IINSURANCE

INTRODUCTION TO INSURANCE

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 allows individuals, businesses and other entities to protect themselves
against significant potential losses and financial hardship at a reasonably affordable rate. We
say "significant" because if the potential loss is small, then it doesn't make sense to pay a
premium to protect against the loss. After all, you would not pay a monthly premium to
protect against a loss because this would not be considered a financial hardship for most.
Insurance is appropriate when you want to protect against a significant monetary loss. Take
life insurance as an example. If you are the primary breadwinner in your home, the loss of
income that your family would experience as a result of our premature death is considered a
significant loss and hardship that you should protect them against. It would be very difficult
for your family to replace your income, so the monthly premiums ensure that if you die, your
income will be replaced by the insured amount. The same principle applies to many other
forms of insurance. If the potential loss will have a detrimental effect on the person or entity,
insurance makes sense. Everyone that wants to protect themselves or someone else against
financial hardship should consider insurance. This may include:

 Protecting family after one's death from loss of income

 Ensuring debt repayment after death
 Covering contingent liabilities
 Protecting against the death of a key employee or person in your business
 Buying out a partner or co-shareholder after his or her death
 Protecting your business from business interruption and loss of income
 Protecting yourself against unforeseeable health expenses
 Protecting your home against theft, fire, flood and other hazards
 Protecting yourself against lawsuits
 Protecting yourself in the event of disability
 Protecting your car against theft or losses incurred because of accidents
 And many more

Insurance- Meaning and definition

Insurance is a contract between two parties. One party is the insured and the
other party is the insurer. Insured is the person whose life or property is insured with the
insurer. That is, the person whose risks are insured is called insured. Insurer is the
insurance company to whom risk is transferred by the insured. That is, the person who
insures the risk of insured is called insurer. Thus insurance is a contract between insurer
and insured. It is a contract in which the insurance company undertakes to indemnify the
insured on the happening of certain event for a payment of consideration. It is a
contract between the insurer and insured under which the insurer undertakes to
compensate the insured for the loss arising from the risk insured against. Some definitions
of insurance are given below:

According to Gosh and Agarwal, “insurance may be defined as a co-operative form

of distributing a certain risk over a group of persons who are exposed to it’
 According to Mc Gill, “Insurance is a process in which uncertainties are made certain”.
In the words of Jon Megi, “Insurance is a plan wherein persons collectively share the
losses of risks”.
Thus, insurance is a device by which a loss likely to be caused by uncertain event is spread
over a large number of persons who are exposed to it and who voluntarily join themselves
against such an event. The document which contains all the terms and conditions of insurance
(i.e. the written contract) is called the ‘insurance policy’. The amount for which the insurance
policy is taken is called ‘sum assured’. The consideration in return for which the insurer agrees
to make good the loss is known as ‘insurance premium’. This premium is to be paid regularly
by the insured. It may be paid monthly, quarterly, half yearly or yearly.

Terms used in Insurance

Insured
The party or the individual who seeks protection against a specified task and entitled to receive
payment from the insurer in the event of happening of stated event is known as insured. An insured is
normally in insurance policy holder.
Insurer
The party who promises to pay indemnity the insured on the happening of contingency is known
as insurer. The insurer is an insurance company.

Beneficiaries
The person or the party to whom the policy proceeds will be paid in the event of the death or
happening of any contingency is called beneficiary.
Contract
An agreement binding at law between two or more parties is called contract.
Premium
The amount which is paid to the insurer by the insured in consideration to insurance contract is
known as premium. It may be paid on monthly, quarterly, half yearly, yearly or as agreed
upon it is the price for an insurance policy.

Insured sum
The sum for which the risk is insured is called the insured sum, or the policy money or the face
value of the policy. This is the maximum liability of the insurer towards the insured.
Peril
A peril i s an event that causes a personal or property loss by fire, windstorm, explosion,
collision premature death, sickness, floods, dishonesty etc.
Hazard
Hazard is a condition that may create, increase or decrease the chances of loss from a given
peril.
Exposure
An exposure is a measure of physical extent of the risk. An individual who owns a business
house may be subjected to economic loss and individual loss because of his business and
personal exposure.
Cover note
An unstamped document issued by or on behalf of insurers as evidence of insurance
pending issue of policy.
Damages
Monetary compensation award at law for a civil wrong or breach of contract.
Indemnity
Compensation for actual loss suffered is call indemnity.
Reinsurance
Reinsurance is a method where by the original insurer transfer all or part of risk he has
assumed to another company or companies with the object of reducing his own commitment to
an reducing his own commitment to an amount that he can bear for his own account
commensurate with his financial resources in the event of loss. It was originally confined to
offers and acceptances on individual risk known as facultative reinsurance transactions.
Double Insurance
Double insurance implies that subject matter is insured in two or more insurance companies
(insurers) and the total sum insured exceeds the actual value of subject matter. In other words,
the same subject matter is insured in more than one insurer.
No claim bonus
The bonus is getting under the policy, if the claim is not reported during the policy period and
after that the time renewal (in time) then as per the policy term no claim bonus is avail for the
vehicle insurance policy and the rate of bonus is different in different general insurance
companies, and the maximum rate should be up to 50% as per the norms.
Characteristics of Insurance
Insurance follows important characteristics – These are follows
1. Sharing of risk
Insurance is a co-operative device to share the burden of risk, which may fall on
happening of some unforeseen events, such as the death of head of family or on happening of
marine perils or loss of by fire.
2. Co-operative device
Insurance is a co-operative form of distributing a certain risk over a group of persons who are
exposed to it. A large number of persons share the losses arising from a particular risk
3. Large number of insured persons
The success of insurance business depends on the large number of persons Insured against
similar risk. This will enable the insurer to spread the losses of risk among large number of
persons, thus keeping the premium rate at the minimum.
4. Evaluation of risk
For the purpose of ascertaining the insurance premium, the volume of risk is evaluated, which
forms the basis of insurance contract.
5. Payment of happening of specified event
On happening of specified event, the insurance company is bound to make payment to the
insured. Happening of specified event is certain in life insurance, but in the case of fire,
marine of accidental insurance, it is not necessary. In such cases, the insurer is not liable for
payment of indemnity.
6. Transfer of risk
Insurance is a plan in which the insured transfers his risk on the insurer. This may be the
reason that may person observes, that insurance is a device to transfer some economic losses
would have been borne by the insured themselves.
7. Spreading of risk
Insurance is a plan which spread the risk & losses of few people among a large
number of people. John Magee writes, “Insurance is a plan by which large number of people
associates themselves and transfers to the shoulders of all, risk attached to Individuals”.
8. Protection against risks
Insurance provides protection against risk involved in life, materials and property. It is a
device to avoid or reduce risks.
9. Insurance is not charity
Charity pays without consideration but in the case of insurance, premium is paid by the
insured to the insurer in consideration of future payment.
10. Insurance is not a gambling
Insurance is not a gambling. Gambling is illegal, which gives gain to one party and loss
to other. Insurance is a valid contact to indemnity against losses. Moreover, Insurable
interest is present in insurance contracts it has the element of investment also.
11. A contract
Insurance is a legal contract between the insurer and insured under which the
Insurer
promises to compensate the insured financially within the scope of insurance Policy,
the insured promises to pay a fixed rate of premium to the insurer.
12. Social device
Insurance is a plan of social welfare and protection of interest of the people. Rieged
and miller observe “insurance is of social nature”.
13. Based upon certain principle
Insurance is a contract based upon certain fundamental principles of insurance, which
includes utmost good faith, insurable interest, contribution, indemnity, causa Proxima,
subrogation etc, which are operating in the various fields of insurance.
14. Regulation under the law
The government of every country enacts the law governing insurance business So as
to regulate, and control its activities for the interest of the people. In India General insurance
act 1972 and the life insurance act 1956 are the major enactment in this direction.
15. Insurance is for pure risk only
Pure risks give only losses to the insured, and no profits. Examples of pure Risks are
accident, misfortune, death, fire, injury, etc., which are all the sided risks and the ultimate
results in loss. Insurance companies issue policies against pure risk only, not against
speculative risks.
16. Based on mutual goodwill
Insurance is a contract based on good faith between the parties. Therefore, both the
parties are bound to disclose the important facts affecting to the contract before each
other. Utmost good faith is one of the important principles of insurance.

Functions of Insurance

Insurance is defined as 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 ensure themselves
against that risk. Risk is uncertainty of a financial loss. It should not be confused with the
chance of loss which is the probable number of losses out of a given number of exposures. It
should not be confused with peril which is defined as the cause of loss or with hazard which
is a condition that may increase the chance of loss. Finally, risk must not be confused with
loss itself which is the unintentional decline in or disappearance of value arising from a
contingency. Wherever there is uncertainty with respect to a probable loss there is risk. Every
risk involves the loss of one or other kind. The function of insurance is to spread the loss over
a large number of persons who are agreed to co-operate each other at the time of loss. The
risk cannot be averted but loss occurring due to a certain risk can be distributed amongst the
agreed persons. They are agreed to share the loss because the chances of loss, i.e., the time,
amount, to a person are not known.

Anybody of them may suffer loss to a given risk, so, the rest of the persons who are agreed
will share the loss. The larger the number of such persons the easier the process of
distribution of loss, In fact; the loss is shared by them by payment of premium which is
calculated on the probability of loss. In olden time, the contribution by the persons was made
at the time of loss. The insurance is also defined as a social device to accumulate funds to
meet the uncertain losses arising through a certain risk to a person insured against the risk.
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.

Advantages of Insurance

1. Assures for financial compensation

Insurance provides financial security to the insured. It gives guarantee of compensation

against large financial losses in return of small premium.

2. Reduction of risks

Human beings are exposed to different kinds of financial risks, which may cause large
financial losses. It is not possible to eliminate the risks but it can be forecasted and reduced
by applying some precautionary measures. Insurance helps in reducing risks by suggesting
for pre caution measures on one side and by sharing the losses to a group of person who has
agreed to join the common pool.

3. Encouragement to saving and investment

In the insurance agreement, the insured has to pay a certain regular premium to the
insurer in return to the compensation of the probable future loss or compensation at old age or
compensation after his/her death. Insurance is thus a method of collecting saving from the
parties willing to get secured from the financial risks. Hence, it encourages persons to make
regular savings.

4. Basis of credit

An insured can easily get loan by pledging insurance policy as a security from the
insurance company itself. Besides, financial institutions grant credit facilities on the pledge of
the properties which are being insured.
 5. Maintains economic stability

Financial risks and uncertainties pushes the entire economy into instability. It is a very
bad sign to total business and social sectors. Insurance assures the compensation of the
financial losses caused by the specified future events and considerably helps in maintaining
economic stability.

6. Promotes business activities

Business sector is riskier sector. The chances of fire in the go down, loss of stocks by theft,
explosion in the ship, train or plane etc. are more frequent in this sector. Insurance takes away
these risks and promotes and develops business activities in consideration to a nominal charge
i.e premium.
7. Provides employment opportunities

As insurance has become business in the modern-day business world, hundreds of

entrepreneurs and thousands of employees have been engaging in this line. Hence, by
establishing and developing insurance companies, it has provided employment opportunities to
thousands of people as per their qualification and calibre.

Disadvantages of Insurance

Besides a number of benefits, insurance has also some limitations.

 Insurance leads to negligence as the insured feels that he/she can be compensated for
any loss or damage.
 Insurance companies do not make the compensation promptly on maturity of the
policy or for the financial losses as the expectation of the insured.
 It may lead to the crimes in the society as the beneficiaries of the policy may be
tempted to commit crimes to receive the insured amount.
 Although insurance encourages savings, it does not provide the facilities that are
provided by bank.

Basic Principles of Insurance

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.

Kinds of Insurance

Business Point of View :

The insurance can be classified into three categories from business point of view: (i) Life
Insurance, (ii) General Insurance, and (iii) Social Insurance.
(i) Life Insurance:

Life Insurance is different from other insurance in the sense that, here, the subject
matter of insurance is life of human being. The insurer will pay the fixed amount of insurance
at the time of death or at the expiry of certain period. At present, life insurance enjoys
maximum scope because the life is the most important property of the society or an
individual. Each and every person requires the insurance. This insurance provides protection
to the family at the premature death or gives adequate amount at the old age when earning
capacities are reduced. Under personal insurance a payment is made at the accident. The
insurance is not only a protection but is a sort of investment because a certain sum is
returnable to the insured at the death or at the expiry of a period. The business of life
insurance is wholly done by that Life insurance Corporation of India.

(ii) General Insurance :

The general insurance includes property insurance, liability insurance and other forms
of insurance. Fire and marine insurances are strictly called property insurance. Motor, theft,
fidelity and machine insurances include the extent of liability insurance to a certain extent.
The strictest form of liability insurance is fidelity insurance, whereby the insurer compensates
the loss to the insured when he is under the liability of payment to the third party.

(iii) Social Insurance:

The social insurance is to provide protection to the weaker section of the society who
is unable to pay the premium for adequate insurance. Pension plans, disability benefits,
unemployment benefits, sickness insurance and industrial insurance are the various forms of
social insurance. With the increase of the socialistic ideas, the social insurance is an
obligatory duty of the nation. The Government of a country must provide social insurance to
its masses.

Risk Point of View:

Insurance is divided into property liability and other form from high point of view

A. Property Insurance:

Under the property insurance property of person/persons are insured against a certain
specified risk. The risk may be fire or marine perils, theft of property or goods, damage to
property at accident.

(a) Marine Insurance:

Marine insurance provides protection against loss of marine perils. The marine perils
are collision with rock, or ship attacks by enemies, fire and capture by pirates, etc. These
perils cause damage, destruction or disappearance of the ship and cargo and non-payment of
freight. So, marine insurance insures ship (Hull), cargo and freight. Previously only certain
nominal risks were insured but now the scope of marine insurance had been divided into two
parts: (i) Ocean Marine Insurance and (ii) Inland Marine Insurance. The former insures only
the marine perils while the latter covers inland peril which may arise with the delivery of
cargo (goods) from the godown of the insured and may extend up to the receipt of the cargo
by the buyer (importer) at his godown.

(b) Fire Insurance:

Fire insurance covers risks of fire. In the absence of fire insurance, the fire waste will
increase not only to the individual but to the society as well. With the help of fire insurance,
the losses, arising due to fire are compensated and the society is not losing much. The
individual is protected from such losses and his property or business or industry will remain
approximately in the same position in which it was before the loss. The fire insurance does
not protect only losses but it provides certain consequential losses also. War risk, turmoil,
riots, etc., can be insured under this insurance, too.

(c) Miscellaneous Insurance:

The Property, goods, machine, furniture, automobile, valuable articles, etc., can be
insured against the damage or destruction due to accident or disappearance due to theft. There
are different forms of insurances for each type of the said property whereby not only property
insurance exists but liability insurance and personal injuries are also insured.

B. Liability Insurance:

The general insurance also includes liability insurance thereby the insured is liable to
pay the damage of property or to compensate the less of personal injury or death. This
insurance is seen in the form of fidelity insurance, automobile insurance and machine
insurance, etc.

C. Other Forms:

Besides the property and liability insurances, there are certain other insurances which
are included under general insurance. The examples of such insurances are export-credit
insurances, State employees insurance, etc., whereby the insurer guarantees to pay certain
amount at the certain events. This insurance is extending rapidly these days.

1. Personal Insurance:

The personal insurance includes insurance of human life which may suffer loss due to
death, accident and disease. Therefore, the personal insurance is further sub-classified into
life insurance, personal accident insurance and health insurance.

2. Property Insurance:

The property of an individual and of the society is insured against the loss of fire and
marine perils, the crop is insured against unexpected decline in production, unexpected death
of the animals engaged in business, break-down of machines and theft of the property and
goods.
3. Liability Insurance:

The liability insurance covers the risks of third party, compensation to employees,
liability of the automobile owners and reinsurances.

4. Guarantee Insurance:

The guarantee insurance covers the loss arising due to dishonesty, disappearance and
disloyalty of the employers or second. The party must be a party of the contract. His failure
causes loss to the first party. For example, in export insurance, the insurer will compensate
the loss at the failure of the importers to pay the amount of debt.

Life Insurance Vs General Insurance

Types

Life insurance is a non-personal insurance contract. This means that the policyholder
and the person being insured do not have to be the same person. General insurance is
always a personal contract where the insurance company contracts with you directly
for insurance protection.

Function

Both life insurance and general insurance accept premiums in exchange for insurance
benefits. Insurance premiums are invested into bonds or bond-like investments that
produce stable and consistent returns for the insurance company. The investments,
plus premium payments, also ensure that the insurance company can pay the promised
benefits that are outlined in the insurance policy. When you need to file a claim, both
types of insurance require a claim form for you to fill out. The payment of benefits,
and the amount of the benefit that is payable, are always spelled out in your insurance
contract.

Significance

Life insurance insures your life or the life of someone that you have an economic
interest in, like your spouse, children, siblings or business partners. When the insured
individual dies, the life insurance policy pays a death benefit that is fixed. This is
called a valued contract. A valued contract pays a fixed sum of money, regardless of
the nature of the loss insured by the contract.

General insurance insures homes, automobiles and other personal property. This type
of insurance is sometimes referred to as "property and casualty" insurance. General
insurance is indemnity insurance. Indemnity insurance pays just enough money to you
to repair or replaced the insured property. For example, your homeowner's insurance
may cover your entire home and the contents of it. However,if your roof is damaged
in a storm, the policy only pays enough to repair the damage.
Benefits

The benefit of life insurance is that it pays off any financial obligations you have left
after you die. It can pay more than that, however, because life insurance pays a fixed
amount. Death benefits can be used to create wealth for the surviving beneficiaries, or
they can be used to replace the primary income earner's salary for a surviving spouse.

General insurance is beneficial in that the insurance ensures that, almost regardless of
the damage done, that the property will be repaired or replaced. While general insurance
generally has a maximum payout determined by the value of your property, it does not
pay a fixed amount, so you won't have to guess at how much insurance you need to
purchase.

Expert Insight

Both types of insurance are necessary to protect your life and your property. They each
serve a different function and fill specific roles in your insurance plan. When buying life
insurance, only buy enough insurance to cover your current and expected future
financial liabilities. When purchasing general insurance, the maximum coverage should
not extend beyond the total replacement value of your property.