The Concept of Insurance

The concept of insurance is as old a man kind. Its origin appears

simultaneously with the appearance of human society. From the
beginning of society protection has remained an important need of
human being.The man has always thought of protection of his life, his
family, his assets and his earning capacity. The owner of the asset has to
suffer heavy loss. Insurance is an arrangement of indemnify the loss or
risk caused by the perils to the property. Fire, flood, earthquake, theft
are the probable events and are called as 'perils. Risk means the
possibility of loss due to the perils which is unforeseen and loss may
occur or not. Uncertainty is an important aspect of risk.

Thus, insurance is contract in which persons exposed to similar risks

come together and decide among themselves, that the loss of any
person due to such risk shall be shared by all persons on some
equitable basis.

The concept of insurance can be understood better with the help of

following

examples.

Assume that there are 10,000 houses in a city and every year 10 houses
destroyed by fire. The amount of loss occurs due to fire is Rs. 1,00,000
per house. It

means the total estimated loss will be 1,00,000 x 10 = Rs.10,00,000. If

this loss is

divided into 10,000 house owners, the amount of share of each house
owner will br Rs.100. Thus, by contributing a small amount of Rs.100
every year all the 10,000 house owners get protection against the risk
of fire.

Definition :

There various definitions of insurance are given by experts. They can be

divided into two groups i.e. functional definition and contractual
definition. They are as follows;

Functional Definitions

1. Ghosh and Agrawal : Insurance is a cooperative form of distributing a

certain risk over a group of persons who are exposed to it.

2. Rock Fell :Insurance is source of distribution of loss of few persons

into many persons.

3. A.Z.Mayerson : Insurance is a device for the transfer to an insurer of

certain risks of economic loss that would otherwise come by the
insured.

4. Encyclopedia Britannica : Insurance may be described as a social

device whereby a large group of individuals, through a system of
equitable contributions, may reduce or eliminate certain measurable
risks of economic loss common to all members of the group

5. W. Beverideges: The collective bearing of risk is Insurance.

6. D.S.Hancsell : Insurance may be defined as a social device providing

financial compensation for the effects of misfortune, the payments
being made from the accumulated contribution of all parties
participating in the scheme.
Characteristics of Insurance

The analysis of above definitions explains the nature of insurance as

follows.

1. Insurance is a Contract

Insurance is a contract between two parties i.e. insurer and insured by

which the insurer, in consideration of insurance premium, agrees to
compensate the insured against certain probable risks. Since insurance
is a contract the provisions of Indian Contract Act viz. proposal,
acceptance, consideration, competency of parties lawful object etc. are
applicable to insurance contracts as well. It is a contract to pay
compensation on the happening of a certain event in the case of fire,
marine and general insurance. If there is no loss, no compensation is
paid and even no premium is returned to policyholder. But in case of life
insurance, insurance company pay certain sum of money on the death
of the insured person or if insured is alive, paid to them the amount of
premium with interest and bonus.

2. Means of Mutual help/ Cooperative device

All for one and one for all is the basis for cooperation. The insurance is a
strong cooperative device to spread the loss caused by a specific event.
Insurance is based on the principle of mutual help. Under this
arrangement persons exposed to same risks come together and create a
common fund and compensate the person who has actually suffered
the loss. People individually can not afford to bear the entire
loss.People individually cannot afford bear the entire loss.But jointly
they can get protection by contributing a small amount each to the
common fund.

In other words, insurance is a cooperative mechanism wherein large

number of persons comes together. They have similar risk and share the
loss by contributing a small amount in the form of premium.

3. Large number of Insured Person -

The insurance mechanism works on the principle of large number of

insured ersons. Insurance is spreading of loss over a large number of
persons. Larger th number of persons, lower the cost of insurance and
amount of premium. On the othe hand, lower the number of persons,
higher the cost of insurance and amount of premium.

4. Uncertainty of events:

The event to be insured must be uncertain and unforeseen. It may occur

or may not occur, e.g. every property insured for fire risk may be not
catches fire Insurance can be taken in case of uncertain events.. In life
insurance even though death of insured person is certain its timing is
uncertain. Hence life insurance is also a lawful agreement.

5. Protection of Financial Risk :

Insurance is a contract to indemnify the financial loss caused to the

insured property due to the specific risk during the period of insurance
contract. If the insured suffers no loss during this period he is not
entitled to receive any amount from the insurer. In other words,
insurance is a contract of indemnity and not a contract of profit. The
maximum amount of compensation is limited to the actual loss of the
property. Thus, the insured can not make any profit out of the loss
incurred. In other words an insurer is protected from financial risks
which are measured in terms of monetary values. Life insurance
contracts are an exception to the principle of indemnity. He can also
take life policies of any amount as the loss of death can not be
measured in monetary terms.

6. Based on certain principles and regulated by law -

Insurance business is regulated by certain act passed by central or state

government in every country. The life insurance is regulated by Life
Insurance Corporation of India Act 1956 whereas General Insurance is
regulated by General Insurance Business (Nationalization)Act 1972 In
India Insurance Regulatory and Development Authority (IRDA) is set up
in 1999 to regulate the Insurance business in the country. The insurance
business is stands upon certain principles such as insurable interest,
utmost good faith, indemnity, subrogation, causa-proxima,contribution
etc.

7. Sharing and transfer of risk :

Insurance is a social and economic device. It share the financial loss

occurred due to unforeseen events between the public who are
exposed to risk. Insurance is a plan to bear the risks and financial losses
occurs due to unexpected event. The death of the insured, fire losses,
marine perils, burglary, fidelity etc. may cause a tremendous loss to the
policy holder. The insurance shared this risk amongst all the insured in
the form of premium. That means the risk is transferred from one
individual (person to a group of person.

8. Valuation of Risk:

irst of all insurance company should evaluate the risk and finalize the
amot premium. Thereafter the insurance company enters into the
contract. It is the bas of charging premium which is depends upon the
risk. If risk is high the rate of premium becomes high. The risks involved
in the subject matter can be evaluated by several methods. The
procedure of valuation of risk is different in case of life, fire, marine and
accident insurance.

9. Payment of claim at contingency:

The insurance company is liable to pay compensation i.e. claim amount

only if certain unforeseen event takes place in case of fire, marine and
accident insurance. In other words if the unforeseen event occurs,
payment is made to policy holder.If contingency not take place, there is
no need to pay any amount of compensation to the insured. In case of
life insurance, the contingency i.e. death or the maturity of the policy
will certainly happen. In such case insurer is liable to pay the policy
amount on the death of the insured or on the expiry of the term
whichever is earlier.

10. Insurance is not Gambling or Wagering :

Insurance is a lawful contract. It transfers the risk of one person to

group of person. Under insurance contract policy holder paid
consideration in the form of premium. The insurance serves indirectly
to increase the productivity and converted the uncertainty into
certainty. Therefore insurance contract is not a gambling or wagering
contract. Persons involved in gambling or wagering bid and expose
themselves to risks of losing. There is no chance to convert risks or
losses into gains.In the game of gambling there may be either result into
profit or loss.

11. Insurance is not a charity but business :

The insurance is a business which provides protection to the life or

property from unforeseen event. However, insurance company collect
the amount of premium as a consideration form policy holders for the
cost of risk so covered. Charity is a payment without claiming anything
in return.
Need of Insurance

Life insurance is an intangible property and its need may not be realized

properly by the people / firms. It is, therefore, rightly said that

"Insurance is a subject matter of solicitation." The need and purpose of

insurance is explained below.

1. Provide Economic Protection :

Insurance provides economic protection to the people and their

property. Events like fire, flood, lightening, earthquake, theft,
breakdown in machinery may damage the property and cause financial
loss. The primary objective of insurance is to provide protection against
the financial loss of property due to specific risks. It should however, be
remembered that insurance does not protect the property from any risk
nor it can avoid the risk. It can also not reduce the loss. It only
indemnifies such financial loss. A fire insurance policy can not prevent
the occurrence of fire. It pays the amount of loss caused to the property
by fire.

2. Investment:

Another important purpose of life insurance is investment for meeting a

person's future needs such as education, marriage of children, provision
of income for old age etc. The small amount paid regularly as premium
for a certain number of years grows into a large investment in the long
run besides providing insurance protection. Thus, insurance helps to
generate investment through collection of small amount of premium
which fulfills the future economic needs of the people.

3. Tax Benefit :

Besides providing insurance protection to policyholder it also helpful to

get income tax relief in proportion of premium payment made during
the financial year.

So through insurance savings in income tax can be made. Thus, It gives

tax rebate to the insured and his tax liability is reduced.

3. Social Security:

In recent years the importance of insurance as a social security device

has increased significantly. The state is devising various insurance
schemes to provide protection to the economically and socially weaker
sections, rural people, farmers, workers and artisans at lower or
subsidized premium. The use of insurance as advice on social security
has helped the state to maintain social stability and peace reduce the
economic burden on the society and discharge its responsibility
towards society.

4. Business Needs:

Business also needs insurance protection. Insurance safeguards the

investment in business against various risks, ensures continuity of
operations, and thus .gives boost to business growth. It indemnifies the
loss of factory buildings, machinery, equipment, inventories and other
assets caused by fire, flood, earthquake, theft etc.

It also provides protection against the fraudulent acts, dishonesty or

misappropriation of money by the employees. Insurance can also be
taken for risks in foreign trade, fluctuations in foreign exchange rates,
political instability etc. Thus the economic tensions and fear of loss,
discontinuity of the business can be reduced.

5. Cover against uncertainty :

By providing financial support insurance system minimizes

uncertainties in business and human life. However, it should be noted
that, insurance does not protect the property from any peril or risk nor
avoid it. But, insurance only indemnifies the financial loss occur due to
unforeseen events. Thus, insurance provides coverage against
uncertainties.

6. Provision against unexpected death :

The life of person is full of uncertainties and risk. Due to unforeseen

incidents like early death life of person becomes end. Sometimes due to
accident life of person becomes non functional through partial or total
disabilities. Insurance system makes a provision to help dependents in
the form of financial compensation

8. To enhance labour welfare :

Insurance provides financial compensation to the employees or workers

getting injured if any unforeseen event takes place at the work place,
when they are at work.Insurance plays an important role as a tool to
increase labour welfare by making provision for payment of financial
assistance as compensation.

9. Medical Support :

Today pattern of life style is changed rapidly. Due to modernization and

industrialization the level of environment pollution is increased
tremendously. It increases the health risk. Anyone can be a victim of
critical illness. However, medical care has become unaffordable.
Medical insurance is one of the ways to fulfill different type of health
risk. Insurance provides medical support to policy holder through
medical insurance policy.

10. Helpful to business organization:

There are chances of loss of business, factory building, vehicles,

computers. machinery, equipment's, raw material, finished goods etc.
caused by fire, flood, earthquake, theft etc. In such case business
organization needs insurance protection.

Insurance provides assurance to the business organizations to

safeguard the investment against such risk by indemnifying the loss. It is
helpful to business organizations to make attention on only on business
activities and to enhance the business.

11. Useful to partnership firm :

In partnership firm, if any partner dies, it is the responsibility of other

partners to pay share of expired partner to his legal heirs. It may likely
to be close down the business. In such case insurance provides the
amount of compensation to the legal heirs of deceased partner:

12. Encourages Savings:

Insurance develops a habit of savibg among citizens.it encourages

people to make systematic savings through payment of regular
premium.The insured get lump sum amount at the maturity of policy.

The Economic and Commercial Significance of Insurance

The significance of insurance in the life of a person has increased over
the years with increase in the risks and uncertainties. The significance of
insurance can be discussed through various views like economic,
commercial or social. It is as follows;

A) Economic Significance of Insurance

The economic significance of insurance may be explained with the help

of following points.

1. Encouragement to saving:

Insurance encourages to people to make systematic savings through

payment of regular premium. The regular payment of premium develops
a habit of saving among citizens in the country.. The small savings of
millions of insured persons results into a huge amount of national
savings.

2. Generation of Employment :

Insurance business has a tremendous capacity of generating

employment both directly and indirectly in the country. It provides
employment to millions of people in administrative and development
department. Insurance business generates direct employment in the
form of agents, advisors, surveyors, development officers,
administrative staff etc.Besides these direct employment opportunities,
the real estate, information technology and other services are also
increased due to protection of insurance which enhanced their
employment capacity.

3. Infrastructure development:

The development of economy is mostly depending upon development

of basic infrastructure such as electricity, water supply, transportation
facilities and communication. Insurance companies provide funds to
development of these basic needs in the form of share capital, loans
and advances. Thus, the rapid development of infrastructural facilities
in the country is the output of insurance.

5. Facilitates agriculture and rural development:

India is an agriculture country. Indian agriculture is mostly depends

upon regularity of monsoon. Therefore, there may be losses caused by
heavy rain, drought. flood, wind, pests and diseases. Through crop
insurance such losses are compensated by insurance. Besides this they
can provide protection to the farmers and their assets as like
agriculture, poultry, cattle, horticulture, sericulture, agricultural pump
sets. farm equipment's etc. Insurance make available the funds for
construction of wells and irrigation schemes. Insurance Regulatory and
Development Authority (IRDA) has made it obligatory to the insurance
company to conduct insurance business to certain extent every year in
rural area. Thus, insurance companies can contribute significantly to the
development of rural areas.

6. Increase in foreign exchange reserves:

By doing business in various countries, insurance companies can earn

valuable foreign currency to the country. It helps to increase the foreign
exchange reserves. It facilitates to meet import requirement of the
country.

7. Facilitates the development of capital market:

The contribution of insurance companies in the development of capital

market in the country is significant. They can invest large amount of
funds in state and central governments securities. The insurance
companies have started issuing unit linked insurance policies. These
schemes provide more attractive benefits to the policy holders. Thus,
insurance helps in development of capital market.

B) Commercial Significance of Insurance:

1. Business continuity :

In a partnership firm, if any partner retires or dies, the continuing

partner should repay the dues and share of such partner. Insurance
helps to pay the share and other due of such partner and remaining
partners may continue their business.

Besides, insurance protects the life of persons and their assets against
several risks. Losses occur due to unforeseen incidence can be
compensated by insurance. Thus, insurance safeguard the business and
ensures business stability.

2. Development of Trade and Industry:

The huge funds collected by insurance companies in the form of

premium are mobilized to the trade and industrial sector. Insurance
companies invest these funds in industrial sector in the form of share
capital, loans and advance. It is helpful to traders and industrialist to
undertake new projects and enter into new business. It accelerates the
trade and industrial development. Besides, the uncertainties in
business are reduced considerably by the insurance arrangement. It
helps to the business people to reduce difficulty or tension in expanding
their business. Thus the business activities get encouragement to go
further.

3. Encourages development of aids to trade/ service sector:

Basically, the development of trade and industry is depends upon

development of aids to trade such as transport facilities, banks,
warehouses, communication etc.

Today service sector emerged as a pillar of nation building. The growth

of service sector increased with simultaneous development of trade
and industry. Insurance helps to develop such aids to trade by giving
assurance the payment of compensation if loss occurs due to
unexpected incidents. In addition to that insurance provides financial
helps to develop these services in the country.

4. Promote foreign Trade :

Insurance plays important role in developing international trade by

promoting foreign trade. Generally foreign trade i.e. export trade carried
out through marine voyage. In marine transport tremendous risk is
involved such as vessel crash, sinking of vessel, robbery, fire, jettison
war perils, cargo or vessel seized by enemy etc..

Huge loss may occur due to such perils. Insurance assures to

compensate if loss occurs and provide protection from these perils.
Thus, insurance helps to promote export i.e. foreign trade.

5. Promotes foreign trade:

Insurance encourages foreign trade in a number of ways. It can provide

protection against various marine perils, fluctuation in the exchange
rate, export risks and loss in air transport etc. Infact marine insurance
has been the oldest form of insurance. Most of the foreign trade is
conducted through marine transport and is exposed to marine perils
and losses.

6. Insurance of Key men/ Key Personnel:

Key men of the business are the assets of the organization. The key man
is the man whose capital, experience, goodwill, ability to control,
devotion etc. make him the most valuable asset of the business. The
absence of such key man may reduce the profit considerably. The
experience and ability of key men helps to carry out business efficiently
and effectively. By insuring the lives of keymen in business the
continuity of business operation can be guaranteed If the keyman
running the business, especially in case of proprietary business or other
key officers on whom the business depends, die unexpectedly or leave
the firm the future of business is endangered. In such case, insurance
provide the compensation to the dependents and helps to cover the
loss by taking out key men insurance policy.

6. Employee welfare and protection of interest:

According to various labour laws, business firms have to provide

provident fund, gratuity, pension and other welfare facilities to
employees. In addition to that, the employees are motivated by
providing bonus and awarding rewards by the organization. Hence,
employer has taking out a group insurance policy of all employees by
paying premium on behalf of employee. Insurance mechanism
facilitates the prompt payment of these liabilities and protects the
interest of the worker.

7. Helps to increase business efficiency:

Business entities are full of risks and uncertainties. There may be

chances of losses occur to the property due to damages, fire, accident,
theft etc. Insurance provide protection to these property by payment of
compensation. It enables to rearrange the business organization. Due to
this, the owners of the business are free from the worries of business
losses. They can concentrate in business activities and maximization of
profit. Thus, insurance helps to increase business efficiency.
9. Provision of Statutory liabilities:

The business entities imposed number of statutory liabilities under

various laws e.g. workmen's compensation liability, product liability,
professional liability consumer protection act, corporate social
responsibility etc. Adequate provision of the raint a mad i aig to i alies
ts, busines people

10. Reduction of loss Probability:

Insurance can help the insured by suggesting him ways and means of
reducing the probability of loss to the assets to be insured. Their
technical persons and surveyors inspect the assets before accepting
the risk and recommend the precautions to be taken for loss reduction
and better functioning. By adopting these measures the insurance
premium can be reduced.

11. Increase in the value of assets:

The insurance of assets increases their value as collateral security.

Banks and other financial institutes are willing to provide more loans
against the security of these assets. Thus, the borrowing capacity of
business increases. The risk of loosing money is less in case of these
assets.

12. Loss prevention measures:

The insurance not only grants protection against loss of assets due to
specific risks but also suggests measures for loss prevention and
minimization. In India Loss Prevention Association is set up for this
purpose.