FUNDAMENTALS OF INSURANCE

UNIT- 1
INTRODUCTION TO INSURANCE
Different types of risks like death, accident, floods, fire, earthquake, etc. make the human life
full of uncertainties. Therefore, it is necessary to have the protection from such risks. Insurance is
the answer to these risks and uncertainties. Insurance is a pool of funds created by persons exposed
to similar type of risks. It is based on the concept that good fortune of many compensates for the
misfortune of the few. The insurance companies were established on the same principle. The
insurance companies shoulder the burden of sufferers in exchange for an assessed payment for the
risk undertaken.

MEANING OF INSURANCE
Insurance is a risk transfer mechanism. It is a contract of compensation in case of potential
loss. The loss maybe of life or property. But the person seeking compensation must have entered
into a contract with the insurance company for that particular loss. The company who indemnifies
the person is known as insurer and the person who is indemnified is known as insured. The insurer
charges the loss for such indemnification in a certain period, that fees is called premium.
The word insurance is taken from late middle English word ensurance which means ensuring
or assurance or a guarantee. The word insurance is a noun and the dictionary(Oxford) meaning is
“an arrangement by which a company or the state undertakes to provide a guarantee of
compensation for specified loss, damage, illness or death in return for payment of a specified
premium”.
As per Macmillan dictionary, insurance is, “an arrangement in which you regularly pay an
insurance company an amount of money so that they will give you money if something you own is
damaged, lost or stolen, or if you die or are ill or injured”.
#DEFINITIONS OF INSURANCE
The definitions of insurance may be classified by two ways:
1) Legal definitions
2) Functional definitions
1. Legal definitions: The legal definitions are as follows-
a) According to Justice Lawrence, “Insurance is a contract by which the one party, in
consideration of a price paid to him adequate to the risk, becomes security to the other
that he shall not suffer loss, damage or prejudice by the happening of the perils specified
to certain things which may be exposed to them”.
b) As per E.W Patterson, “Insurance is a contract by which the one party, in consideration
of a price paid to him adequate to the risk, becomes security to the other that he shall not
suffer loss, damage or prejudice by the happening of the perils specified to certain things
which may be exposed to them”.
2. Functional definitions: The functional definitions are as follows-
a) According to John Megi, “Insurance is a plan wherein persons collectively share the
losses of risks”.
b) In the words of Rock Fell, “Insurance is a source of distribution of loss of few persons
into many persons”.
 c) As per Boone and Kurtz, “Insurance is a substitution for a small know loss(the insurance
premium) for a large unknown loss which may or may not occur”.

OBJECTIVES/NEED/IMPORTANCE/PURPOSE OF INSURANCE
1. Individual aspects
a) Security: The most important objective of insurance is security against the risk. The
insurance company guarantees the insured person to compensate the loss on
occurrence of uncertain event. Hence, the insured gets the feeling of security against
the adverse effects of uncertain events.
b) Forced savings: The Indian Income Tax Act allows the life insurance premium to be
included under Section 80C as savings. Thus, the life insurance works as forced
saving as the persons go for it for saving the tax. Also, it develops the habit of savings
among individuals.
c) Mental peace: Every person is exposed to different types of hazards, like life,
accident, health, etc. the losses like life, fire, burglary, accidental, etc. removes all
tensions and fears from the mind of insured person.
d) Future needs: The insurance is also necessary for compensating the future needs like
old age needs, re-adjustment needs, children education needs, marriage and settlement
of children, etc. The person can make small savings in the form of insurance for
meeting his future requirements.
e) Economic independence
f) Tax exemption
g) Protection against mortgage
h) Profitable investment
2. Economic aspects
a) Safety against business loss: Like an individual, business is also exposed to different
types of risks. The business has different types of properties and any negligence may
lead to huge loss to it. The only safeguard against the uncertain losses is the insurance.
If the assets are insured, then there will be no risk as in the case of loss the insurance
company will pay it off.
b) Increased efficiency: A person with free mind or without worries can work with more
efficiency than a worried person. The insurance of property makes a man free from all
worries. Thus, the businessman can devote much of his time in business and thus the
efficiency increases. As a result, the wealth maximization becomes possible.
c) Keyman indemnification: Keyman means the important person of the organization
who is needed in the organization due to either his capital an/or experience and/or
expertise and/or goodwill, etc. The organization may suffer in his absence. The death
or disability of him may cost more than the loss of physical assets to the organization.
d) Credit facilities: Like an individual, the business can also avail loan by pledging the
policies as collateral security. Therefore, the credit worthiness increases and the
business can avail more loans. Also the financial institutions feel secured as they can
surrender the policy and can get their amount realized. Thus, the insurance removes
the uncertainty from the mind of businessman which increases their efficiency.
e) Business partner funding
f) Employee welfare
 g) Inflation control
h) Financial help
3. Social aspects
a) Employment opportunity: Insurance is also a business organization like other
manufacturing or trading concerns. It comes under service industry. The company
employs the large number of persons as managers, deputy managers, development
officers, agents, clerical staff and supporting staff. The agents work on commission
basis and not a regular employee. Even the unemployed persons can get their
livelihood if they work sincerely as agents.
b) Economic growth: The insurance industry promotes growth in a number of ways.
These can be by improving financial soundness by providing insurance by enhancing
financial intermediation, creating liquidity and mobilizing savings, etc.
c) Standard of living: The level of wealth, comfort, material goods and necessities
available to a certain socio-economic class is known as standard of living. Healthcare,
quality education, safety, climate, life after retirement, etc. are the certain parameters
of standard of living. The insurance helps in achieving all these. The insurance
provides help in health hazards, financial help in education, after retirement, etc. Thus,
the insurance is helpful or required for improving the standard of living.
d) Social security: Insurance can be used as a social security tool which otherwise
government has to provide. The main points here are health hazards and old age
pension, etc. Since in India, the Government is not providing these benefits to citizens,
therefore, an individual has to secured himself by taking appropriate and sufficient
insurance. In addition to these, one can get himself secured by taking fire insurance
policy, accidental policy, etc. Thus, the insurance provides social security to the
individuals.
e) Social wealth
f) Loss reduction
4. National aspects
a) Capital formation: The money collected as insurance premium from insured persons
by insurance companies is invested by them in the securities of other companies.
Thus, it helps in capital formation in the country. Insurance is one of the biggest
channel for mobilizing household savings. These savings are channelized into industry
for capital formation.
b) Economic development: Insurance serves a number of valuable economic functions
that are largely different from other types of financial intermediaries. It is needed in
all the areas of the economy including industry, agriculture, household, etc. Various
researches indicated that insurance contributes materially to economic growth by
improving the investment climate and promoting a more efficient mix of activities due
to availability of risk management instruments. Thus, insurance helps in economic
development of the country.
c) National savings: Growth of a country depends upon the savings of that country. A
country which saves more tend to grow faster. Insurance is one of those channels
which mobilise domestic savings into domestic investment. The insurance maybe said
 to be better source in comparison of banks and other financial intermediaries as the
insurance mobilise funds for longer period in comparison of others.
d) Money market development
e) Foreign exchange

INSURANCE AS A SOCIAL SECURITY TOOL

Insurance reduces the risk in terms of life and property and thus it is treated as social security tool.
The United Nations Universal Declarations of Human Rights was adopted by UN General
Assembly on 10th December, 1948. The Article 25 of it provides,”Everyone has the right to a
standard of living adequate for the health and well-being of himself and of his family, including
food, clothing, housing and medical care and necessary social services, and the right of security in
the event of unemployment, sickness, disability, widowhood, old age or other lack of livelihood in
circumstances beyond his control”. In the light of the above statement, it becomes the duty of the
state to provide social security. But all the nations of the world are not in the position to provide the
full social security. Therefore, insurance is the another alternative available to the citizens since it
provides certainty of compensation to them.
From the point of view of International Labour Organisation, social security is the protection which
society provides to its members through a series of public measures against the economic and social
distress that otherwise would be caused by the stoppage of or substantial reduction in earnings
resulting from sickness, maternity, employment injuries, unemployment, invalidity, old age and
death. It also provides the extension of social security measures to provide a basic income to all in
need of such protection and comprehensive medical care, child welfare, maternity protection, etc.

India is a socialist country. In a socialist system, the government is responsible for providing
necessary social security to its citizen. But in the developing countries like India, it is very difficult
for the Government to provide all type of social security to its citizens. Article 41 of Indian
Constitution provides that the state shall make effective provisions for securing the right to work, to
education and to public assistance in cases of unemployment, old age, sickness and disablement
within the limits of its economic capacity and development. Keeping in view of the Article 42, the
Indian Government has passed some legislations to protect the rights and to provide benefits to the
citizens. These are as follows:
1. Workman Compensation Act, 1923
2. Employee State Insurance Act, 1948
3. Payment of Gratuity Act, 1972
4. Motor Vehicle(Amended) Act, 1988
5. Public Liability Act, 1991
6. Maintenance and Welfare of Parents and Senior Citizens Act, 2007
7. The Unorganised Workers Social Security Act, 2008.

In addition to above Acts, the Government of India started a number of schemes, out of which
important insurance schemes are as follows:
a) Livestock Insurance Scheme
b) Aam Admi Bima Yojana
c) National Pension Scheme.

The insurance is known as a social security tool because of the following reasons-
1. Social security: Insurance can be used as a social security tool which otherwise
government has to provide. The main points here are health hazards and old-age
pension, etc. Since in India, the government is not providing these benefits to general
citizens, therefore, an individual has to secure himself by taking appropriate and
sufficient insurance. In addition to these, one can get himself secured by taking fire
insurance policy, accidental policy, etc. Thus, the insurance provides social security to
the individuals.
2. Standard of Living: The level of wealth, comfort, material goods and necessities
available to a certain socio-economic class is known as standard of living. Healthcare,
quality education, safety, climate, life after retirement, etc. are the certain parameters
of standard of living. The insurance is helpful in achieving all these. The insurance
provides help in health hazards, financial help in education, after retirement, etc. Thus,
the insurance is helpful or required for improving the standard of living.
3. Economic Independence: A family depends upon the earning hand. If the earning
hand dies or becomes handicapped due to any reason, the family will loose its
economic independence. If the earning hand was sufficiently insured, the family will
not loose economically and would be able to maintain its economic independence
from the amount received.
4. Protection against Mortgage: In case a person took the loan against the property and
dies suddenly, then the family will be deprived off the use of the property. If the
person had the insurance, the insurance company will pay the amount to the
dependents through which they can pay off the loan and can retain their right on the
property. Secondly, the mortgage also wishes to get the property insured because he
will get the amount of loan from insurance company in case of damage of property.
5. Future needs: The insurance is also necessary for compensating the future needs like
old age needs, readjustment needs, children education needs, marriage and settlement
of children, etc. A person can make small savings in the form of insurance for meeting
his future requirements.
6. Safety against business loss: Like an individual, business is also exposed to different
types of risks. The business has different types of properties and any negligence may
lead to huge loss to it. The only safeguard against the uncertain losses is the insurance.
If the assets are insured, then there will be no risk as in the case of loss the insurance
company will pay it off.
7. Profitable investment: There are number of policies, namely, endowment policies,
ULIPs, deferred annuities, etc. which are proved profitable investments in long run.
Regular savings, capital formation and return of the capital are the basic features of a
investment which can be perfectly found in life insurance. High market returns in case
of ULIPs, periodical bonus and maternity bonus in case of other forms of life
insurance, etc. are found in it.
8. Employee welfare
9. Inflation control
 10. Employment opportunity.

INSURANCE AND ECONOMIC DEVELOPMENT

No single definition incorporates all the different strands of economic development. To understand
the economic development, the best way is to understand its objectives. The major objectives of
economic development are the creation of job and wealth, growth and restructuring of an economy
to enhance the economic well-being of a community and improving the quality of life. As per the
Wikipedia, the encyclopaedia, economic development is the sustained, concerted actions of policy
makers and communities that promote the standard of living and economic health of a specific area.
Economic development can also be referred to as the quantitative and qualitative changes in the
economy.

Thus, the main goal of economic development is improving the well-being of the community. The
importance of the insurance industry in the development process of a country was acknowledged by
UNCTAD in 1964 as: a sound insurance sector represents as essential feature of a proper economic
system, contributing to economic growth and fostering high employment.

A low and uneven development of insurance increases the level of risk in the economic decisions
taken by individuals and firms, which in turn hampers the economic activity. Francois Outreville
(UNCTAD 1990) examined the relationship between insurance development and economic growth
for developing countries and found that both life and non-life insurers generate significant economic
growth. The insurance industry promotes economic growth and structural development through the
following-

1. Improves financial soundness of firms: In case the firm is insured, it need not to keep funds
for contingency. It releases the extra funds for the firm otherwise which is to keep by firm for
contingency. In the absence of the insurance, the small firms may have to face the hardship
in case of adverse events. The large size firms have investment of huge capital in the
business. They have to suffer a lot in case of non-insurance and it becomes very difficult to
replace the asset in case of accident, fire or natural calamity. Thus, the insurance improves
the financial soundness of the firm by reimbursing the amount in case of loss.
2. Fosters Entrepreneurship and encourage investment: Insurance encourages new
entrepreneurs as the new entrepreneurs may not enter the business due to the fear of risk. The
insurance removes this hurdle by providing different types of insurance and guarantees
against risk. Thus, it fosters entrepreneurship in the country. If the entrepreneurship attitude
increases, it also increases the investment in country. Also, in case of non-insurance, the
existing firms invest less in innovation due to the fear of failure. Thus, the insurance also
brings innovation in markets.
3. Releases pressure from State funds: In all the countries and specially in advanced countries,
the social security is provided by State. The Government have to spend a hefty amount on
healthcare, pensions, unemployment allowance and other social benefits. Government of
India introduced the New Pension Scheme (NPS) in 2004. This scheme helps the
Government to reduce its pension liabilities.
4. Financial intermediation and mobilisation of savings: Insurance companies work as
financial intermediaries as they collect the money from the public in the form of premiums.
 Thus, the insurance companies mobilised the savings and create liquidity in the economy by
providing loans to firms, investing in securities, capital market, etc.
5. Promotion of sensible risk management: Insurance companies charge different premiums
for different types of risk. Life insurance premium is also fixed according to age. Thus, the
insurance companies offer firms and households an indicator of their risk level. One can
reduce the risk profile or to reduce potential damage to both. Thus, the insurers work as
sensible risk managers and a precaution improver, etc.
6. Fosters stable consumption: Consumption is the main driver of economic growth because
the consumption leads to demand which further leads to production. It provides protection
against old age needs, marriages and settlement of children, health and accident, loss of life,
etc.

Thus, insurance serves a number of valuable economic functions that are largely different from
other types of financial intermediaries. This sector works as a catalyst for economic
development.

Assignment:
Q. Explain the features of insurance in detail. (8marks)

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