Concept of Insurance

The insurance business has a positive correlation with economic development in an economy. As an economy develops over the years, the insurance business starts making inroads into the various sectors of economic activity in the country. Insurance is basically a device to share the losses of a few by transferring a portion of the loss to the insurance company. The company which is compensating the loss collects a price which is called as premium. It means that a lot of people, who think that they may suffer a loss, will put in a little money as premium to cover the financial costs of the unfortunate. Hence, insurance works on the concept of risk sharing, which divides risk among many people. ⁽¹⁾

The term ‘insurance’ can be defined in both financial and legal terms. The financial definition focuses on an arrangement that redistributes the cost of unexpected losses. It is the collection of a small premium payments from all the suspected and distribute it to those suffering actual losses. The legal definition focus on the contractual arrangement whereby one party agrees to compensate the loss of other parties. Thus the financial definition provides for the funding of the losses, whereas the legal definition provides for the legally enforceable contract that spells out the legal rights, duties, and obligations of all the parties to the contract.

Combining the above two dimensions of insurance, Dictionary of Business and Finance, defines insurance as ‘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 something of value in which the insured has a pecuniary interest as a result of some uncertain event. It is a device by which the loss likely to be caused by an uncertain event is spread over a number of persons who are exposed to it and propose to insure themselves against such an event”.

In brief, insurance is the provision, which a prudent man makes against happenings by chance, or inevitable contingencies, loss of the unfortunate. This agreement of contract is put in writing and is known as ‘insurance policy’. The person whose risk is insured is called ‘Insured’ or ‘Assured’ and the person or the company, which insures is known as ‘Insurer’, or ‘Assure or ‘Underwriter’. The consideration in return for which the insurer agrees to make good the loss is known as ‘Premium’. This premium is to be paid regularly by the insured which contributes to build ‘Insurance Fund’. The compensation which the insurer is obliged to pay is a charge against this Fund.

Insurance can be classified broadly into: (a) life insurance and (b) general or non-life insurance.

(a) Life insurance or life assurance is a contract between the policy owner and insurer, where the insurer agrees to pay the designated beneficiary a sum of money upon the occurrence of the insured individual’s death or other events, such as terminal or critical illness. In return, the policy owner agrees to pay a stipulated amount at regular intervals or in lump sums. Life-based contracts tend to fall into two major categories:

Protection policies: designed to provide a benefit in case of a specified event, typically against lump sum payment. A common form of this policy is term insurance.

Investment policies: the main objective is to facilitate the growth of capital by single or regular premiums. The common forms in this category include whole life, universal life, and variable life policies.

(b) General insurance or non-life insurance policies, including automobile and home owners’ policies, provide payments depending on the loss from a particular financial event. General insurance typically comprises any insurance cover that is not deemed to be life insurance. Some categories of general insurance policies are: vehicle, home, health, property, accident, sickness and unemployment, casualty, liability, and credit. The terms of insurance generally depend on the company providing the cover. A detailed discussion is presented elsewhere in this Chapter.

Functions of Insurance:

Briefly, the following are the financial functions of insurance business activities since it is a means of bailing out the people from the losses or damages and consequently a system to protect the wealth of the community.

1. It is a system of security against financial losses and protection of trade and commerce, leading to the preservation of national wealth and business confidence.
2. Insurance, as a matter of fact, does not reduce the risk or uncertainty for the individual whether or not the event will occur, nor does it alter the responsibility of its occurrence. However, it compensates for the loss as per the operating rules of the contract of indemnity.
3. The social obligation of every member of society is to contribute and provide relief to those who need it. On account of this social purpose, democratic governments provide health insurance at subsidized prices to the people below the poverty line.
4. It minimizes the loss and avoids the waste of resources of the country.
5. It is a means of educating the people about the ‘concept of risk’ and ways and means of compensating for the loss.
6. It is a method of creating the ‘insurance fund’ that is available for investment in infrastructure projects like road construction and housing facilities.

Classification of Insurance Business

Activities: It is already observed that the general purpose of insurance is to compensate for the loss arising out of the risk. Business is always surrounded by uncertain circumstances which bring unpredictable risks. Some risks are not controlled, but others can be minimized, or their effect can be reduced to a certain extent through insurance contracts with insurance companies offering compensation as per the agreement. These compensation services have been classified on the basis of ‘insurable interests’ ⁽²⁾ of the insured. Some people’s interest may be in life, and some have the insurable interest in the property possessed by them or in both. Individually, a businessman as a proprietor can have life as well as non-life insurance contracts. In the case of organizations (like partnership firms or corporate bodies), the significant ‘insurable interest’ is in property such as goods in warehouses, goods in transit, machinery and equipment, land, and buildings; therefore insurance business can be classified in to (a) life insurance business and (b) non-life insurance business.⁽³⁾

Typical Features of General Insurance Business

General insurance business activities are treated as an exclusive business portfolio by the insurance community. The business characteristics of general insurance are quite different from the life insurance business. Annexure Table 1.B depicts the peculiar characteristics of general insurance as compared to the life insurance business. In addition to these special features, the general insurance products in the form of policies may also be different and large in number. Hence, the liberalized environment offers freedom to the insurance companies to develop new products as per the market demand. As such, the business environment of general insurance is likely to be complex and ever-changing.

In view of the above distinctive features of general insurance, the service package to the customer must be clear and convincing on the part of the insurer. Further, possession of technical knowledge to estimate the loss is also a prerequisite for general insurers. Again the need for investigative skills on the part of the general insurer is more because which claims may become unchallengeable.

References:

1. Gupta P.K, Fundamentals of Insurance, Himalaya Publishing House, Mumbai, 2005, pp. 10-20
2. . ‘Insurable interest’ is one of the principles of insurance. A person or an organization is said to have an insurable interest in the property if he or it is benefited by its existence and prejudiced by its destruction. Without insurable interest the insurance contract is void.
3. Sharma R.K. and Shashi K. Gupta (1997), Business Organization and Management; Kalyani Publishers; New Delhi; pp. 336-345

For Citing this article, use:

• K, S. (2016). An analysis of quality factor in general insurance sector.