Functions of Insurance

Definition

Insurance is a legal contract (insurance policy) made between two parties, i.e. the insurance company (known as insurer) and the individual or group (known as insured). Both these parties enter into a contract under which the insured pays a predetermined sum of money to the insurer (known as a premium) with the promise that the company will compensate the insured in the event of a financial loss (risk) due to the causes that the insurer has agreed to provide a cover for.

The basic principle behind any insurance contract is that the insured would prefer to spend small amounts of money on a periodic basis against the possibility of incurring a huge unexpected loss. This concept works because all the policyholders pool in their risks together, and in case there are any losses arising due to the occurrence of the insured event, the person suffering the loss will be compensated up to the extent agreed in the contract.

Also check: Types of Insurance

Basic Functions of Insurance

It is important to understand that an insurance policy has both a financial and an emotional aspect for the policyholder. There are certain functions that an insurance company must promise to take care of while they are finalising the contract with the insured party. We will attempt to explain those functions below:

• To provide safety and security to the insured – One of the prime reasons for entering into an insurance contract is to seek financial security in the event of a loss from an unexpected occurrence. Insurance offers support to the policyholder and helps to reduce the uncertainties in the business or in human lives. With the help of a policy, the insured party is protected against future hazards, vulnerabilities and accidents. Although no insurer in the world can prevent the dangerous event from occurring, they can certainly help by providing some sort of financial protection to compensate the insured party.
• Protection for your loved ones – Medical insurance can help you and your family get the right sort of treatment and cover hospitalisation expenses. It helps to take care of their health in case of an accident, illness or any other unfortunate event. The well being of your family comes before anything, and insurance helps take care of that in the best possible manner.
• Collective Risks – Another function of an insurance contract is that it helps a number of individuals get an insurance policy to safeguard themselves from the losses that may occur due to an unfortunate event. This strategy works on the principle that not all of the policyholders for a particular risk will face it at the same time. For example, if a total of fifty thousand people are insured against damage to their cars due to accidents, the most likely scenario is that only a few of them would have accidents in a single year. So the amount that they can claim from the insurance company for the financial losses due to the accidents would be adequately covered by the insurance premiums from all fifty thousand policyholders.
• Risk Assessment – Insurance organisations play an important role in determining the actual amount of risk from the occurrence of a particular event by assessing the situation. They analyse all the aspects of a risk carefully to make an informed decision. It helps them to arrive at the final insurance amount as well as fix the premium to be paid by the insured.
• Certainty – One of the main benefits of taking a policy for the insured is that they can feel secure about meeting the future losses after taking coverage for a particular risk. It can be very reassuring for the insured party and can also help them to proceed with their daily activities in a much more assured manner without fear or hesitation.
• It helps to forestall losses – An insurance contract can help the insured to mitigate their losses by providing some sort of security in case of an unforeseen event. It helps businesses have a contingency plan in case things do not go as planned. Insurance is a very important tool for organisations as it allows them to cover their bases while operating in a very risky environment where the losses can be huge if they do not play their cards right. It also allows them to be able to cover these huge risks in their businesses by paying a relatively small amount as the premium.
• Fulfil the legal requirements – In some countries, any business is required to have certain insurance covers in order to engage in any economic activity. So the insurance company can help organisations fulfil these requirements.
• It allows the development of big businesses – Any large-sized organisation is exposed to a greater amount of risk. If the chances of loss are relatively higher, it may prevent the management in those organisations from taking calculated risks, which has the potential of bringing more profits. Insurance helps to mitigate that risk in a way and encourage businesses to take bold decisions. Insurance takes away some of the financial pressures and allows businesses to flourish in the long run.
• It can help in boosting the economy – When the businesses have sufficient insurance cover, they can increase their scope of economic activity that will bring commensurate rewards. This can provide an impetus to the overall economy of a country in the long run.

Conclusion

There are several functions of insurance in the everyday life of both an individual as well as a business. It provides a safety net against the uncertainties of life and helps to minimise the loss for the insured, and give them some sort of comfort in the face of a loss or tragedy. It is important for us to look at insurance as a necessity in our life that can help protect us both financially and emotionally in the long run.

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• MCQs on International Trade and Finance