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Unit 12: Insurance

after meeting claims, it distributes it among policyholders in form of bonus or reduction Notes
in premium.
6. It follows the principles of Indian Contract Act, which help to prevent its misuse or abuse.

12.10 Functions and Characteristics of Insurance

Functions of Insurance

1. It helps capital formation
2. It provides certainty
3. It provides protection
4. It helps prevention of losses
5. It shares risk.

Characteristics of Insurance

An insurance contract has the following characteristics, which are generally, observed in case of
all kinds of insurance contracts whether life, marine, fire, or miscellaneous insurance.
1. Risk Sharing and Risk Transfer: Insurance is a device to share the financial losses, which
might occur to an individual or his family on the happening of a specified event. The event
may be the death of earning member of the family in the case of life insurance, marine-
perils in marine insurance, fire in fire insurance and other certain events in miscellaneous
insurance,

Example: Theft in burglary insurance, accidents in motor insurance, etc.
The loss arising from these events if insured are shared by all the insured in the form of
premium which they have already paid in advance. Hence, the risk is transferred from one
individual to a group.
2. Cooperative Device: A group of persons who agree to share the financial loss may be
brought together voluntarily or through publicity or through solicitations of the agents.
An insurer, by insuring a large number of persons, is able to pay the amount of loss. Like
all cooperative devices, there is no compulsion here on anybody to purchase the insurance
policy (third party liability insurance in case of a vehicle owner is an exception).
3. Calculates risk in advance: The risk is evaluated on the basis of probability theory before
insuring since the premium payable on a policy is to be determined. Probability theory is
that body of knowledge, which is concerned with measuring the likelihood that something
will happen and making estimates on the basis of this likelihood. The likelihood of an
event is assigned a numerical value between 0 and 1. Those events that are impossible are
assigned a value of 0 and those that are inevitable are assigned a value of 1. The higher
values (between 0 and 1) are assigned to those events estimated to have a greater likelihood
or probability of occurrence.
4. Payment of claim at the occurrence of contingency: The payment is made on happening of
a certain contingency insured. It is true for all non-life insurances that payment will be
made on happening of the specified contingency only.
The life insurance claim is a certainty, because the contingency of death or the expiry of
term, will certainly occur and the payment is certain.

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