It is sure that our lives as human beings are surrounded by different types of unexpected risks daily. To mitigate the risks from such unexpected events, insurance has become an important tool for us.
Let’s understand, what it is, its components, importance, benefits, and types.
What is Insurance?
Insurance is a contract between two parties, one is the insurer (company) and another is the insured or policyholder (individual) in which the policyholder agrees to pay some amount periodically to enjoy monetary compensation for unexpected events from the insurer.
It is a legal contract between the insurer and the policyholder. Under this contract, as the insured, you have to agree to pay some money periodically, and as a return, the company i.e. insurer agrees to protect you financially.
The amount you pay regularly or periodically to the insurance company is called the insurance premium. Depending upon the nature and types of contracts, the premium price also differs.
There can be different types of risks you face in your life. Some risks you can manage on your own but there are some risks that can not be bearable by human beings.
Such as various calamities like a loss in an accident, loss of property by fire, loss by earthquake, floods, ultimate death, and other natural calamities. For this reason, insurance contracts have become significant to human lives as well as businesses.
It can be studied in two ways:
- Functional Basis – Under functional basis, insurance is a cooperation for mutual help. People used to gather and contribute a small amount to a fund and whenever member (s) of the group faced unexpected loss gets compensated.
- Contractual Basis – Under a contractual basis, it is a legal contract between an insurer and the insured where the insurer takes responsibility for protecting financially to the policyholder in the occurrence of unexpected losses or events.
Objectives of Insurance
The following are the main objectives of the insurance contract.
- Protects the policyholder or insured parties financially.
- Provide peace of mind to the policyholders.
- Fulfill the legal process.
- Diversify the risks.
- Mitigate the risks.
- Protects from unexpected events.
Essentials of Insurance Contract
Generally, insurance companies insure only the pure risks but all pure risks are not insurable. From the insurer’s point of view, the following six are the requirements for insurable risks.
A Large Number of Exposure Units
For an insurable risk to be viable, there must be a significant number of exposure units. These units should belong to a large, homogeneous group that is exposed to the same or similar perils. Although the exposure units within the group should be similar, they need not be identical.
Unintentional Loss
A crucial criterion for insurance is that the loss should be fortuitous or unplanned. The policyholder must not purposely cause damage to their property in order to receive compensation.
The loss should be unforeseen and outside the insured parties’ power to control.
Measurable Loss
According to this requirement, the loss should be measurable and determinable. It means the loss should be definite regarding, person, place, time, and amount.
No Catastrophic Loss
Additionally, the loss should not be catastrophic, which implies that a significant portion of the exposure units should not experience losses simultaneously.
If all the exposure units in a particular class suffer losses at the same time, the pooling strategy would become impractical.
Calculable Chance of Loss
It is important that the probability of loss can be estimated. The insurer should be capable of determining the average frequency and average severity of potential losses with reasonable precision.
Economic Feasible Premium
A crucial prerequisite for an insurance policy is that the premium must be financially viable. It should be established in a manner that enables the policyholder to afford it.
Components of Insurance Contract
The key components of an insurance contract include the following:
- Declarations: These are statements provided by the policyholder that specify important details about the insured item or individual, such as their name, address, occupation, and other relevant information.
- Definitions: The contract will provide clear definitions for specific terms that are used throughout the policy, such as “insured event” or “coverage limits.”
- Insuring Agreement: This outlines the scope of coverage and the specific risks that are covered by the policy.
- Exclusions: These are the circumstances or events that are explicitly not covered by the policy.
- Conditions: This section sets out the obligations and responsibilities of both the policyholder and the insurer, such as requirements for providing notice of claims or cooperating in investigations.
- Policy Limits: The contract will specify the maximum amount the insurer will pay out for a covered loss or event.
- Deductibles: This is the amount of money the policyholder agrees to pay out of pocket before the insurance coverage kicks in.
- Premium: The cost of the policy, which the policyholder pays in exchange for the coverage provided by the insurer.
Types of Insurance Contracts
The following are the main types of insurance contracts.
Life Insurance
Provides financial protection to the beneficiary of the policy in the event of the policyholder’s death. It can be used to cover funeral expenses, provide ongoing income for dependents, pay off debts, or leave a legacy.
Fire Insurance
Provides coverage for damage or destruction of property caused by fire. It typically covers the cost of repairing or replacing the damaged property, as well as any associated expenses.
Marine Insurance
Provides coverage for losses or damages related to ships, cargo, and other marine-related risks. It includes different types of policies such as hull insurance, cargo insurance, and liability insurance.
Auto Insurance
Provides coverage for damage or loss of a vehicle as well as liability for any injuries or damages caused to others in an accident. It can also include coverage for theft or other types of damage to the vehicle.
Travel Insurance
Provides coverage for unexpected events that may occur while traveling such as trip cancellation, medical emergencies, lost or stolen luggage, or travel-related accidents.
Education Insurance
Provides a savings plan to help pay for future educational expenses, such as college tuition, for the policyholder or their dependents.
Home Insurance
Provides coverage for damage or loss of a home and its contents caused by various perils, such as fire, theft, or natural disasters.
Business Insurance
Provides coverage for various risks associated with running a business, such as property damage, liability claims, and business interruption. It includes different types of policies such as general liability, professional liability, and property insurance.
Principles of Insurance
A short description of insurance principles is mentioned below.
Insurable Interest
For an insurance contract to be legally binding, there must be a stake or interest in the subject matter of the insurance policy, such as a person’s life or property.
The concept of “insurable interest” refers to a relationship in which the policyholder benefits from the protection of the insured subject matter and incurs losses if it is damaged or destroyed.
This principle allows the policyholder to safeguard their property from intentional harm by others and receive compensation as if it were their own.
Good Faith
There must be good faith between the insurer and the insured in the insurance contract. They must provide true and actual information about the different subject matters of the contract.
Contract of Indemnity
An insurance policy is considered to be a contract of indemnity, meaning it is an agreement to pay a specified amount upon the occurrence of a particular event.
Indemnity refers to the act of providing compensation for an actual loss or protecting against the possibility of unforeseen losses.
This principle dictates that insurance is intended solely for the purpose of compensating losses, and not for providing financial benefits or gains.
Subrogation
The principle of subrogation allows the insurer to take legal action against third parties responsible for causing a loss to the policyholder after the insurer has compensated the policyholder for the loss.
Proximate Cause
The proximate cause principle determines the cause of a loss or damage and whether it is covered under the policy.
It is the dominant and most effective cause that determines the extent of liability. If the proximate cause is covered under the policy, the loss will be compensated; if not, it will not be covered.
Benefits of Insurance
An insurance contract is beneficial for both individual persons and the business owners. The following are the main benefits/importance of insurance to individual persons and businesses.
- Provides Financial Security: It can provide individuals with a sense of financial security by protecting them from unexpected losses, such as medical expenses or damage to property.
- Promotes Peace of Mind: Knowing that one’s assets and loved ones are protected by an insurance policy can bring peace of mind and reduce anxiety.
- Helps Manage Risk: Insurance policies can help individuals manage risk by providing coverage for potential losses, such as disability or long-term care.
- Protects Businesses Against Financial Losses: Business insurance policies can help protect companies from financial losses due to unexpected events, such as property damage, liability claims, or business interruption.
- Ensures Legal Compliance: Many types of business insurance, such as workers’ compensation or commercial auto insurance, are required by law, to ensure compliance with legal requirements.
- Improves Credibility and Trust: Having insurance coverage can help improve a business’s credibility and build trust with clients, as it shows a commitment to risk management and the protection of assets.
Hence, in conclusion, we can say that insurance is a legal contract between the insured and the insurer in which both parties have to act legally during the limitations or period of the insurance contract or policy. It is a win-win legal contract for both the policyholder and the insurer.