Introduction to Insurance
Investopedia has defined Insurance as a contract, represented by a policy, in which an individual or entity receives financial protection or reimbursement against losses from an insurance company.
Insurance is a valid contract between insured and insurer for bearing risk and repayment compensation by insurer according to contract in a condition of certain accident or maturity of time. For insurance, the insured person or entity pays the premium for compensation to the insurance company.
Insurance is considered as a risk management tool as well as an investment opportunity. In insurance, an insured person or entity transfers the cost of potential loss to another entity for monetary compensation known as premium. It allows individuals, businesses and other entities to protect themselves against significant losses and financial hardship at a reasonable rate. Higher the losses and financial hardship, higher is the premium for such insurance.
Some of the coverage given under Insurance policies are:
- Protection against the death of a key individual in your business
- Ensuring debt repayment after death
- Covering contingent liabilities
- Protection of business from business interruption and loss of income
- Protection yourself against unforeseeable health expenses.
- Protection against theft, fire, flood and other hazards
- Protection against any legal complications
- Protection against any event of accident
- Protection of vehicles against theft or losses
Functions of Insurance
Functions of Insurance can be categorised into:
- Primary Function
- Secondary/Subsidiary Function
The act of bearing financial risks and collecting premiums for the distribution of risks are the primary of insurance. Some of the primary functions are:
- Provides certainty and assurance : Financial risks are unpredictable therefore insurance provides assurance by the agreement of compensation of losses. Misfortune may occur at any stage of life and both the loss and the time of losses are uncertain. Insurance helps change uncertainty into certainty.
- Provides guarantee for the protection : Insurance provides guarantee for the protection against large and certain losses in return of a nominal amount of premium. Insurance provides certainty of payment in case of losses.Insurance is to provide protection against future risk, accident, and uncertainty.
- Distribution of risks: Individuals and business are always prone to various risks which can be eliminated or minimized. Insurance is such a cooperative which shares risk through distribution of risks. Risks are distributed among all the insured individuals and business.
All functions other than primary functions are subsidiary or secondary functions:
- Insurance mobilizes capital: Insurance creates a pool of funds through premium against the policies taken by individual clients and corporate clients. The collected premiums amounts to huge capital which is used for compensation for the future losses and for investment purposes.
- Helps to increase efficiency: Insurance is a risk management tool and provides protection against future risks. Individuals and entities feel safe, more active and enterprising which eventually lead to increase in efficiency.
- Helps to minimize losses: Insurance companies insure individuals and entities from future uncertainties. Insurance companies make investigations to find out the tools to minimize the losses. Insurance companies investigate the circumstances for the losses and later it can be used for minimizing future losses.
- Helps to maintain financial stability: Various natural hazards and other similar nature of risks create instability in the business world. Insurance companies compensate for the amount of loss which stabilizes the financial position.
- Helps in Economic Progress: The insurance protects the society from huge losses of damage, destruction, and provides an initiative to work hard for the betterment of the masses.
Insurance companies are the major source for capital as they have a huge pool of funds. Insurance companies resort to funds during financial stress and bailout.