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Insurance can be defined as the“term used to refer to a commercial insurance transaction whereby an insurance applicant,as contracted,pays insurance premiums to the insurer,and the insurer bears an obligation to indemnify for property loss or damage caused by an occurrence of a possible event that is agreed upon in the contract,or to pay the insurance benefits when the insured person dies,is injured or disabled,suffers diseases or reaches the age or term agreed upon in the contract.
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In simple words,an
applicant or an insured pays the premiums to the insurance company;the insurer bears the liability to pay the claims or give the benefit under the terms of the insurance policy.
The primary function of insurance is to act as risk transfer mechanism.Think of a car owner.He has a car valued at$200 000.The car could be stolen,damaged in an accident or catch a fire.There could be an accident,resulting in serious injury to passengers or other people.How will the owner of the car cope with all of these potential risks and their financial loss?We know that the owner of the car can transfer the financial loss to the insurer,in return for paying a premium.
The basic function of insurance is to provide financial indemnity and insurance benefit. 11 In property insurance,when a subject-matter of insurance is damaged and the loss occurs,the insurer will give indemnity to the insured under the insurance contract.In life insurance,when an insured person dies,suffer diseases,is disabled or reaches the age under the life contract,then the insurer will give insurance benefit to insured person or his beneficiary.
In order to demonstrate the common pool,let us concentrate on the risk of the owner of a house being totally destroyed and say that there is a one in a thousand chance that will happen during the year.It has no great value that one house will be destroyed in every thousand houses.But if a large number of houses would be destroyed,it does begin to mean something.For example,if there were one thousand similar houses,then we could say that one of them will probably be destroyed during a year.On average,therefore,the expected total loss would amount to$60 000.Knowing this,the owners of one thousand houses could all contribute at least$60 into a common pool,and there would be enough to pay the one loss.
The insured's premium is received by the insurer into the pool or fund for the type of risk.By collecting premiums from all individuals and enterprises,insurers can spread the cost of the few losses among all the insureds. 12 The insurer takes the insurance premiums from many people and pays the losses of the few out of the pool.The premiums have to be enough to meet the total losses in any one-year and cover the other costs of operating the pool including the profit of the insurer.Even after taking all these costs into account,insurance is still an attractive business in the world. 13
It is clear that there can be several of these pools,one for each type of risk.The people who have a house to insure would not contribute to the same pool as those insuring a car.Operating in this way allows an insurer to identify which types of insurance are profitable and which are not profitable.
Even when risks of a similar type are brought together in a common pool,they do not all represent the same degree of risk to the pool itself.So the insurer has to ensure that a fair premium is charged,which reflects the hazard and the value which the person or company brings to the pool.Besides,the premium must also be competitive.There is not just one insurer in the market place and hence competition enters into the calculation.If an insurer charges a premium that exceeds the one quoted by other insurers,then he may lose the business.If he charges too little,the contribution to the pool would be less than required and loss would be made.
The three functions are all interest-dependent.Insurance can provide risk transfer mechanism by means of a common pool and each insured pays an equitable premium.
When risks are proposed to an insurance company,they will carry out a survey in order to assess the degree of risk.They make recommendations as to reduce the possibility of the occurrence of loss.Preventing disasters and
losses is the important aspect in the risk management.The insurance itself is also the important aspect of risk management.Insurer plays an active role in participating in the work of preventing disasters and losses with other related departments.
When an insurance premium is received and put into the fund,claims will arise from a few weeks or months until several years.The insurer can make full use of the idle fund to invest in order to gain the best overall return.The insurer can use the fund to buy government security,stock,money market fund or invest it in the real estate.
First of all,insurance can ensure the society to carry out the reproduction.By insurance,the risk can be transferred and the social reproduction can be ensured.Secondary,insurance can guarantee the insured to enjoy his financial interest.As long as the insured has taken out insurance,he can get financial indemnity or insurance benefits from insurance company if the damages or losses or injuries are covered by insurance policy.Thirdly,insurance can bring the stability to the society.When a disaster or accident happens,perhaps it will cause damages or losses to property and injuries or death to people.Insurer tries his best to pay claims to individuals or business units and protects their normal life.Therefore insurance stabilizes the society.