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Insurance is nothing but a system of spreading the risk of one onto the shoulders of many.
Whilst it becomes somewhat impossible for a man to bear by himself 100% loss to his own
property or interest arising out of an unforeseen contingency, insurance is a method or
process which distributes the burden of the loss on a number of persons within the group
formed for this particular purpose.

The definition of insurance can be made from two points:

 Functional definition.
 Contractual definition.

Functional definition
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

Contractual definition
Insurance has been defined to be that in which a sum of money as a premium is paid in
consideration of the insurer’s incurring the risk of paying a large sum upon a given

Insurance is a social device which combines the risks of individuals into a group, using funds
contributed by members of the group to pay for losses.
--- James L. Athearn

“Insurance is a legal contract in which an insurer promise to pay a specified amount to

another party, the insured, if a particular event happens and the insured suffers a financial
loss as a result.
--- Oxford Dictionary

“Insurance is a promise by an insurer to an insured of protection and/or service.”

--- Mowbray and Blacnchard

“Insurance is a co-operative form of distribution a certain risk over a group of persons who
are exposed to it.”
--- M.K. Gehosh and A.N. Agorwala

From the above discuss we can write, insurance is a social device which reduces uncertainty
by spreading the economic burden of losses among members of a group who have similar

1. Insurance spreads the economic burden of losses by using funds contributed by

members of the group to pay for them. Thus, it is a loss spreading device.

2. The fundamental purpose of insurance however is neither the spreading nor the
prevention of losses. Rather, it is reduction of the uncertainty which is caused by
awareness of the possibility of loss.

3. An insurance scheme provides certainty for the individual members of the group by
averaging loss costs. The contribution made by the individual to the group is
assumed, on the basis of predictions, to be his share of losses suffered by the

In exchange for this contribution, he is assured that the group will assume any losses that
involve him. He transfers his risk to the group and averages his loss costs, thus substituting
certainty for uncertainty. He pays a certain premium instead of facing the uncertainty of
the possibility of large loss.

The functions of Insurance can be bifurcated into three parts:

1. Primary Functions
2. Secondary Functions
3. Other Functions

The primary functions of insurance include the following:

Provide Protection
The primary function of insurance is to provide protection against future risk, accidents and
uncertainty. Insurance cannot check the happening of the risk, but can certainly provide for
the losses of risk.

Collective bearing of risk

Insurance is a mean by which few losses are shared among larger number of people. All the
insured contribute the premiums towards a fund and out of which the persons exposed to a
particular risk is paid.

Assessment of risk
Insurance determines the probable volume of risk by evaluating various factors that give
rise to risk. Risk is the basis for determining the premium rate also

Provide Certainty
Insurance is a device, which helps to change from uncertainty to certainty. Insurance is
device whereby the uncertain risks may be made more certain.

Research and publicity

Insurers also spend money in research and publicity in creating risk consciousness amongst
which has a far reaching effect on reduction in national waste.
The secondary functions of insurance include the following:
Prevention of Losses
Prevention of losses causes lesser payment to the assured by the insurer and this will
encourage for more savings by way of premium. Reduced rate of premiums stimulate for
more business and better protection to the insured.

Small capital to cover larger risks

Insurance relieves the businessmen from security investments, by paying small amount of
premium against larger risks and uncertainty.

Contributes towards the development of larger industries

Insurance provides development opportunity to those larger industries having more risks in
their setting up. Even the financial institutions may be prepared to give credit to sick
industrial units which have insured their assets including plant and machinery.

If improves efficiency
The insurance eliminates worries and miseries of loans at death and destruction of
property. The carefree person an devote his body and soul together for better
achievement. It improves not only his efficiency, but the efficiencies of the masses are also

It helps economic progress

The insurance by protecting the society from huge losses of damage, destruction and death,
provides an initiative to work hard for the betterment of the masses. The next factor of
economic progress. The capital is also immensely provided by the masses. The property, the
valuable assets, the man, the machine and the society cannot lose much at the disaster.

The other functions of insurance include the following:

Means of savings and investment
Insurance serves as savings and investment, insurance is a compulsory way of savings and it
restricts the unnecessary expenses by the insured's For the purpose of availing income-tax
exemptions also, people invest in insurance.

Source of earning foreign exchange

Insurance is an international business. The country can earn foreign exchange by way of
issue of marine insurance policies and various other ways.

Risk Free trade

Insurance promotes exports insurance, which makes the foreign trade risk free with the
help of different types of policies under marine insurance cover.

Sharing of risk
Insurance is a device to share the financial losses which might be fall on an individual or his
family on the happening of specified event. The event may be death, incase of life insurance,
marine perils, marine insurance, fire in fire insurance and other certain events in general
Co-operative Device
The most important feature of every insurance plan is the co-operation of large number of
persons who, agree to share the financial loss arising due to a particular risk which is
insured. All co-operative devices, there is no compulsion here on anybody to purchase the
insurance policy.

Value of risk
The risk is evaluated before inuring to charge the amount of share of an insured, here is
called, consideration or premium. If there is expectation of more loss, higher premium may
be charged. So, the probability of loss is calculated at the time of insurance.

Payment at Contingency
The payment is made at a certain contingency insured. If the contingency occurs, payment is
made. Since the life insurance is a contract of certainty, because the contingency, the
death or the expiry of term, will certainly occur, the payment is certain.

Amount of payment
The amount of payment depends upon the value of loss occurred due to the particular
insured risk provided insurance is there up to that amount. In case of life insurance, the
insurer promises to pay a fixed sum on the happening of an even.(Either death or the expiry
of the term).

Large number of insured persons

The co-operation of a small number of persons may also be insurance but in that case, the
cost of insurance to each number may be higher. In case of large number of persons
opposite condition is applicable.

Insurance is not gambling

The insurance is just opposite of gambling. In gambling by bidding the persons exposes
himself to risk of losing ,in the insurance the insured is always opposed to risk and will
suffer loss if he is not insured.

Insurance is not charity

Charity is given without consideration but security and safety provided by insurance is not
possible without consideration or premium. It provides security and safety to an individual
and to the society although it is a kind of business because inconsideration of premium it
guarantees the payment of loss.

Principles of Co-operation.
Insurance is co-operative device. If one person is providing for his own losses, it can not be
strictly an insurance because in insurance, the loss is shared by a group of persons who are
willing to co-operate. It is the duty and responsibility of the insurer to obtain adequate
funds from the members of the society to pay them at the happening of the insured risk.
Thus, the shares of loss took the form of premium. Today, all the insured give a premium to
join the scheme of insurance. Thus, the insured are co-operating to share the loss of an
individual be payment of a premium in advance.
Principles of Probability
The loss in the shape of premium can be distributed only on the basis of theory of
probability. The chances of loss are estimated in advance to affix the amount of premium.
Since the degree of loss depends upon various factors, the affecting factors are analyzed
before determining the amount of loss. With the help of this principle, the uncertainty of
loss is converted into certainty. The insurer will have not to suffer loss as well have to gain
windfall. Therefore, the insurer has to charge only so much of amount which is adequate to
meet the loss. The probability tells what the chances of loss are and what will be the
amount of losses.

The insurance, on the basis of past experience, present conditions and future prospects,
fixes the amount of premium. Without premium, no-operation is possible and the premium
can not be calculated without the help of theory of probability, and consequently no
insurance is possible. So, these two principles are the two main legs of insurance.


Insurance and gambling was considered alike because there are uncertainties of events and
payment is made when the event occurs. Like gambles the insured is unaware of the time and
amount of loss. If the event occurs, the insured like the gambler gains; otherwise they are
experiencing the loss. But there are certain differences between the insurance contract
and gambling.

Nature of Risk
In insurance, risks are existing, they may occur at any time. For example, death, old age,
fire, marine perils, accident etc; may occur at any time.

In case of gambling, the risk does not exist, it is being created for game or amusement
while one will suffer and another will gain. In absence of such game nobody will suffer. In
absence of insurance, the property owner will suffer while due to insurance, no party will

Insurable interest
In insurance contract, insurable interest is essential. Without insurable interest, it would be
wagering contract. Thus, this principle clearly distinguishes the insurance contract from the

Role/ Importance/ Social value of Insurance:

The role and importance of insurance has been discussed here in three phases:


Insurance provides security and safety

The insurance provides safety and security against the loss at damage or in olden age,
against the loss at fire, against the loss at damage, destruction or disappearance of
property, goods, furniture and machines, etc
Insurance efforts peace of mind:
The security wishes the prime motivating factor. This is the wish which tends to stimulate
to more work. By means of insurance, however, much of the uncertainty that centre about
the wish for security and its attainment may be eliminated.

Insurance protect mortgage property

At the death of the owner of the mortgage property, the property is taken over by the
lender of the money and the family will be deprived uses of the property. The insurance will
provide adequate amount to the dependents at the early death of the property-owner to
pay-off the unpaid loans. Similarly, the mortgagee gets adequate amount at the destruction
of the property.

Insurance eliminates dependency

Destruction of any kinds brings reduced standards of living and suffering may go to any
extend. The economic independence of the family is reduced or sometimes, lost totally. In
absence of protection against such dependency, the social welfare may be negatively
affected. The insurance only can provides adequate amount at the time of suffering.

Life insurance encourage savings

The elements of protection and investment are present only incase of insurance. These
policies combine the programs of insurance & savings. In property insurance only protection
elements exists;
The savings of insurance has certain extra advantage-
 Systematic saving is possible because regular premiums are required to
be compulsorily paid.
 In insurance the deposited premium can not be withdrawn easily
before expiry of the term the policy which can not be done in case of a
saving account in a bank.
 The insurance will pay the policy money irrespective of the premium
deposited while in case of bank –deposit; only the deposited amount
along with the interest is paid.
 The compulsion or force to premium in insurance is so high that if the
policy holder fails to pay premiums within the days of grace, he
subjects his policy to lapsation and may get back only a very nominal
potion of the total premiums paid on the policy.

Life insurance provides profitable investment

Individuals are willing or unable to handle their own fund had been pleased to find an outlet
for their investment in life insurance policies. The elements of investment i.e. regular
saving, capital formation and to return of the capital along with certain additional return are
perfectly observe is life insurance.

Life insurance fulfills the needs of a person

a. Family needs.
b. Old age needs.
c. Re-adjustment Needs:
At the time of reduction in income whether by loss of unemployment,
disability, or death, adjustment in the standard of living of family is required.
The life insurance helps to accumulate adequate funds. Endowment policy.
Anticipated endowment policy and guaranteed triple benefit policies are
deemed to be a good substitute for old age needs.
d. Special Needs:
 Need for education.
 Marriage.
 Insurance needs for settlement of children.
 Clean-up funds.


Uncertainty of business loss is reduced

In world of business, commerce and industry a huge number of properties are employed.
With a slight slackness or negligence, the property may be turned into ashes. In absence of
it uncertainty will be to maximum and the huge investment may be at a great risk. By
purchasing insurance policy this sort of risk can be minimized.

Business efficiency is increased with insurance

Business efficiency is increased with insurance. When the owner of a business is free from
the botheration of losses, he will certainly devote much time to the business. The care free
owner can work better for the maximization of the profit. The uncertainty of loss may
affect the mind of the businessmen adversely. The insurance, removing the uncertainty,
stimulate the businessmen to work hard

Key man indemnification

Key man is that particular man whose capital, expertise, experience, energy, ability to
control, goodwill and dutifulness make him the most value able asset in the business and
whose absence will reduce the income of the employer tremendously and up to that time
when such employee is not substituted. The amount of loss may be up to the amount of
reduced profit, expenses involved in appointing and training, of such persons and payment to
the dependents of the key man. The term insurance policy or convertible term insurance
policy is more suitable.

Enhancement of credit
The business can obtain loan by pledging the policies as collateral for the loan. The insured
persons are getting more loans due to certainty of payment of their deaths. The
redeemable debenture can be issued on the collateral of capital redemption. The insurance
properties are the best collateral and adequate loans are granted by the lenders.

Business continuation
In any business, particularly in partnership may discontinue at the death of any partner
although the surviving partners can restart the business but in both cases the business and
the partner will suffer economically. The insurance policies provide adequate fund at the
time of death.

Welfare of employees
The welfare of employees is the responsibility of the employer. Therefore, the latter has to
look after the welfare or the former which can be provision for early death, provision for
disability and provision for old age. These requirements are easily met by the life insurance,
accident and sickness benefit, and pensions which are generally paid by insurance.
The employees will devote their maximum capacities for any assigned task. The struggle and
strife between employees and employer can be minimized with such schemes.


Wealth of the society is protected

The loss of a particular wealth can be protected with the insurance through the prevention
of economic losses likes death damage or loss. Life insurance provides loss of human wealth.
The human material, if it is strong, educated and care-free, will generate more income.
Through stabilization and expansion of business and industry, the economic security is

Economic growth of the country

Welfare of employees creates a conducive atmosphere to work;
 Adequate capital form insurance accelerates the production cycle.
 In case of business the property and human material are protected against
certain losses, capital and credit are expanded.
Insurance meets all the requirements mentioned here for the economic growth of a country.

Reduction in inflation:
The insurance reduces the inflationary pressure in two ways-
 Firstly, by extracting money in supply to the amount of premium collected.
 Secondly, by providing sufficient funds, for production narrow down the
inflationary gap.

Created by, Russel (DIIT)

Composed by, Sojib (DIIT)