Concept of

Insurance
 Functional definition

Insurance is defined as a cooperative 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

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Concept of Insurance- Illustration

Houses in a village= 2000

Value of 1 house= Rs. 50,000

Houses burning in a year= 5

Total annual loss due to fire=

Rs. 2,50,000
Contribution of each house
owner (premium) = Rs. 500=
Total value of the fund= Rs.
10,00,000
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Underlying assumption – All 2000 house owners are exposed to a common risk, i.e.
fire

Procedure

Total value of fund= Rs. 10,00,000

5 houses get burnt during the year

Insurance Company pays Rs. 50,000

out of the pool to all 5 house owners (
i.e. Rs. 250,000)

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Effect of Insurance

Risk of 5 house owners is spread over 2000 house owners in the village, thus
reducing the burden on any one of the owners

Thus Insurance works on the principle of risk sharing

It spreads the risk of a few people over a large number of people exposed to risk of
similar type

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 Contractual Definition
Insurance is a contract in which sum of money is paid in consideration
of the insurer’s incurring the risk of paying a large sum of money upon a
given contingency

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Nature of Insurance
Does not eliminate risk- reduces the financial burden
1.Sharing of risk
All insured persons share the loss caused by a specified event by way of premium
paid by them

2. Co-operative Device
Co-operation of large number of persons- agree- to share financial loss
Persons brought together voluntarily/through solicitation

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3. Value of risk
Premium is directly proportional to risk

4. Payment at Contingency
Life insurance-contract of certainty- payment is certain either on
death/maturity of policy
In other insurances-the contingency is fire/marine perils- which may/not
occur

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5. Amount of Payment
Insurance is contract to compensate the loss- the amount of payment is equal to
actual loss suffered by the insured/amount of policy, whichever is less
Life Insurance- fixed amount is paid

6. Large number of insured persons

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Functions of Insurance
1.Provides protection against financial losses
2.It provides capital -industries in different forms - long term loans/share
capital etc
3. It improves efficiency
4. It provides credit facilities ( pledging insurance policies to raise loans)
5. It encourages savings

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The Insurance Market and Asymmetric
Information

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Legislation Governing Insurance

• Entry 47 -Union List – Insurance . Entry 23-Concurrent list- Social

Insurance
• Insurance Act, 1938 (Also refer to Insurance ( Amendment) Act 2015)
• Life Insurance Corporation Act, 1956
• General Insurance Business (Nationalisation) Act, 1982
• Chapter XI of Motor Vehicles Act
• Insurance Regulatory and Development Authority of India Act, 1999
• Marine Insurance Act, 1963
• Indian Contract Act, 1872
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Study of Insurance Contracts

1.General characteristics of insurance contracts

2. Special characteristics of insurance contracts
3. Individual characteristics of each class of insurance

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 Insurance and Assurance
• England- assurance- applied to life business & insurance is used in other
insurances ( fire/motor etc)
Contingency insured against in life ( death/attaining a particular age) is
certainty & in other insurances the contingency insured against may not
occur at all

• In USA & India – use insurance in all branches

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 Construction of Insurance Policy

• In case of ambiguity/doubt- the contract is likely to be construed Contra

Proferentem i.e. against the insurance company

• Written words will be given more effect than those words printed

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