INSURANCE: CONCEPT, FUNCTION AND IMPORTANCE

Different terms are used in the theory and practices of Insurance. Important among them are given
below:
1) 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 an insurance policy holder.
2) 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.
3) UNDERWRITER
An insurer or an official in an insurance company whose main responsibility is to accept risks.
4) 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.
5) CONCRACT
An agreement binding at law (enforceable by law) between two or more parties is called contract.
6) 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.
7) 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.
8) PERIL
A peril is an event that causes a personal or property loss by fire, windstorm, explosion, collision
premature death, sickness, floods, dishonesty etc.
9) EXCEPTION
A peril specifically excluded from the scope of a policy is called exception.
10) HAZARD
Hazard is a condition that may create, increase or decrease the chances of loss from a given peril.
11) 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.
12) CHANCE OF LOSS
It is the probable number of times in any given number of that loss will occur. The highest chance
of loss is 100 percent that means the loss is certain. When the chance of loss is zero, the degree of
risk is also zero.

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MEANING AND CONCEPT OF INSURANCE

Life is a roller coaster ride and is full of twists and turns. Human life is exposed to many risks,
which may result in heavy financial losses. Insurance is one of the devices by which risks may be
reduced or eliminated in exchange for premium. Insurance policies are a safeguard against the
uncertainties of life. As in all insurance, the insured transfers a risk to the insurer, receiving a policy
and paying a premium in exchange. The risk assumed by the insurer is the risk of death of the
insured in case of life insurance.
Insurance policies cover the risk of life as well as other assets and valuables such as home,
automobiles, jewelry etc. On the basis of the risk they cover, insurance policies can be classified
into two categories:
(a) Life Insurance
(b) Non-Life Insurance or General Insurance
Life insurance products cover risk for the insurer against eventualities like death or disability. Non-
life insurance products cover risks against natural calamities, burglary, etc.
Insurance is system by which the losses suffered by a few are spread over many, exposed to similar
risks. With the help of Insurance, large numbers of people exposed to a similar risk make
contributions to a common fund out of which the losses suffered by the unfortunate few, due to
accidental events, are made good. Insurance is a protection against financial loss arising on the
happening of an unexpected event. Insurance policy helps in not only mitigating risks but also
provides a financial cushion against adverse financial burdens suffered.

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. Insurance is also defined as a social device to accumulate funds to
meet the uncertain losses arising through a certain risk to a person injured against the risk. Insurance
provides financial protection against a loss arising out of happening of an uncertain event. A person
can avail this protection by paying premium to an insurance company. A pool is created through
contributions made by persons seeking to protect themselves from common risk. Any loss to the
insured in case of happening of an uncertain event is paid out of this pool. Life insurance has come
a long way from the earlier days when it was originally conceived as a risk-covering medium for
short periods of time, covering temporary risk situations, such as sea voyages. As life insurance
became more established, it was realized what a useful tool it was for a number of situations that
includes temporary needs, threats, savings, investment, retirement etc. 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'.
The definition of insurance can be seen from two view points:
(a) Functional Definition
(b) Contractual Definition
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(a) Functional Definition
Insurance is a co-operative device of distributing losses, falling on an individual or his family over
large number of persons each bearing a nominal expenditure and feeling secure against heavy loss.

(b) Contractual Definition

Insurance may be defined as a contract consisting of one party (the insurer) who agrees to pay to
other party (the insured) or his beneficiary, a certain sum upon a given contingency against which
insurance is sought.
Insurance is a contract in which a sum of money is paid by the assured in consideration of the
insurer's incurring the risk of paying larger sum upon a given contingency.
In its legal aspects it is a contract whereby one person agrees to indemnify another against a loss
which may happen or to pay a sum of money to him on the occurring of a particular event.
Insurance is based upon:
(a) Principles of Co-operation
(b) Principles of Probability

(a) Principles of Co-operation

Insurance is a co-operative device. If one person is providing for his own losses, it cannot be a
strictly insurance because in insurance the loss is shared by a group of persons who are willing to
co-operate. Insurance is a co-operative endeavour. People, who are exposed to similar risks come
together and pool up a fund out of which the loss suffered by a single person is met. Pooling of risks
and resources is the essence of insurance.
(b) Principles of Probability
The loss in the form of premium can be distributed only on the basis of theory of probability. The
chances of loss are estimated in advance to affix the amount of premium. Since the degree of loss
depends upon various factors, the affecting factors are analyzed before determining the amount of
loss. With the help of this principle, the uncertainty of loss is converted into certainty. The insurer
will not have to suffer loss as well as gain windfall. Therefore, the insurer has to charge only so
much of amount which is adequate to meet the losses.
The insurance, on the basis of past experience, present conditions and future prospects, fixes the
amount of premium. Without premium, no co-operation is possible and the premium cannot be
calculated without the help of theory of probability, and consequently no insurance is possible.

NATURE AND CHARACTRISTIC OF INSURANCE:

Insurance contracts like other contracts are governed by the general principles of the law of contract
as codified in the Indian contract act 1872, which prescribed the following essential elements in
order for contract to be legally valid:
a) Offer and acceptance
b) Consideration
c) Agreement between parties
d) Capacity of the parties
e) Legality of the contract

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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) 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.
6) AMOUNT OF PAYMENT
The amount of payment in indemnity insurance depends on the nature of losses occurred, subject to
a maximum of the sum insured. In life insurance, however, a fixed amount is paid on the happening
of some uncertain event or on the maturity of the policy.
7) 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.
8) TRANSFER OF RISK
Insurance is a plan in which the insured transfers his risk on the insurer. This may be the reason that
Myerson observes, that insurance is a device to transfer some economic losses would have been
borne by the insured themselves.
9) SPEADING 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”.
10) PROTECTION AGAINST RISKS
Insurance provides protection against risk involved in life, materials and property. It is a device to
avoid or reduce risks.
11) 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.

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12) 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.
13) 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”.
14) BASED UPON CERTAIN PRINCIPLE
Insurance is a contract based upon certain fundamental principles of insurance, which includes
utmost good faith, insurable interest, contribution, indemnity, cause proxima, subrogation etc,
which are operating in the various fields of insurance.
15) 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.
16) WIDE SCOPE
The scope insurance is much wider and extensive various types of policies have been developed in
the country against risk of fire, marine, accident, theft, burglary, life, etc.
17) INSTITUTIONAL SETUP
After nationalisation, the insurance business in the country is operation under statutory organization
setup. In India, the General Insurance Companies and the Life Insurance Corporation and subsidiary
companies of General Insurance Corporation are operating the various fields of insurance.
18) INSURANCE 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. Speculative
risks have chances of profit of losses.
19) 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:
The functions of Insurance can be bifurcated into three parts:
(a) Primary Functions
(b) Secondary Functions

(a) Primary Functions

The primary functions of insurance include the following:
 Provide Protection
The primary function of insurance is to provide protection against future risk, accidents and
uncertainty. Insurance cannot check the happening of the risk, but can certainly provide for losses
of risk. Insurance is actually a protection against economic loss, by sharing the risk with others.
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 Assessment of risk
Insurance determines the probable volume of risk by evaluating various factors that give rise to risk.
Risk is the basis for determining the premium rate also.
 Collective bearing of risk
Insurance is a device to share the financial loss of few among many others. Insurance is a mean by
which few losses are shared among larger number of people. All the insured contribute premiums
towards a fund, out of which the persons exposed to a particular risk, are paid.
 Savings and investment
Insurance serves as a tool for savings and investment, insurance is a compulsory way of savings and
it restricts the unnecessary expenses by the insured. For the purpose of availing income-tax
exemptions, people invest in insurance also.
(b) Secondary Functions
The secondary functions of insurance include the following:
 Prevention of Losses
Insurance cautions individuals and businessmen to adopt suitable device to prevent unfortunate
consequences of risk by observing safety instructions; installation of automatic sparkler or alarm
systems, etc. Reduced rate of premiums stimulate more business and better protection to the
insured.
 Small capital to cover large risks
Insurance relieves the businessmen from security investments, by paying small amount of premium
against larger risks and uncertainty.
 Contributes towards the development of large industries
Insurance provides development opportunity to large industries having more risks. Even the
financial institutions may be prepared to give credit to sick industrial units which have insured their
assets including plant and machinery.
 Source of Earning Foreign Exchange
Insurance is an international business. The country can earn foreign exchange by way of issue of
insurance policies.
 Risk Free Trade
Insurance promotes exports insurance, which makes the foreign trade risk free with the help of
different types of policies under marine insurance cover.
IMPORTANCE OF INSURANCE:
The process of insurance has been evolved to safeguard the interests of people from uncertainty by
providing certainty of payment at a given contingency. Insurance not only serve the ends of
individuals, or of special groups of individuals, it tends to pervade and transform our modern social
order, too. The role and importance of insurance, here, has been discussed from an individual,
business and society’s view:
(A) Individual
 Insurance provides security and safety
Insurance provides safety and security against the loss on a particular event. In case of life
insurance, payment is made when death occurs or the term of insurance expires. The loss to the
family at a premature death and payment in old age are adequately provided by insurance.

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In other words security against premature death and old age sufferings are provided by life insurance.
In other insurance, too, this security is provided against the loss at a given contingency. for eg.
property of insured is secured against loss due to fire in fire insurance.
 Insurance affords peace of mind
Insurance provide security which is the prime motivating factor. It tends to stimulate an individual
do more work.
 Insurance protects mortgaged property
At the death of the owner of the mortgaged property, the property is taken over by the lender of
money and the family is deprived of the use of the property. On the other hand, the mortgagee
wishes to get the property insured because at the damage or destruction of the property he may lose
his right. Insurance provides adequate amount to the dependents at the early death and the property-
owner to pay off the unpaid loans. Similarly, the mortgagee gets adequate amount at the loss of the
property.
 Insurance eliminates dependency
At the death of the husband or father or earning mother, the loss to the family needs no elaboration.
Similarly, at destruction of property and goods, the family would suffer a lot. The economic
independence of the family is reduced or, sometimes, lost totally. Insurance tries to eliminate
dependency.
 Life Insurance encourages saving
The elements of protection and investment are present only in case of life insurance. In property
insurance, only protection element exists. In most of the life policies elements of saving
predominates. Systematic saving is possible because regular premiums are required to be
compulsorily paid. In insurance the deposited premium cannot be withdrawn easily before the
expiry of the term of the policy. The compulsion to pay premium in insurance is so high that if the
policy-holder fails to pay premiums within the days of grace, he subjects his policy to lapse and
may get back only a very nominal portion of the total premiums paid on the policy. For the
preservation of the policy, he has to try his level best to pay the premium.
 Life Insurance provides profitable investment
Individuals unwilling or unable to handle their own funds are pleased to find an outlet for their
investment in life insurance policies. The elements of investment i.e. regular saving, capital
formation, and return of capital along with certain additional return are perfectly observed in life
insurance. Life insurance fulfils all these requirements at a low cost.
(B) Business
 Business efficiency is increased with insurance
When the owner of a business is free from the botheration of losses, he will certainly devote much
time to the business. The carefree owner can work better for the maximization of the profit. The
new as well as old businessmen are guaranteed payment of certain amount with the insurance
policies at the death of the person; at the damage, destruction or disappearance of the property or
goods. The uncertainty of loss may affect the mind of the businessman adversely. Insurance
removes the uncertainty and stimulates the businessmen to work hard.

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  Enhancement of Credit
Business can obtain loan by pledging the policy as collateral for the loan. And persons can get more
loans due to certainty of payment at their deaths. The insurance properties are the best collateral and
adequate loans are granted by the lenders.
 Business continuation
In partnership, business may discontinue at the death of any partner although the surviving partners
can re-start the businesses, but in both the cases the business and the partners will suffer
economically. Insurance policies provide adequate fund at the time of death. Each partner may be
insured for the amount of his interest in the partnership and his dependents may get that amount at
the death of partner. With the help of property insurance, the property of the business is protected
against disasters and the chance of disclosure of the business is reduced.
 Welfare of Employee
The welfare of employees is the responsibility of the employer. The former works for the latter.
Therefore, the latter has to look after the welfare of the former which can be provision for early
death, provision for disability and provision for old age. These requirements are easily met by the
life insurance, accident and sickness benefit and pensions which are generally provided by group
insurance. The premium for group insurance is generally paid by the employer. This plan is the
cheapest form of insurance for employers to fulfill their responsibilities. The employees will devote
their maximum capacities to complete their jobs when they are assured of the above benefits. The
struggle and strife between employees and employer can be minimized easily with the help of such
schemes.
(C) Society
 Wealth of the society is protected
The loss of a particular wealth can be protected with insurance. Life insurance provides for loss of
human wealth. The human force, if it is strong, educated and care-free, will generate more income.
Similarly, the loss of damage of property at fire, accident etc., can well indemnified by property
insurance , cattle, crop, profit and machines are also protected against their accidental and
economical losses. With the advancement of the society, the wealth or the property of the society
attracts more hazard and so new types of insurance are also invented to protect them against
possible losses. Through the prevention of economic losses, insurance protects the society against
degradation. Through stabilization and expansion of business and industry, the economic security is
maximized. The present, future and potential human and the property resources are well protected.
(D) Nation/ country
 Economic Growth of the country
For the economic growth of the country, insurance provides protection against loss of property and
adequate capital to produce more wealth. Welfare of employees creates a conductive atmosphere to
work. Adequate capital from insurers accelerates production cycle. Similarly in business, too, the
property and human materials are protected against certain losses; capital and credit are expanded
with the help of insurance. Thus, the insurance meets all the requirements for the economic growth
of a country.
 Development of capital markets
Insurance companies invest the premiums collected by them in the capital markets and provide
stimulus for the growth of capital markets. However for ensuring life insurance an important vehicle
for savings mobilization and sustain the capital markets, there is a need of flexible regulations for
investment of funds by life insurance companies and also the availability of wide spectrum of
financial instruments.
THESE NOTES ARE ONLY FOR REFERENCE. IT IS SUGGESTED TO GO THROUGH
THE CLASS NOTES AND BOOKS ALSO.
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