Insurance- The Concept of

Meaning:

An insurance is an act, business  or system by which pecuniary indemnity is guaranteed by one party to another in certain contingencies, as of death, accident ,damage, disaster injury, loss, old age. Sickness etc. upon specified terms.[1]  A contract of insurance in widest sense of term is a contract, whereby, one person called the ‘insurer’  undertakes in return of the agreed consideration , called the ‘premium’ to pay to another person called the ‘insured’ a sum of money on the happening of a specified event.[2] In a contract of insurance happening of certain event can not be insured but what is insured is that a sum of money shall be paid upon the happening of a certain event.[3]  Further, that event should be one which involves some amount of uncertainty. Uncertainty either in a way as to whether the event will ever happen or not or if the event is one which must happen  there must be uncertainty as to the time at which it will happen. The event must be prima-facie adverse to the interest of insured.[4]

Functioning:   

The primary function of the insurance is to substitute certainty for uncertainty.[5] By the insurance the loss is spread over a large number of persons through the mechanism of cooperation. The risk is not averted but the loss on it’s occurrence is shared by the members. Number of persons who are exposed to a particular risk and who agree to insure themselves against that risk, share heavy sudden loss caused to one person.[6] Thus insurance is a social device that makes it possible for an individual or an organization to substitute a small definite cost (the premium) for a large but uncertain loss up to the amount of insurance. under this arrangement, the fortunate many who escape the loss will help to compensate the unfortunate few who suffer the loss.[7]

Basis of estimation by insurer:

By pooling both the financial contributions and insurable risks of a large number of policy holders, the insurer is typically able to absorb losses incurred over any given period much more easily than would the uninsured individual. For example, while the destruction of an automobile  in a traffic accident imposes a heavy financial loss on an individual, one such loss is of relatively small consequence to an insurer who is collecting sufficient premium on a large number of automobiles.[8]

Insurance relies heavily upon the ‘Law of large numbers’. The insurer can estimate the normal frequency of common events in large homogeneous population. What the insurer estimate is

1. the insured objects must be numerous enough and homogeneous enough to allow a reasonably close calculation of the probable frequency and severity of losses;

2.  the insured object must not be subject to simultaneous destruction;

3. the possible loss must be accidental in nature and beyond the control of the insured because, if the insured could cause the loss, the element of randomness and predictability would be destroyed; and

4. there must be some way to determine whether a loss has occurred, and how great one.[9]

Basis of estimation by insured:

On the other hand the insured person estimates on the basis that an insurable risk is one for which the probability of loss is not so high as to require excessive premiums and at the same time the potential loss must be enough to cause financial hardship if a person does not insure against it.[10]

Thus it can be said that the risk must be such that pooling is both feasible and advantageous to the both parties. The accident insured against must be of sufficient frequency and similarity to allow for reasonably precise statistical estimations of the liability so that the insurer can expect to suffer across the entire group of those insured, and the loses resulting must be potentially so severe as to produce an incentive for the insured to insure against it.