Insurance provides financial protection against a loss arising out of the happening of an uncertain event. A person can avail of this protection by paying a premium to an insurance company.

A pool is created through contributions made by persons seeking to protect themselves from common risk. Premium is collected by insurance companies which also act as trustees to the pool. Any loss to the insured in case of an uncertain event is paid out of this pool.

Insurance works on the basic principle of risk-sharing. A great advantage of insurance is that it spreads the risk of a few people over a large group of people exposed to risks of a similar type.

Definition

Insurance is a contract between two parties whereby one party agrees to undertake the risk of another in exchange for consideration known as premium and promises to pay a fixed sum of money to the other party on happening of an uncertain event (death) or after the expiry of a certain period in case of life insurance or to indemnify the other party on happening of an uncertain event in case of general insurance.

The party bearing the risk is known as the insurer or assurer and the party whose risk is covered is known as the insured or assured.

Concept of Insurance / How Insurance Works

The concept behind insurance is that a group of people exposed to similar risks come together and make contributions towards the formation of a pool of funds. In case a person actually suffers a loss on account of such risk, he is compensated out of the same pool of funds. Contribution to the pool is made by a group of people sharing common risks and collected by the insurance companies in the form of premiums.

WHY SHOULD I BUY INSURANCE?

All assets have some economic value attached to them. No person can deny that there is also a possibility that these assets may get damaged/destroyed or become non-operational due to risks like breakdowns, fire, floods, earthquakes, etc. Different assets are exposed to different types of risks like a car has a risk of theft or meeting an accident, a house is exposed to the risk of catching fire, a human is exposed to the risk of death/accident. Insurance is needed because of the following reasons:

Social Security Tool

Insurance acts as an important tool providing a sense of security to society as a whole. It is the right of every human being to have basic amenities like food, clothing, housing, medical care, the standard of living necessary for his personal and family well being, and the right to security in case of unemployment, disability, sickness, or any other circumstances out of his control.

In case the bread earner of a family dies, the family suffers from direct financial loss as the family’s income ceases. As a result, the family’s economic condition gets affected unless there are other arrangements to rescue the family from this situation. Life insurance is one alternate arrangement that offers some respite to the family from financial distress. Otherwise, this family would have been pushed into the lower strata of society, which would be an additional cost to society. This is because subsidies would have to be given to the family so as to enable it to survive and enjoy the basic rights at par with other people. Moreover, a poor family is generally seen to have a large family size with family members being illiterate. This on a whole affects society and is a cost to society. Therefore, insurance complements the state in social management efforts.

Uncertainty

The basic need for insurance arises as risks are uncertain and unpredictable in nature. Getting insurance for an asset does not mean that the asset is protected against risks or its exposure to risk is reduced, but it actually implies that in case the asset suffers any loss in value due to such risk, the insurance company bears the loss and compensates the insured by making payment to him.

Some people naturally resist the process of creating a Financial Plan. Initially, it seems overwhelming and/or just too much of trouble. However, the potentially devastating consequences of not having it are far greater than the initial discomfort that you experience of the process. For most people we have worked with, the hardest part is just making the decision to get started. Once the process has begun, most clients find it engaging and interesting.