Introduction to Insurance - Part 1

Introduction to Insurance - Part 1

WHAT IS INSURANCE?

Let’s answer this question first.

What are the important things which a company has?

People, Machines etc.

These are assets to a company, because this carries value.

The business of insurance is related to the protection of the economic value of assets. Every asset has a value, and is valuable to the owner as he expects to derive benefits from the asset. The benefit can be an income or anything else.

Every asset is expected to last for a certain period of time during which it will perform. So the owner arranges for its substitute. However an asset can be lost earlier due to a fire or anything adverse. Insurance helps in reducing the effect of the adverse conditions.

For example a PC for a IT company is a valuable asset, as it helps in generating income by helping in software development process. The company knows it will perform for say 5 years. So the company arranges for its substitute at the end of 5 years so that benefits derived from it don’t stop. But let’s say a fire occurs so the PC gets destroyed. But the company was not prepared for this adverse situation. But if the PC was insured the insurance would have helped in reducing the effect of the adverse condition.

At the time of 9/11 also, insurance company helped people by giving compensation and reduced the effect of the adverse condition.

PURPOSE AND NEED OF INSURANCE

Before knowing the purpose and need of insurance, first we should understand the concept of risk.

Risk – Risk is the possibility of adverse results flowing from any occurrence. Uncertainty gives rise to risk and for risk to exist there should be two outcomes out of which one should be undesirable.

For example for an export company there is a risk of loss of goods during the time of shipping. There are two outcomes in this situation either the goods will reach the destination safely or they will get lost or destroyed.

One more concept to be understood is Perils. Perils are the events like fire, flood, earthquakes, breakdown etc which can cause accidental destruction.

Insurance is relevant to uncertainties. If there is no uncertainty about the event it cannot be insured.

For example a person is crossing the river and in his boat there is a whole. And it is certain he will drown. So the insurance of this event cannot be done.

But there can be 1 question in case of life, death is a certain event. But there is insurance for this. Why?

The insurance is done because the time of death is uncertain.

Only economic consequences are insured.

For example there is a family of four with one earning member. The earning member works hard to get the money flowing to meet the requirements of his family. They have plans to construct their own house in the next two years. Everything is going as per plan.

The various events which can upset these plans are:
ü Burglary
ü Death
ü Accidental Permanent disability
ü Sickness
ü Critical Illness

All this events are out of control of family and more in hands of destiny. All these events can erode the wealth of the family.

In order to reduce the effect of risk to which family is subjected and to safeguard their economic value insurance should be taken.

HOW INSURANCE WORKS?

Insurance is based on business of ‘Sharing’. The mechanism of Insurance is very simple. People who share the same risk come together and agree that if any one of us suffers from the loss, others will share the loss and make good to the person who has suffered from the loss.

For example all houses in salt lake are faced with the risk of burglary. So the people in salt lake come together and agree to share the loss and make good to the house who has suffered from the loss.

Another example can be in a village there are 200 houses. And there is a risk of earthquake over there. And from the past experiences it is known that 10% of houses get destroyed each year due to earthquake. And the loss suffered by each house is Rs. 10000. So the total loss suffered by the village is Rs 2 lac. So each house contributes Rs. 1000 and share the risk of loss to those 20 houses.

BUSINESS OF INSURANCE

Insurance companies are called as insurers. The business of insurance is to
1. Bring together persons with common insurance interests (sharing the same risks)
2. Collect the share or contribution (called premium) from all of them, and
3. Pay out compensations (called claims) to those who suffer.

Note:
Please pour in your comments and suggestions to improve my writing and grammatical capabilities.
In coming posts we will keep learning about Insurance basics.

Disclaimer: This post is from point of view of Elizabeth, if anyone feels hurt or disrespected by any post please revert back, Elizabeth will try to correct her ways of expressing. This is her first attempt to writing.

Regards,

Eliz
(Motto of Life - Mast Raho)