Insurance is a mechanism that helps to reduce the effects of adverse situations in the economical way. It promises to pay to the owner or beneficiary of the asset, a certain sum if the loss occurs.
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What Is Insurance ?
The business of insurance is related to the protection of the economic values of assets. The asset would have been created through the efforts of the owner. The asset is valuable to the owner, because he expects to get some benefits from it because it meets some of his needs. This benefit may be an income or in some other form.
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In the case of a factory or a cow, the product generated by it is sold and income is generated. In the case of a motor car, it provides comfort and convenience in transportation, there is no direct income. Both are assets and provide benefits.
Every asset is expected to last for a certain period of time during which it will provide the benefits, after that, the benefit may not be available. There is a life-time for a machine in a factory or a cow or a motor car. None of them will last for ever. The owner is aware of this and he can so manage his affairs that by the end of that period or life-time, a substitute is made available. Thus, he makes sure that the benefit is not lost. However, the asset may get lost earlier. An accident or some other unfortunate event may destroy it or make it incapable of giving the benefits. An epidemic may kill the cow suddenly. In that case, the owner and those enjoying the benefits therefrom, would be deprived of the benefits. The planned substitute would not have been ready. There is an adverse or unpleasant situation. Here, insurance helps to reduce the effects of such adverse situations.
Purpose & Need Of Insurance
The risk only means that there is a possibility of loss or damage. The damage may or may not happen. Insurance is done against the possibility that the damage may happen. There has to be an uncertainty about the risk. The earthquake may occur, but the building may not have been affected at all. The word ‘possibility’ implies uncertainty. Insurance is relevant only if there are uncertainties.
In case of a human being, death is certain, but it’s time is uncertain. The person is insured, because of the uncertainty about the time of his death. In the case of a person who is ill,the time of death is not uncertain, though not exactly known. It would be ‘soon’. He can’t be insured.
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How Insurance Works
The mechanism of insurance is very simple. People who are exposed to the same risks come together and agree that, if any one of them suffers a loss, the others will share the loss and make good to the person who lost. The manner in which the loss is to be shared can be determined beforehand. It can be equal among all. It can also be proportional to the risk that each person is exposed to.