Page 141 - DMGT515_PERSONAL_FINANCIAL_PLANNING

Personal Financial Planning

Notes Insurance is defined as a cooperative device to spread the loss caused by a particular risk
over a number of persons who are exposed to it and

It does not reduce the risk,
It does not alter the probability of risk, but
It only reduces/ spreads the financial losses.

8.1 Characteristics of Insurance

An Insurance contract has the following characteristics, which are generally, observed in the
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 death of the 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, e.g., 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. Co-operative 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 co-operative 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 insured contingency. It is true for all non-life insurances that payment will be
made on the 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.
Similarly, in certain types of life policies, payment is not certain due to uncertainty of a
particular contingency within a particular period. For example, in term-insurance the
payment is made only when death of the assured occurs within the specified term, may be
one or two years. Similarly, in pure endowment, payment is made only at the survival of
the insured at the expiry of the period.
5. Amount of Payment: The amount of payment depends upon the value of loss suffered due
to the happening of that particular insured risk, provided insurance is there upto that
amount.

In life insurance, the purpose is not to make good the financial loss suffered. Moreover,
one cannot estimate the value of a human being. A person is no doubt precious to his/her

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