Insurance - An Introduction

Human beings in their life span have to go through different ups and downs. Some of the uncertain events can be listed as untimely death, loss of valuable property by fire, loss due to accidents, etc. These events are likely to happen but are impossible to eliminate. Such events create a great loss and difficulties in one’s life. So to have compensation from such events, a mechanism of ‘Insurance’ has been introduced. Insurance is a financial mechanism to reduce or eliminate the financial loss due to uncertain risks.

The concept of insurance can be best illustrated with an example. Suppose a village has 10,000 houses of worth Rs. 100,000 each. On an analysis carried out, it is found that four houses of the village are destroyed by fire every year. Thus, it is clear that four houses will catch four houses next year. But it cannot be sure as to which house will catch fire and destroyed to what extent.  But everyone is likely to suffer from a loss of Rs. 100,000 which tends to be a big loss if that is to be borne by a single individual. A method of providing relief against this risk can be establishing a common fund to which each contributes Rs. 40 every year. The four unfortunate householders can be compensated to their losses by the fund contributed by each of the householders. The concept of insurance has originated with the same motive. Insurance make people put collective effort to share losses of risks. Insurance thus can be said as the mechanism of distributing the loss of few people into many people.

In the words of Dr. W.A. Dinsale : “Insurance is a device for transfer of risks of individual entities to an entities to an insurer to a specified extent of losses suffered by the insured.”

Insurance at present times has become a business in which the party doing the business promises to indemnify the losses in return for a consideration against a risk to people who propose to insure themselves. Thus, now-a-days insurance is defined as “A contract by which the insurer undertakes to compensate the insured by paying a fixed sum of money or up to a fixed amount of money on the happening of a predecided but accidental loss in exchange of a premium paid periodically or in lump sum”.

It should be kept in mind that insurance cannot stop an event to happen. But the loss occurred if such incident happens can be somewhat reduced by the insurance. Thus, it is a social device which only reduces the risk and does not completely eliminate it from the society.