Describe the concept of insurance.

Human life and properties are always exposed to risk and uncertainties. Such risks and uncertainties may

cause great loss to human beings. Risk cannot be completely eliminated but there is a device to cover the

loss of the financial risk, which is known as insurance. In this modern generation, insurance had become

an essential tool to manage the risks of an individuals the corporation.

Insurance can be defined as the act of providing indemnity or coverage against harm, as per the contract.

Insurance is a legal contract that protects people from the financial losses. It protects from the risk of

person and business. Insurance is an economic institution that allows the transfer of financial risk from an

individual to a group by the means of a two-party contract. It is a contract between the insurer and insured

in which the insurer promises to pay the financial loss to the insured. Such contract is known as an

insurance policy.

According to M.N. Mishra, "Insurance is a cooperative device to spread the loss caused by a particular

risk over a number of persons, who are exposed to it who agree to insure themselves against the risk."

According to John H. Magee, "Insurance has been defined as a plan by which a large number of people

associate themselves and to the shoulders of all, the risk that attached to individuals."

Likewise, Insurance is a legal contract in which an individual receives financial protection against losses

from an insurance company. In the modern age, insurance has become an essential tool to manage the

risks of an individual and the corporations.

Explain the importance of insurance.

The insurance provides a safeguard against uncertainties and risk. It is important for individuals as well

as for institutions due to the following reasons.

1. Insurance provides security

The Businessman should not have worry about the losses or damages at the time of loss in their property

if they are duly insured. Insurance provides financial protection to business assets and properties against

the risk of theft, fire accidents or any other natural calamities. Insurance keeps the person free from

tension, fear and worries of various risks.

2. Insurance reduces business risk or losses

In Business, commerce and industry, huge properties are employed. The property may be turned into

ashes due to the slight negligence. A person may not be sure of his life and health. It is impossible to

eliminate risk and uncertainty completely. Insurance is a cooperative effort of sharing risk. Thus, the

impact of risk can be reduced through the distribution of risk.

3. Insurance provides mental peace

Insurance provides mental peace to the insured. It removes tension, fear, and anxiety associated with

risks and uncertainties. An individual can devote himself to achieve efficiency in economic activities due

to the peaceful state of mind.

4. Insurance maintains your family’s standard of living

Insurance provides financial protection against unexpected risk. Due to the financial protection of life and

property, insurance avoids the unfortunate financial crisis of an individual and his family. The insured

helps the individual to maintain his standard of living even in old age.

5. Generates financial resources

Insurance generates funds by collecting the premium. The funds are invested in government securities

and stock. These funds are gainfully employed in the industrial development of a country for generating

more funds. It can be utilized for the economic development of the country. Employment opportunities are

increased by big investments that lead to capital formation.

6. Life insurance encourages savings

Insured should pay the amount of premium regularly. It develops the habit of saving. The deposited

premium cannot be withdrawn like a bank deposit. Life insurance is the best medium of saving and

investment. It is a good means to make provision for retirement age.

7. Promotes foreign trade:

Foreign trade is relatively riskier than domestic trade. There ae different types of risk in transit like marine

perils, explosion, terrorism etc. Insurance provides protection and covers the loss of such risks and thus

promotes foreign trade.

8. Medical support

A medical insurance is considered as an essential element in managing risk in health. Anyone can be a

victim of critical illness unexpectedly. Rising medical expense is of great concern. Medical Insurance is

one of the insurance policies that cater for differently.

9. Reduce inflation

Premium collected by the insurance company reduces the supply of money. On the other hand, the

collected fund can be invested in productive purpose. Such investment helps in increasing production and

decreasing the impact of inflation in the country.

10. Employment opportunities

Insurance companies need different types of personnel with distinct skills, experiences, and academic

qualifications. They provide employment opportunities to the people of the country. So, hundreds of

people are engaged in insurance business.

What are the major essential elements of insurance?

The essential elements of insurance are listed below:

1. Agreement

The agreement means communication by the parties with one another. There must be an offer and

acceptance of the terms and conditions of the insurance contract. The acceptance or rejection of an offer

is made by the insurer. The insurance contract becomes valid after the issuance of acceptance notice by

the insurer to the insured.

2. Free consent

The parties involved in a contract are said to consent freely when they agree upon the same thing in

same sense. There must be free consent between the two parties in the contract. The consent is free

when the contract is not made by coercion, undue influence, fraud or misrepresentation or mistake.

3. Competent to contract

The parties to the contract should be competent to enter into contracts. Every person is competent to

contract who is of the age of majority according to the law and who is of sound mind and is not

disqualified from by any law. The insurer must also be legally competent. The insurer must have license

to sell the insurance contract.

4. Increase self-respect

There is the direct connection between self-respect and independence of a person in the society.

Insurance supports to the person to be independent. It provides economic support to an individual,

businessman which helps to increase the self-respect of the person in the society.

5. Legal consideration

In every contract, there should be a legal consideration. In an insurance contract, payment of premium is

taken as a valid consideration. Without payment of premium, the insurance contract cannot be initiated.

6. Compliance with legal formalities

In the contract of insurance, the agreement between parties must be in written form and signed by both

the parties. It must be properly tested by the witness and registered otherwise; it may not be enforced by

the court.

7. Certainty

The terms and conditions of a contract should be clear and certain. They should be clearly understood by

both the parties. In insurance, the insurance company gives printed policy document which contains all

the terms and conditions of the policy.

8. Insurable interest

Insurable interest refers that the insured must suffer if the loss takes place in the property. In case of the

property interest, ownership of property can support to insurable interest but in the case of life insurance,

close family ties or marriage will satisfy the requirement of insurable interest.

9. Encourage saving

The insurance should pay the amount of premium regularly and compulsorily. It develops the habit of

saving. The deposited insurance premium cannot be withdrawn like a blank deposit. Life insurance is the

best method of saving an investment. It is a good meant to make provision for retirement age.

10. Writing and registration

The insurance contract must be in writing and duly signed, stamped and registered. The condition is

fulfilled as the proposer signs in a printed proposal form. The insurance company issues the policy

document properly signed and stamped.

Explain the principle of insurance.

The principles of insurance are listed below:

1. Principle of nature of contract

Nature of contract is a fundamental principle of an insurance contract. An insurance contract comes into

existence when one party makes a proposal of a contract and the other party accepts the proposal. A

contract should be simple to be a valid contract. The person who is entering into a contract should enter

with his free consent.

2. Principle of utmost good faith

An insurance contract is based on the principle of utmost good faith. Under this insurance contract both

the parties should have faith over each other. They must behave or act in utmost good faith. It means that

they should disclose all material facts or information fully and truly at the time of entering into a contract.

3. Principle of insurable interest

Under this principle of insurance, the insured must have an interest in the subject matter of the insurance.

In the absence of insurable interest, no one can get a property insured and can claim the compensation

of loss from the insurance company by destroying property.

4. Principle of indemnity

The principle of indemnity the insurer makes compensation to the insured against the loss in financial

terms. This principle clarifies that the insurance is only for compensation of loss but not for any financial

benefits. It means compensation given to the insured can never be more than the actual loss of the

property.

5. Principal of mitigation

According to this principle, it is the duty of the insured to make every effort and to take all possible steps

to minimize the loss in the event of an accident. He must do his best to minimize the damage and save

the property from damage.

6. Double insurance

Double insurance denotes the insurance of same subject matter with two different companies. It is the

same company under two different policies. A double insurance policy is adopted where the financial

position of the insurer is doubtful. Here, the insured cannot recover more than the actual loss and cannot

claim the whole amount from both the insurers.

7. Principle of proximate cause

The Proximate cause literally means the ‘nearest cause’ or ‘direct cause’. This principle states that if the

loss is caused by two or more than two reasons, then it becomes necessary to identify the nearest cause

of the loss. The insurance company is not liable to compensate the loss caused by remote cause.

8. Principle of subrogation

This principle of subrogation strongly supports the principle of indemnity. Subrogation is the right of the

subject matter of insurance gets to be transferred from insured to the insurance company after indemnity.

9. Principle of contribution
The principle of Contribution allows insurance companies to share the cost of claims and prevents an

insured from collecting in full on more than one policy. This principle exists when the insured can insure

the same property within more than one insurance company. It states that if a person takes insurance

policy from more than one insurance company for a single property than the insured will be paid the

actual loss by these insurance companies in the ratio of the value of policy issued by them.

What are the types of policies of insurance?

The different types of life insurance include the following policies.

1. Term Life Insurance

Term insurance provides protection for a specified period of time. This period can be for one year or

provide coverage for a specific number of years such as 5, 10, 20 years. It refers longer the guarantee,

the higher the initial premium. If a person dies during the term period, the company will pay the face

amount of the policy to his beneficiary. If he lives beyond the term period he had selected, no benefit is

payable. According to the rule, the term policies offer a death benefit with no savings element or cash

value. This policy has some basic features, which are given as follows:

a) Temporary protection

The temporary protection of this policy may be 1 year, 5 years, 10 years or 20 years. The protection

expires at the end of the period unless the policy is renewed.

b) Convertible

Most of the policy can be convertible which means the term policy can be exchanged. The policies may

be exchanged for a cash- value policy without evidence of insurability.

c) Renewal

The policy can be renewed for the additional period without evidence of insurability. Most of the term

policies are renewal.

d) No cash surrender value

The term policy provides protection after the death of insured in a specified time period. It does not

provide amount after the period expired.

2. Whole life policy

The Whole life policy is a type of permanent insurance. It is combine life coverage with an investment

fund. It provides for the payment of the fresh amount of the policy on the death of the insured to his/her

nominee. The premium of the life insurance is made during the entire life time of the insured. Generally,

this policy is a policy purchased by the person to protect the family or dependents. The amount of

premium of this policy is lower as compared to other policies.

There are three types of whole life insurance which are as follows:

a) Ordinary whole life policy

Ordinary whole life is a form of whole life insurance that provides life time protection to the insured. This

policy is useful to provide lump sum continuing income to beneficiaries.

b) Limited payment whole life insurance

Whole life insurance provides lifetime protection with the single premium. The insured also has life time

protection, but the premiums are paid for a limited period such as 10, 20, or 30 years, until age 65.

c) Convertible whole life insurance

The main purpose of convertible whole life policy is to provide maximum protection at minimum cost. It

brings flexibility in life insurance.

3. Endowment policy

An endowment policy is insurance contract designed to pay a lump sum after a specific term or on death.

Here, the maturities are 10, 15 or 20 years up to a certain age limit. An endowment is payable at the

death of the insured or on a specified maturity death if the insured survives to the end of the endowment

period. The face amount of insurance is paid to the policyholder at that time. The insured pays the

premium for a fixed period of maturity to the end of the endowment period. This types of policy has higher

rate of premium but offers both investment and protection advantage.

a) Ordinary endowment policy

This policy is purchased for a fixed period of time. The premium is to be paid till the maturity of

endowment period or up to the time of the death of the insured.

b) Double endowment policy

Double endowment is the policy at which double of policy amount is payable to insured if he survives to

the end of endowment period.

c) Joint life endowment policy

In this policy, the amount is paid to the survivor after the death of the person. If both of them are alive until

the policy period, the amount is refunded. It is generally purchased by the married couple.

d) Pure endowment policy

In this policy, the insured amount is payable to the policyholder only if he survives till the maturity of the

policy. If the policyholder dies before the maturity of the policy, the insured amount is not payable by the

insurance company.

e) Deferred endowment policy

In this policy, the insured amount is payable only at the end of the endowment period even the insured

dies prior to the maturity.

4. Unit Linked Insurance Plans

A unit-linked insurance plan is a type of insurance vehicle in which net asset values are purchased by the

policyholder. It helps to provide an option to invest in any number of qualified investments, such as stock,

bonds or mutual funds. In certain areas, ULIPs differ from traditional endowment plans. As the name

suggests, the performance of ULIP is linked to markets. Individuals can choose the allocation for

investments in stock or debt markets. The value of the investment portfolio is captured by the net asset

value.

5. Money Back Policy

In a money back plan, the insured person gets a percentage of sums assured at regular intervals. The

person will not get the lump sum amount at the end of the term. In this Policy, the sum assured by the

company will be paid in installments at periodic intervals. However, the full sum of assured is payable

without any deduction in the event of death. The bonus additions to the policy will be reckoned and they

are payable at the end of the selected term of years or at the Life Assured's death.
Understanding Risk
(Nature and Type of Risk)

Definitions

- Risk is a condition in which there is a possibility that something unpleasant or dangerous

might happen.
- Exposure to adverse situations or chances of happening of unhappening things.
- Dispersion or deviations from the expectations.
- Chances or possibility of loss or uncertain situations.

Major Elements of Risks

- Outcome is uncertain
- At least two possible outcomes
- One is unfavorable

Loss and Chances of Loss

Loss: Portion of the expired cost

Chances of Loss (in Insurance): Probability of Loss

The whole game of Insurance Business is based on probability of loss. If insurer estimates
correctly, he wins else close the business.

Probability of loss is based on 2 elements

- Perils: Immediate causes of loss (Ex: Losses by fire)
- Hazards : Conditions that increase the severity of loss (Ex: stocking of crackers)
Hazards has two types
– Physical Hazard – like parking of vehicle without lock etc.
– Intangible Hazard – it is attitude and culture and more is psychological
It has again three types:
- Moral Hazard –Fraud – putting fire in loss making unit
- Indifference Hazard – carelessness
- Societal Hazard – Legal problems like construction of shop or flats at parking area.

Types of Risks

1. Financial and Non-Financial Risks

2. Individual and Group Risks
3. Pure and Speculative Risks
4. Static and Dynamic Risks
5. Quantifiable and Non Quantifiable Risks
1. Financial Risks: Exposed to the financial losses from the occurrence of the events
Non-Financial Risks: When financial loss does not exist, the situation can be referred to a
non-financial risk

2. Group Risks
- affects the economy, macro basis, impersonal in origin
- Affect social segment or entire population

Risk factors: Socio economic, Political, Natural Calamities.

Ex: Earthquakes, Floods, Wars, Unemployment, 11th September event etc.

Social insurance Program May be undertaken by the govt. to handle fundamental risk.

Individual Risks

These risk are confined to individual identities or small group

Ex: Theft, Robbery, Fire etc.

Some of these are insurable

Fire insurance may be bought by an individual to prevent against the adverse consequences
of fire.

3. Pure Risk

There is a possibility of loss or no loss. There is no gain to individual or organization. These

risks are insurable. It has inherent advantages to the economy or society.

Speculative Risk

There is a possibility of gain or loss. These are not insurable. Highly damaging in nature.

Ex: invest in a stock market or loss.

4. Dynamic Risk: Resulting from the changes in the economy or environment.

Risk Factor: Macro Economic, inflation, technology, income level.

Difficult to quantify and these are not insurable.

Static Risk: More or less predictable and not affected by economic conditions.
Ex: Possibility of loss in business, unemployment due to non-professional qualification.

5. Quantifiable Risks: Which can be measured in financial terms?

Non Quantifiable Risks: Can’t be measured in financial terms like tension, loss of peace etc.