huge losses of damage, destruction and death,
provides an initiative to work hard for the betterment of the masses. The next factor of economic
progress, the capital, is also immensely provided by the masses. The property, the valuable assets,
the man, the machine and the society cannot lose much at the disaster.

7 MOST IMPORTANT PRINCIPLES OF INSURANCE

The important principle of insurance are as follows:

The main motive of insurance is cooperation. Insurance is defined as the equitable transfer of risk
of loss from one entity to another, in exchange for a premium.

1. Nature of contract:
Nature of contract is a fundamental principle of insurance contract. An insurance contract comes
into existence when one party makes an offer or proposal of a contract and the other party accepts
the proposal.

A contract should be simple to be a valid contract. The person entering into a contract should enter
with his free consent.
2. Principal of utmost good faith:
Under this insurance contract both the parties should have faith over each other. As a client it is
the duty of the insured to disclose all the facts to the insurance company. Any fraud or
misrepresentation of facts can result into cancellation of the contract.

3. Principle of Insurable interest:

Under this principle of insurance, the insured must have interest in the subject matter of the
insurance. Absence of insurance makes the contract null and void. If there is no insurable interest,
an insurance company will not issue a policy.

An insurable interest must exist at the time of the purchase of the insurance. For example, a creditor
has an insurable interest in the life of a debtor, A person is considered to have an unlimited interest
in the life of their spouse etc.

4. Principle of indemnity:
Indemnity means security or compensation against loss or damage. The principle of indemnity is
such principle of insurance stating that an insured may not be compensated by the insurance
company in an amount exceeding the insured’s economic loss.

In type of insurance the insured would be compensation with the amount equivalent to the actual
loss and not the amount exceeding the loss.

This is a regulatory principal. This principle is observed more strictly in property insurance than
in life insurance.

The purpose of this principle is to set back the insured to the same financial position that existed
before the loss or damage occurred.

5. Principal of subrogation:
The principle of subrogation enables the insured to claim the amount from the third party
responsible for the loss. It allows the insurer to pursue legal methods to recover the amount of loss,
For example, if you get injured in a road accident, due to reckless driving of a third party, the
insurance company will compensate your loss and will also sue the third party to recover the money
paid as claim.

6. Double insurance:
Double insurance denotes insurance of same subject matter with two different companies or with
the same company under two different policies. Insurance is possible in case of indemnity contract
like fire, marine and property insurance.

Double insurance policy is adopted where the financial position of the insurer is doubtful. The
insured cannot recover more than the actual loss and cannot claim the whole amount from both the
insurers.

7. Principle of proximate cause:

Proximate cause literally means the ‘nearest cause’ or ‘direct cause’. This principle is applicable
when the loss is the result of two or more causes. The proximate cause means; the most dominant
and most effective cause of loss is considered. This principle is applicable when there are series of
causes of damage or loss.

BENEFITS OF INSURANCE OR ROLE AND IMPORTANCE OF INSURANCE

Benefit of insurance can be divided into these categories -

1. Benefits to Individual

2 Benefits to Business or Industry

3. Benefits to the Society

It can be explained as under -

1. Benefits to Individual

(a) Insurance provides security & safety : Insurance gives a sense of security to the policy
holder. Insurance provide security and safety against the loss of earning at death or in old
age, against the loss at fire, against the loss at damage, destruction of property, goods,
furniture etc.
 Life insurance provides protection to the dependents in case of death of policyholders and
to the policyholder in old age. Fire insurance insured the property against loss on a fire.
Similarly other insurance provide security against the loss by indemnifying to the extent of
actual loss.

(b) Encourage Savings : Life insurance is best form of saving. The insured person must
regularly save out of his current income an amount equal to the premium to be paid
otherwise his policy get lapsed if premium is not paid on time.

(c) Providing Investment Opportunity : Life insurance provide different policies in which
individual can invest smoothly and with security; like endowment policies, deferred
annuities etc. There is special exemption in the Income Tax, Wealth Tax etc. regarding this
type of investment

2 Benefits to Business or Industry

(a) Shifting of Risk : Insurance is a social device whereby businessmen shift specific risks to
the insurance company. This helps the businessmen to concentrate more on important
business issues.

(b) Assuring Expected Profits : An insured businessman or policyholder can enjoy normal
expected profits as he would not be required to make provisions or allocate funds for
meeting future contingencies.

(c) Improve Credit Standing : Insured assets are easily accepted as security for loans by the
banks and financial institutions so insurance improve credit standing of the business firm

(d) Business Continuation – With the help of property insurance, the property of business is
protected against disasters and chance of closure of business is reduced

3. Benefits to the Society

(a) Capital Formation : As institutional investors, insurance companies provide funds for
financing economic development. They mobilize the saving of the people and invest these
saving into more productive channels

(b) Generating Employment Opportunities : With the growth of the insurance business, the
insurance companies are creating more and more employment opportunities.
 (c) Promoting Social Welfare : Policies like old age pension scheme, policies for education,
marriage provide sense of security to the policyholders and thus ensure social welfare.

(d) Helps Controlling Inflation : The insurance reduces the inflationary pressure in two ways,
first, by extracting money in supply to the amount of premium collected and secondly, by
providing funds for production narrow down the inflationary gap.

TYPE OF INSURANCE

Insurance cover various types of risks and include various insurance policies which provide
protection against various losses.

There are two different views regarding classification if insurance:-

I. From the business point of view; and

II From the risk points of view

I. Business point of view

The insurance can be classified into three categories from business point of view

1. Life insurance;

2. General Insurance; and

3. Social Insurance.

1. Life Insurance: The life insurance contract provide elements of protection and investment
after getting insurance, the policyholder feels a sense of protection because he shall be paid
a definite sum at the death or maturity. Since a definite sum must be paid, the element of
investment is also present. In other words, life insurance provides against pre-mature
death and a fixed sum at the maturity of policy. At present, life insurance enjoys maximum
scope because each and every person requires the insurance.

Life insurance is a contract under which one person, in consideration of a premium paid
either in lump sum or by monthly, quarterly, half yearly or yearly installments, undertakes
to pay to the person (for whose benefits the insurance is made), a certain sum of money
either on the death of the insured person or on the expiry of a specified period of time.
 Life insurance offers various polices according to the requirement of the persons -

- Term Assurance

- Whole Life

- Endowment Assurance

- Family Income Policy

- Life Annuity Joint Life Assurance

- Pension Plans

- Unit Linked Plans

- Policy for maintenance of handicapped dependent

- Endowment Policies with Health Insurance benefits

2. General Insurance: The general insurance includes property insurance, liability insurance
and other form of insurance. Property insurance includes fire and marine insurance.
Property of the individual and business involves various risks like fire, theft etc. This need
insurance Liability insurance includes motor, theft, fidelity and machine insurance

Type of General Insurance policies available are -

- Health Insurance

- Medi- Claim Policy

- Personal Accident Policy

- Group Insurance Policy

- Automobile Insurance

- Worker’s Compensation Insurance

- Liability Insurance

- Aviation Insurance

- Business Insurance
 - Fire Insurance Policy

- Travel Insurance Policy

3. Social Insurance: Social insurance provide protection to the weaker sections of the
society who are unable to pay the premium. It includes pension plans, disability benefits,
unemployment benefits, sickness insurance and industrial insurance.

II Risk Points of View

The insurance can be classified into three categories from Risk point of view

1. Property Insurance

2. Liability Insurance

3. Other forms of Insurance

1. Property Insurance: Property of the individual and business is exposed to risk of fire,
theft marine peril etc. This needs insurance. This is insured with the help of:-

(i) Fire Insurance

(ii) Marine Insurance

(iii) Miscellaneous Insurance

(i) Fire Insurance: Fire insurance covers risks of fire. It is contract of indemnity. Fire
insurance is a contract under which the insurer agrees to indemnify the insured, in
return for payment of the premium in lump sum or by instalments, losses suffered by
the him due to destruction of or damage to the insured property, caused by fire during
an agreed period of time. It includes losses directly caused through fire or ignition.
There are various types of fire insurance policies.

- Consequential loss policy

- Comprehensive policy

- Valued policy

- Valuable policy
 - Floating policy

- Average policy

(ii) Marine Insurance: Marine insurance is an arrangement by which the insurer

undertakes to compensate the owner of the ship or cargo for complete or partial loss at
sea. So it provides protection against loss because of marine perils. The marine perils
are collisions with rock, ship attack by enemies, fire etc. Marine insurance insures ship,
cargo and freight.

The following kinds of marine policies are -

- Voyage policy

- Time policy

- Valued policy

- Hull Policy

- Cargo Policy

- Freight Policy

(iii) Miscellaneous Insurance: It includes various forms of insurance including property

insurance, liability insurance, personal injuries are also insured. The property, goods,
machine, furniture, automobile, valuable goods etc. can be insured against the damage
or destruction due to accident or disappearance due to theft.

Miscellaneous insurance covers

- Motor

- Disability

- Engineering and aviation risks

- Credit insurance

- Construction risks

- Money Insurance
 - Burglary and theft insurance

- All risks insurance

2. Liability Insurance: The insurer is liable top pay the damage of the property or to
compensate the loss of personal injury or death. It includes fidelity insurance, automobile
insurance and machine insurance.

The following are types of liability Insurance:-

- Third party insurance

- Employees insurance

- Reinsurance

3. Other forms of Insurance: It include export credit insurance, state employee insurance
etc. whereby the insurer guarantees to pay certain amount at the happening of certain
events.

The following are other form of Insurance-

- Fidelity Insurance

- Credit Insurance

- Privilege Insurance