The most common question which we fail to answer with a sense of clarity is what is Insurance?
We in general tend to compare insurance with other investment options like mutual funds , shares without even knowing what exactly insurance is and how is it different from other investment options.
In fact Insurance is not merely an investment option.
Insurance in very simple terms is a transfer of risk, from the subject insured to the insurance companies with premiums being its consideration.
The biggest mistake we are doing is the comparison of insurance with other investment options.
Being insured gives us a privilege of getting the big sum assured in case any risk takes place, by paying really low premiums for that sum.
Let’s take an example to understand this better :-
Gogi , 24 years old graduate and 50 of his friends purchased a BMW each to start with their car rally. As they are afraid of the car getting damaged, they look for some option to deal with this problem. (Assuming there is no insurance company in their country) They figure out that according to the statistics in their area, there is 1 car accident out of every 50 cars driven. They take the case forward to the smartest person in their community and asks him for a solution, for which he suggests them to contribute small amounts of money and invest that amount in a bank for which they’ll even earn interest. And in case of any accident, that fund can be used for the indemnification of the losses.
This is what we call the concept of insurance.
Although there is no single definition of insurance, the Commission on Insurance Terminology of the American Risk and Insurance Association has defined insurance as the pooling of fortuitous losses by transfer of such risks to insurers, who agree to indemnify insureds for such losses, to provide other pecuniary benefits on their occurrence.
We can infer 4 main characteristics of insurance according to the definition as well as the example stated above.
Pooling of insurance
Risk Transfer
Payment of Fortuitous losses
Indemnification
To explain further Insurance is a contract between the insurer (the one who insures) and the insured (the one who takes the insurance) which works on the principal of pooling of money from the people (as premiums), which affects to the transfer of risk from the insured to the insurer. The insurer then invests that pooled money into an investment option. This is one of the ways by which insurance companies makes profit and termed as investment profit. Fortuitous losses are unseen and unexpected and the insurance companies pays only for fortuitous losses. This payment is called indemnification. To indemnify means to restore the insured to his/her approximate financial position prior to the occurrence of the loss.
The Insurance works on the concept of Law of Large numbers , which you can get to know in detail here .
As you are now clear about the concept of Insurance , in India Insurance is Divided in 3 main categories.
GENERAL INSURANCE
HEALTH INSURANCE
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