INTRODUCTION

The business of Insurance relates to safeguarding the

economic values of assets. Every asset has a value. The
asset is beneficial to the owner, because the owner
expects to get some return from it. The return can be a
financial income or some other benefit that addresses
few of his requirements.

Let’s consider a factory. In a factory, the product manufactured earns an income when it is
sold. Therefore, the factory is an asset to its owner. Similarly an automobile is an asset,
because it provides easy and convenient transportation. However, every asset whether it is the
machinery in a factory or an automobile, has a defined life after which, it may not be as
beneficial. To avoid losses in income or a depreciated value, the owner needs to arrange for a
substitution of the asset before the end of the life time of the asset.

However, there are chances of the asset being lost earlier. A mishap or some other calamity
may damage it or make it unusable. In such a scenario, the owner and those benefiting from it
would not be able to profit and the pre-planned substitute would not be ready. Insurance is a
tool that helps to reduce the effect of such unfavourable situations.

BRIEF HISTORY OF INSURANCE I

Insurance is known to exist in some form or the other since

3000 BC. It was practiced by the Chinese, the Babylonians,
and the inhabitants of Rhodes and by the Greeks in the 7th
century AD.

There was a great fire in London in 1666, in which more

13000 houses were lost and this huge lose caused the
opening of a fire in London, called the fire office, in 1680.

Post this, the business of insurance began by traders, who

would gather in the Lloyd’s coffeehouse in London and
agreed to share the losses to their goods while being carried
by ships. The losses primarily occurred because pirates
robbed them on the high seas or because of bad weather
running the goods or sinking the ship.

In India, insurance began only in 1818 with life insurance being transacted by an English
company, the European and the Albert. The first Indian insurance company was the Bombay
Mutual Assurance Society Ltd formed in 1870 in Mumbai. The Oriental Life Assurance came
next in 1874. This was followed by the Bharat in 1896 in Delhi and the Empire of India in
1897.

BRIEF HISTORY OF INSURANCE II

Later on, the Hindustan Cooperative was formed in

Kolkatta, the United India in Chennai, the Bombay Life in
Bombay, the National in Calcutta, the New India in Bombay,
the Jupiter in Bombay and the Lakshmi in New Delhi. These
were all Indian companies, which began as a result of the
Swadeshi movement in the early 1900s. In the year 1956,
the life insurance business was nationalised and the Life
Insurance Corporation of India (LIC) was formed on 1st
September 1956, merging 170 companies and 75 provident
fund societies transacting life insurance business in India.

Apart from LIC, only Post Life Insurance (under central govt.) was permitted to do life
insurance business after nationalisation . Reforms process was started in nineties and to
encourage competition, private companies were permitted to do life insurance business in
India. Between 1999 and 2007, 16 new private companies started life insurance business in
India.

PURPOSE & NEED OF INSURANCE

Insurance is required for assets to prevent damages

through unpredictable and accidental events, such as fire,
floods, breakdowns, lightning and earthquakes. Such
unpredictable and accidental events are known as perils.
When an asset is prone to a serious damage or significant
loss from such perils, you can say that the asset is
exposed to a risk. The financial damage due to the peril
varies depending on the cost of the asset and its contents.

A risk only indicates the possibility of a loss or damage. Assets are insured based on this
possibility of a loss or damage. However, to insure an asset there has to be a certain amount of
uncertainty involved in the risk. For example, death is certain for every human being, but the
time of death is not certain. Therefore, you can insure a person’s life. However, you may have
noticed that insurance companies typically don’t have any schemes for insuring people who
are terminally ill. That’s because in an illness the time of death is certain, though not exactly
known.

Another interesting fact about insurance is that insurance does not provide protection for the
asset. Insurance also doesn’t guarantee you that a peril can be avoided. Insurance only
minimizes the impact of the risk on the owner of the asset and people depending on it. It also
partly compensates for the loss. Insurance only applies to financial losses.

CLASSIFICATION AND RISKS

Risks can be classified as follows:

Based on the extent of loss, risks can be classified into three types: critical, important and
unimportant:

Critical risks are catastrophic in nature which may lead to bankruptcy of the owner or total
loss due to the Tsunami.

Important risks, which may affect family or business finances badly

Less damaging risks, such as temporary illness or Accident may be called as

Unimportant Risks

Financial and Non-Financial Risks: Insurance is concerned with the financial risks

Dynamic and Static Risks: Dynamic risks are caused by perils haven national
consequences like inflation calamities, practical disturbances and static risks are such
which do not affect national economy like fire, or theft or main appropriation. Static
risks are managed by insurance.

Fundamental Risks affect large population while Particular Risks affect specific persons.
Accident is a fundamental risk while theft is a particular risk. Insurance companies
cover particular risks

Pure and Speculative Risks: Insurance deals with pure risks

HOW INSURANCE WORKS

Basically, in any insurance scheme, people who are prone

to similar risks come together and agree to share and
compensate the losses should any of them suffer a loss.
Groups are formed based on the kind of risks people are
prone to. The loss of a particular member of a group is
shared by all members of that group. Thus, the risk is
shared by the community and a particular person doesn’t
have to face the impact of a heavy loss alone.

However, there are some rules and principles, which make it possible for insurance to remain a
fair arrangement. For example, in case of an unexpected peril, the loss is proportionately
divided amongst the members of the community who are prone to similar risks, and this
method is predetermined. The share can be collected before or after the losses arise or at the
time of admission to the group. Insurance companies collect in advance and create a fund from
which the losses are paid. Assumptions are made based on past experiences of individuals and
collections are determined accordingly.

Any person who generates an income is an asset to the family. His manual labour, professional
abilities, talents and his perception of business are all assets, which can be lost due to
accidents. Death is a certainty, but the timing is unpredictable. An untimely death can cause the
family severe losses if no alternate arrangements have been made. Insurance is necessary to aid
those depending on this person’s income.

THE BUSINESS OF INSURANCE I

Insurance companies are called insurers. The insurers perform the following functions.

They bring together persons with similar insurance interests (sharing the same risks).

They collect the share or contribution (premium) from all of them.

They pay out compensations (or claims) to those who suffer.

Insurance is classified into the following two types

Life insurance: Life Insurance covers loss due to risks related to the lives of human beings.

Non-life or General insurance: Non-life or general insurance covers losses due to all other
risks. Broadly, you can classify general insurance into the following three types:

Fire Insurance which deals with cover of losses caused by fire related risks.

Marine Insurance which deals with cover of losses caused by all transport related risks and
ships.

Miscellaneous Insurance which deals with cover of losses caused by all others, such as
liability, fidelity, motor, crop, personal Accident, etc).
Note: Personal Accident and sickness insurance related to human beings, is classified as ‘non-
life’ in India, but is classified as ‘life’ in many other countries.

THE BUSINESS OF INSURANCE II

The premium is based on expectations of the losses that are based on information through the
study of occurrences in the past and the use of statistical principles. There is, in statistics, a
“law of large numbers”. The variation will be less as a percentage. Therefore,

the greater the number of risks included in the pool; the better the chances that the assumptions
regarding the probability of the risk occurring (on which premium calculation is based) will be
realized in practice. Hence, the greater the spread of the business, the better the expectations.

The insurer holds the position of a trustee as it manages the common fund on behalf the
community of policyholders. It has to make sure that no one is allowed to take unfair
advantage of the arrangement. For example: the management of the insurance business is
responsible for preventing entry of such individuals to the group whose risks are not similar or
who are asking for claims on losses that are not accidental.

The decision to allow entry is known as the process of underwriting of risk. Underwriting
includes determining the risk or evaluating how much risk exposure is involved. The premium
that is charged is dependent on the determination of the risk involved.

ROLE OF INSURANCE AS A SOCIAL SECURITY

TOOL

The U.N. Declaration of Human Rights of 1948 states

that:

“Everyone has a right to a standard of living that is

adequate for the health and wellbeing of himself and his
family.”

This includes food, clothing, housing, medical care,

necessary social services and the right to security in the
event of unemployment, sickness, disability, widowhood
or other lack of livelihood in circumstances beyond his
control.

Social security is a part of the Indian constitution as well. According to Article 41, the state
within the limits of its economic capacity and development should provide for the right to
work, education, unemployment, old age, sickness and disablement. The state also has
obligations towards the poorer sections of the society and they are met through the services of
life insurance. The directions of the regulatory authorities extend insurance benefits to
economically weaker sections of the society

Reinsurance:

Insurance companies take the risks that they have to pay claims as and when the need arises.
Insurers are normally financially sound enough to be able to pay claims but there are limits, a
catastrophic claim like Tsunami or a Hurricane may be to the tune of crores of rupees and this
may put a very heavy strain on the reserve of the insurers. Insurers protect themselves against
such situations that may be beyond their capacity by reinsuring the risk with other insurers. If
there is a claim then the burden is shared by the primary insurers and the reinsurers. There are
only some companies who do reinsurance business. In India, General Insurance Corporation of
India is the national reinsurer. Reinsurance otherwise is a global business.

ROLE OF INSURANCE IN ECONOMIC DEVELOPMENT

Investments are made out of savings and they are necessary for the growth of economic
development. A life insurance company plays an important role in mobilizing savings of
people; especially from the middle and lower income groups and these savings are channeled
into investments for economic growth. Most life insurance companies have large funds that are
accumulated through the payments of small amounts of premium from individuals

And these funds help the growth of the economic development of the countries in which they
do business. These funds are collected and held in trust for the benefit of the policyholders.
The management of life insurance companies needs to remember this aspect and take decisions
keeping in mind the benefit of the community.

Business and trade also benefit through insurance. Without insurance, trade and commerce is
exposed to perils and will find it difficult to face the impact of such events. Huge funds of
insurance companies can be used for economic development of country and national
reconstruction. Express roads, rural electrification, dams and hospitals have been possible
through insurance funds.
ADVANTAGES OF LIFE INSURANCE 1

It is incorrect to say that life insurance is investment or

means of saving. The saving and investment options are
deposits in the bank, in national savings certificates, in
mutual funds and all other saving instruments. Money
invested in buying shares and stocks are at risk of being lost
in the fluctuations of the stock market. Assuming there is no
loss, the money available at any time is the amount invested
plus appreciation.

In life insurance, the fund available is not the total of the saving already made (premiums
paid), but the amount one wished to have at the end of the saving period (which is the next 20
or 30 years) and the final fund secured from the very beginning. One is paying for it later, out
of the savings. One has to pay for it only as long as one’s lifetime or for a lesser period
according to his choice. Hence life insurance cannot be substituted with any other investment
or savings scheme as there are no other schemes provides this kind of benefit.

ADVANTAGES OF LIFE INSURANCE 2

Life insurance has the following advantages in comparison to other forms of savings.

Settlement is easy in case of the event of death.

Facility of nomination and assignment makes the collection of money by the heirs quicker.
Now some bank accounts provide the facility of nomination.

Creditors can be protected against attachment by courts but cannot claim the life insurance
money.

There are tax benefits in income tax and in capital gains.

A life insurance policy is property and can be transferred or mortgaged and loans can be raised
against the policy as marketability is better.

Tangibles and Intangibles

You refer to the things that we can touch or feel as

tangibles. You can insure tangible assets.
You refer to the things that you cannot touch but can
only feel as intangibles. You can now insure
intangible assets as well.

For example: you can insure intangible assets, such as

the vocal chord of a singer, fluctuations in the dollar-
rupee or pound-rupee.

In insurance, what is sold is only a promise and what the insured gets is only the assurance of
compensation in the event of occurrence of loss. Therefore, all insurance products are
intangible.

All income generating skills of a human being are assets, such as manners, professionalism,
problem solving skills and entrepreneurial skills etc. The value of these assets can be measured
by the income generated by him. The human asset provides a scientific method to determine
the asset value of human life and therefore the amount of insurance required.

A human being is prone to the following risks.

Early Death
Living too long
Disabilities, sickness
Unemployment