The concept of insurance originates from the principle of sharing the risks by a large group to reduce the burden on the few. Insurance, in the realm of risk management techniques, embodies the concept of ‘Risk Transfer.’ Here, individuals or entities shift the burden of potential losses to an insurer. By doing so, they seek to mitigate financial uncertainties and secure peace of mind in the face of unforeseen perils. So, let’s discuss in detail what is the meaning of Insurance.
An insurance contract involves two parties, where one party proposes to the other indemnification against financial loss arising from an event that is not in control of either party. The party proposing the contract is called the proposer and the party examining and reacting to the proposal is the insurer. If the insurer accepts the proposal, the proposer becomes the insured. And pays the premium specified by the insurer for the cover.
In this contractual arrangement where individuals or businesses secure financial protection against potential losses or risks. It comes in various forms, such as car insurance, medical insurance, and more. Insurance agents play a vital role in guiding individuals through policy options and finding suitable coverage tailored to their needs. Additionally, certain insurance policies may offer tax benefits, providing an added incentive for individuals to safeguard themselves and their assets. With insurance, individuals gain peace of mind, knowing they have a safety net to mitigate the impact of unforeseen events.
Life insurance policy contracts are different in the manner that the insured himself does not benefit from the protection. Since it is difficult to assign an economic value to a person’s life, deciding the sum assured becomes hard.
Life insurance can also be seen as covering the financial interests of the dependents of the insured. Life cover not only serves as a protective measure for the insured against unforeseen events but also extends to safeguard the financial interests of their dependents, ensuring they receive the lump sum payout in the event of the insured’s passing. Though, conceptually it remains the same as any other insurance contract.
Let us see an example to understand the same.
Case
A town has about 5000 families and houses, and each year about 10 of these houses are either damaged or destroyed by the storm and temporary floods that hit the area during the rainy season. Repairing these houses cost an average of Rs. 150,000 each year.
The simple statistical analysis of historical data shows that while all the houses are at risk of damage or destruction only 10 (i.e. Rs. 150,000 in repair costs) will need all-time preparation. Therefore, decided that funds to the tune of the town management should pool Rs. 1.5 Lakh with the contribution from each family.
Since there are 5000 houses individually owned by the families, each family must contribute only Rs. 30 every year to cover the cost of property damage. This is the simplest arrangement of the insurance contract, where Rs. 30 is the premium payable for the life insurance cover.
Read More: What are the different types of Life Insurance Policies?
Another example of the same can be, a merchant seeking insurance coverage for his cargo going overseas. To ensure the shipment cost he can approach a person with sound financial stature and repute (possibly a bank) and propose to pay a premium to the banker if he/she agrees to cover the costs if loses the cargo on the seas. The banker, on the other hand, will try to diversify his risk of covering the entire loss by insuring multiple merchant shipments.
The premium in this case as well will be based on the experience of losses.
Case of Life Insurance
In a city of 4 lakh inhabitants, employed ones are 1 lakh who are earning money. These one lakh income earners are responsible for the remaining three lakh residents. Assume that each working person has three dependents. Any mishap with this person can lead to loss of income for the remaining dependent members, and result in long-enduring distress and poverty for them.
To safeguard citizens, the city estimated the funds needed to support dependents in case of premature death. They aimed to secure their future and protect against unforeseen events. Estimating that out of 1 lakh working population, expect at least two die each year prematurely. It estimating that a family of three needs approximately Rs. 20 Lakh to survive and complete their educational goals and thus, the city must maintain a pool of at least Rs. 40 lakh each year, to support such families. The income earners must share the pool burden equally, and thus they all get to pay a premium of Rs. 40 each year to safeguard the future of their dependents.
Additional read: What are the advantages to a borrower to buy credit life insurance
In property insurance, a homeowner pays premiums to insure against damages from fire, theft, or natural disasters. One unfortunate day, a massive fire breaks out, reducing their beloved home to ashes. However, thanks to the its coverage, the homeowner can file a claim and receive the necessary funds to rebuild their property. Without insurance, this calamity could have left them devastated, both emotionally and financially. Property insurance, therefore, serves as a vital safety net, protecting one’s valuable assets from unforeseen perils.
Similarly, let’s look at life insurance through a different lens. Picture a young family with a primary breadwinner who takes out a life insurance policy. Tragedy strikes, and the breadwinner passes away unexpectedly. Life insurance payout eases financial burdens for surviving family members in times of loss. It provides them with the financial resources to cover immediate expenses, pay off debts, and secure their future. Life insurance becomes a thoughtful legacy, supporting the insured’s dreams and aspirations even after they’re gone.
In both examples, insurance serves as a safety net, mitigating the impact of uncertainties. It provides a sense of security in the face of adversity. While the specific terms and coverage may vary based on individual needs and policies, the underlying essence of insurance remains constant – it is a contract that fosters trust and assurance, where the insured and insurer work together to navigate the uncertainties. It is this collective effort that makes insurance an essential aspect of responsible financial planning, assuring a brighter and more secure tomorrow for all.
Conclusion
In conclusion, insurance plays a crucial role in safeguarding individuals and businesses from unexpected risks, providing them with financial security and peace of mind. To illustrate this, let’s consider two examples: property and life insurance. Insurance is a financial arrangement that provides protection against unforeseen risks over the long term. The insured pays regular premiums to the insurer, who, in return, covers expenses or pays a lump sum for insurance claims. The Income Tax Act may offer tax benefits on certain insurance policies, encouraging individuals to safeguard themselves and their assets.
