History to Insurance
Individuals and organizations expose themselves to the chance of loss in all activities due to uncertainties. The more industrialized a society becomes, the more complicated it becomes in its structure which in turn increases the exposure to risks.
These risks are multitudinous and range from the unavoidable to those assumed by choice, annual losses to individuals from untimely death, accidents and sickness or to property from fire, windstorms, sea perils, earthquakes, floods, dishonesty, negligence etc. When estimated in monetary terms would come to high figures and indicate the importance of recognizing and meeting intelligently such risks.
According to the philosophers, all the activities of the universe are obedient to law. Chance has no place in their line of thinking. Events which appear to take place in a purely accidental way are just as much determined as those whose occurrence can be accurately foretold.
The appearance of accident is due entirely to human limitations. It is because we do not know all the previous conditions or all the laws governing them that a particular phenomenon appears to us to occur by chance. In this sense, chance is merely an appearance, resulting from the imperfection of human knowledge and not a part of the course of external nature. However, the imperfect knowledge of laws of nature leaves a great deal of uncertainty about the outcome of human actions and wherever there is uncertainty, there is risk.
As knowledge of natural laws expands and control over the forces that may enter into a given situation increases, risks tend to be eliminated. So far there is uncertainty there is insecurity. The drive for security is one of the basic motivating forces determining the human attitudes. Out of the search for security, insurance was born.
Example for Concept of Insurance
The following example will make the concept of insurance more clearer:
In a college, let us suppose that 500 students come to the college on bikes. By past experience, it is found that every year, say two bikes are lost. Thus it can be said that out of 500 students, any two will lose their bikes, but who those two students would be is not known in advance.
Hence, with this element of uncertainty, each one of the 500 students is exposed to the risk of losing his bike the cost of which maybe Rs. 37,500.
The total cost of two bikes will be Rs. 75,000. To safeguard against this loss, all the 500 students may contribute equally to a fund of Rs. 75,000 by paying Rs. 150 each and whenever the bikes are lost, the sufferers will be paid Rs. 37,500 each out of the common fund.
Every student undertakes to bear a definite monthly loss of Rs. 12.50 in exchange for a probable loss of Rs. 37,500 a year. Thus, insurance makes it possible for a student to bargain an annual loss of Rs. 37,500, which though uncertain, is very probable, in exchange for a definite monthly loss of Rs. 12.50, Rs. 150 to compensate a loss of Rs. 37,500.
What an ingenious device, it is ! Prima facie it seems almost a miracle but to the students of insurance, it will be an unadulterated fact.
Definition of Insurance
Different authors / authorities have defined the term ‘Insurance’ differently. Some of the popular definitions are as follows:
Ghosh and Agarwal
Insurance is a co-operative form of distributing a certain risk over a group of persons who are exposed to it.
Mowbray and Blan Chard
Insurance is a social device for eliminating or reducing the cost to society of certain types of risk.
Dictionary of Business and Finance
Insurance is a form of contract or agreement under which one party agrees in return for a consideration to pay an agreed amount of money to another party to make good for a loss, damage, or injury to something of value in which the insured has a pecuniary interest as a result of some uncertain events.
Allen Z : Mayerson
Insurance is a device for the transfer to an insurer certain risks of economic loss that would otherwise come to the insured.
Nature or Characteristics of Insurance
On the basis of the definitions of insurance discussed above, one can observe the following nature or characteristics:
Insurance is a contract between the insurance company and the policyholder wherein the policyholder (insured) makes an offer and the insurance company (insurer) accepts his offer. The contract of insurance is always made in writing.
Like other contracts, there must be lawful consideration in insurance also. The consideration is in the form of premium which the insured agrees to pay to the insurer.
3. Co-operative Device
All for one and one for all is the basis for cooperation. The insurance is a system wherein large number of persons, exposed to a similar risk, are covered and the risk is spread over among the larger insurable public. Therefore, insurance is a social or cooperative method wherein losses of one is borne by the society.
4. Protection of financial risks
An insurer is protected from financial risks which can be measured in terms of money. As such insurance compensates only financial or monetary loss or risks.
5. Risk sharing and risk transfer
Insurance is a social device for division of financial losses which may fall on an individual or his family on the happening of some unforeseen events. When insured, the loss arising out of the events are shared by all the insured in the form of premium. Therefore the risk is transferred from one individual to a group.
6. Based upon certain principles
The insurance is based upon certain principles like insurable interest, utmost good faith, indemnity, subrogation, causa-proxima, contribution, etc.
7. Regulated by Law
Insurance companies are regulated by statutory laws in almost all the countries. In India, life insurance and general insurance are regulated by Life Insurance Corporation of India Act 1956, and General Insurance Business (Nationalization) Act 1972, and IRDA Regulations etc.
8. Value of Risk
Before insuring the subject matter of the insurance contract, the risk is evaluated in order to determine the amount of premium to be charged on the insured. Several methods are being adopted to evaluate the risks involved in the subject matter. If there is an expectation of heavy loss, higher premiums will be charged. Hence, the probability of occurrence of loss is calculated at the time of insurance.
9. Payment at contingency
An insurer is liable to pay compensation to the insureds only when certain contingencies arise. In life insurance, the contingency — the death or the expiry of the term will certainly occur. In such cases, the life insurer has to pay the assured sum.
In other insurance contracts, the contingency — a fire accident or the marine perils, may or may not occur. So, if the contingency occurs, payment is made, otherwise no payment need to be made to the policyholders.
10. Insurance is not gambling
An insurance contract cannot be considered as gambling as the person insured is assured of his loss indemnified only on the happening of such uncertain event as stipulated in the contract of insurance, whereas the game of gambling may either result into profit or loss.
11. Insurance is not a charity
Premium collected from the policyholders under an insurance is the cost of risk so covered. Hence, it cannot be taken as charity. Charity lacks the element of contract of indemnity and compensation of loss to the person whosoever makes it.
12. Investment portfolio
Since insurers’ liability to pay compensation to the insured arises on the happening of certain uncertain event, the insurers do not have to keep the collected premium with them. They invest the premium received in selected securities and earn interest and dividend on them. Thus, the insurers have two sources of income: the insurance premium and the investment income (i.e. interest / dividend) which occurs over time.