Insurance: Definition, Features (Explained)

Insurance: Definition, FeaturesIn day-to-day life, the man is confronted with various risks.

However great a genius he may be, it is not possible for him to foresee all the calamities that are in store for him and to provide necessaries for them to advance.

Many happy lives are ruined either by the untimely death of the earning member of the family or by other disastrous calamities such as floods fire, earthquake war, accident, etc. which may take a heavy toll on human life.

These risks are such which cannot be known in advance as to when they win happen and it is physically impossible for an individual to make provision against them by him.

Insurance is a device not to avert these risks but to mitigate they’re rigorous on individuals.

Insurance is defined as a co-operative device to spread the loss caused by a particular risk over a number of persons who are exposed to it and who agree to insure themselves against that risk.

The risk is the uncertainty of a financial loss.

It should not be confused with the chance of loss which is the probable number of losses out of a given number of exposures’.

It should not be confused with peril which is defined as the cause of the loss or with a hazard which is a condition that may increase the chance of loss.

Finally; risk must not be confused with the loss itself which is the unintentional decline in or disappearance of value arising from a contingency.

Wherever there is uncertainty with respect to a probable loss there is a risk.

The risk is the uncertainty of a financial loss. It should not be confused with the chance of loss, which is the probable number of losses out of a given number of exposures.

It should not be confused with “peril” which is defined as the cause of the loss or with “hazard” which is a condition that may increase the chance of loss.

Before we fully elaborate on the definition of insurance; we should get familiar with the following terms;

The definition of insurance can be made from two points:

  1. Functional Definition and,
  2. Contractual Definition.

Let’s get a brief idea about the tow points;

Functional Definition of Insurance

Insurance is a co-operative device to spread the loss caused by a particular risk over a number of persons, who are exposed to it and who agree to insure themselves against the risk.

Thus, the insurance is;

  1. a co-operative device to spread the risk;
  2. the system to spread the risk over a number of persons who are insured against the risk;
  3. the principle to share the loss of each member of the society on the basis of the probability of loss to their risk; and
  4. the method to provide security against losses to the insured.

Similarly, another definition can be given.

Insurance is a co-operative device of distributing losses, falling on an individual or his family over a large number of persons, each bearing a nominal expenditure and feeling secure against heavy loss.

Related: Insurance Contract

Contractual Definition of Insurance

Insurance has been defined to be that in which a sum of money as a premium is paid in consideration of the insurance incurring the risk of paying a large sum upon a given contingency. The insurance, thus, is a contract whereby;

  1. Certain sum, called premium, is charged in consideration,
  2. Against the said consideration, a large sum is guaranteed to be paid by the insurer who received the premium,
  3. The payment will be made in a certain definite sum, i.e., the loss or the policy amount whichever may be, and
  4. The payment is made only upon a contingency.

The more specific definition can be given as following “Insurance may be defined as a consisting one party (the insurer) agrees to pay to the other party (the insurer) or his beneficiary, a certain sum upon a given contingency (the risk) against which insurance is sought.”

So it is clear that every risk involves the loss of one or the other kind. The function of insurance is to spread this loss over a large number of persons through the mechanism of co-operation.

The persons who are exposed to a particular risk cooperate to share the less caused by that risk whenever it takes place.

Thus the risk is not averted but the loss on its occurrence is shared by the members. The Significance of this fact will be clear by the following example.

The legal definition focuses on a contractual arrangement whereby one party agrees to compensate another party for losses.

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.

Every risk involves the loss of one or another kind. The function of insurance is to spread the loss over a large number of persons who agree to co-operate with each other at the time of loss.

The risk cannot be averted but loss occurring due to a certain risk can be distributed amongst the agreed persons.

They are agreed to share the loss because the chances of loss, i.e., the time, amount, to a person are not known. Anybody of them may suffer a loss to a given risk, so, the rest of the persons who arc agreed will share the loss.

The larger the number of such persons, the easier the process of distribution of loss.

In fact; the loss is shared by them by payment of premium which is calculated on the probability of loss. In olden times, the contribution by the persons was made at the time of loss.

The insurance is also defined as a social device to accumulate funds to meet the uncertain losses arising through a certain risk to a person insured against the risk.

Related: 7 Types of Insurance

Features of Insurance

From the above explanation, we can find the following characteristics which are, generally, observed in the case of life, marine, fire, and general insurances.

1. Sharing of Risk

Insurance is a device to share the financial losses which might befall on an individual or his family on the happening of a specified event.

The event may be the death of a breadwinner to the family in the case of life insurance, marine-perils in marine insurance, fire in fire insurance and other certain events in general insurance, e.g., theft in burglary insurance, accident in motor insurance, etc. The loss arising from these events, if insured are shared by all the insured in the form of premium.

Related: Risks and Insurance

2. Co-operative Device

The most important feature of every insurance plan is the co-operation of a large number of persons who, in effect, agree to share the financial loss arising due to a particular risk that is insured.

Such a group of persons may be brought together voluntarily or through publicity or through solicitation of the agents.

An insurer would be unable to compensate for all the losses from his own capital. So, by insuring or underwriting a large number of persons, he is able to pay the amount of loss.

Like all co­operative devices, there is no compulsion here on anybody to purchase the insurance policy.

3. Value of Risk

The risk is evaluated before insuring to charge the amount of share of an insured, herein called, consideration or premium. There are several methods of evaluation of risks.

If there is an expectation of more loss, a higher premium may be charged. So, the probability of loss is calculated at the time of insurance.

Related: 7 Elements of an Insurable Risk

4. Payment at Contingency

The payment is made at a certain contingency insured. If the contingency occurs, payment is made.

Since the life insurance contract is a contract of certainty, because the contingency, the death or the expiry of the term, will certainly occur, the payment is certain. In other insurance contracts, the contingency is the fire or the marine perils, etc., may or may not occur.

So, if the contingency occurs, payment is made, otherwise, no amount is given to the policy-holder. Similarly, in certain types of policies, payment is not certain due to the uncertainty of a particular contingency within a particular period.

For example, in term-insurance, payment is made only when the death of the assured occurs within the specified term, maybe one or two years.

Similarly, in Pure Endowment payment is made only at the survival of the insured at the expiry of the period.

5. Payment of Fortuitous Losses

Another characteristic of insurance is the payment of fortuitous losses. A fortuitous loss is one that is unforeseen and unexpected and occurs as a result of chance. In other words, the loss must be accidental.

The law of large numbers is based on the assumption that losses are accidental and occur randomly.

For example, a person may slip on an icy sidewalk and break a leg. The loss would be fortuitous. Insurance policies do not cover intentional issues.

6. Amount of Payment

The amount of payment depends upon the value of loss that occurred due to the particular insured risk provided insurance is there up to that amount. In life insurance, the purpose is not to make good the financial loss suffered. The insurer promises to pay a fixed sum on the happening of an event.

If the event or the contingency takes place, the payment does fail due if the policy is valid and in force at the time of the event, like property insurance, the dependents will not be required to prove the occurring of loss and the amount of loss.

It is immaterial in life insurance what was the amount of loss was at the time of contingency. But in the property and general insurances, the amount of loss, as well as the happening of loss, is required to be proved.

7. A large Number of Insured Persons

To spread the loss immediately, smoothly and cheaply, a large number of persons should be insured. The co-operation of a small number of persons may also be insurance but it will be limited to the smaller area.

The cost of insurance for each member may be higher.

So, it may be unmarketable. Therefore, to make the insurance cheaper, it is essential to insure a large number of persons or property because the lessor would be the cost of insurance and so, the lower would be premium.

In past years, tariff associations or mutual fire insurance associations were found to share the loss at a cheaper rate. In order to function successfully, the insurance should be joined by a large number of persons.

Insurance is a form of risk management primarily used to hedge against the risk of potential financial loss. Again insurance is defined as the equitable transfers of the risk of a potential loss, from one entity to another, in exchange for a premium and duty of care.

Final Words

Insurance is taken against the possible financial loss caused by pure risk, speculative risk, and fundamental risk.

Pure risk is the loss or no loss with no possibility of gams, such as fire, death of a key person, the bankruptcy of a customer and that.

The speculative risk may cause either gain or lose, such as the purchase of land with speculation that the value will increase bur due to certain reasons it reduces.

Fundamental risk arises from the economic, political, social, or natural forces acting on society. Some specific sources of fundamental risk are floods and earthquakes, inflation and war.

Property insurance protects losses that may occur io business property already owned. This includes real property or plant, equipment, and

but Ming; personal property which includes machines, office supplies, furniture and fixture, and computers; inventory; and so forth.

This field is fair well covered by insurance. The loss of property because of dishonesty or unfaithfulness of individuals such as burglary, improper handling of money and securities by the trustees, stealing or forgery of pa>roll cheques, stealing of or the setting of customer mailing fist to the competitors, etc.

Moreover, other persons are likely to fail in the performance of some expected act.

A debtor may be unable to pay his or her debt, a contractor may be unable to complete a building, a supplier may be unable to furnish critical pans ora person may buy a piece of property with a defective title.

Individuals and businesses can protect themselves from such failures of others by credit insurance, surety bonding, and title insurance.

The loss of earning power is the loss of property that will probably be acquired in the future.

It involves the wages, interest, profit, rent, royalties, and operating expenses that will be earned by future effort. The Joss of earning power by persons may result from such events as death, illness, accident, old age, childbearing. or loss of employment. Life insurance, health insurance, etc cover this loss.

The earning power loss may result from the loss of use of property suffering the direct losses of profits through interruption of business by fire and also loss of rent s by reason of buildings remaining untamed as a result of a windstorm.

Future expense is another type of loss that frequently results from common perils. Medical expense insurance, leasehold insurance and commercial and homeowners multi-peril insurance, etc cover future expenses.

Legal liability for the consequences of certain acts or omissions would be a possible financial loss.

A poorly designed machine injures the operator; a salesperson is injured on defective stairs, may raise damage claims that are to be paid to the injured parties.

Many forms of insurance have been devised to protect individuals and businesses from their liability at law for injuries to persons and damage to property.

Entrepreneurs have limited resources in the beginning. Thus, it is important for the entrepreneur to not only determine what kind of insurance to purchase but also much to purchase and from what company.

The entrepreneur should ask bankers or lawyers to select the insurance company and the agent.

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