Meaning of Insurance
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. Premium is collected by insurance companies which also act as trustee to the pool. Any loss to the insured in case of happening of an uncertain event is paid out of this pool.
Insurance works on the basic principle of risk-sharing. A great advantage of insurance is that it spreads the risk of a few people over a large group of people exposed to risk of similar type.
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'.
Concept of Insurance / How Insurance Works
The concept behind insurance is that a group of people exposed to similar risk come together and make contributions towards formation of a pool of funds. In case a person actually suffers a loss on account of such risk, he is compensated out of the same pool of funds. Contribution to the pool is made by a group of people sharing common risks and collected by the insurance companies in the form of premiums.
Lets take some examples to understand how insurance actually works: |Example 1 |Example 2 | |SUPPOSE |SUPPOSE | |Houses in a village = 1000 |Number of Persons = 5000 | |Value of 1 House = Rs. 40,000/- |Age and Physical condition = 50 years & Healthy | |Houses burning in a yr = 5 |Number of persons dying in a yr = 50 | |Total annual loss due to fire = Rs. 2,00,000/- |Economic value of loss suffered by family of each dying person = | |Contribution of each house owner = Rs. 300/- |Rs. 1,00,000/- | | |Total annual loss due to deaths = Rs. 50,00,000/- | | |Contribution per person = Rs. 1,200/- | |UNDERLYING ASSUMPTION |UNDERLYING ASSUMPTION | |All 1000 house owners are exposed to a common risk, i.e. fire |All 5000 persons are exposed to common risk, i.e. death | |PROCEDURE |PROCEDURE | |All owners contribute Rs. 300/- each as premium to the pool of |Everybody contributes Rs. 1200/- each as premium to the pool of | |funds |funds | |[pic] |[pic] | |Total value of the fund = Rs. 3,00,000 (i.e. 1000 houses * Rs. |Total value of the fund = Rs. 60,00,000 (i.e. 5000 persons * Rs. | |300)...