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Unit 8: Insurance Planning

8.3 Role of Insurance Notes

Insurance is a part of the financial system. Financial system may be defined as a set of institutions,
instruments and markets, which gather savings and channel them to their most efficient use.

The system consists of individuals (savers), intermediaries, markets and users of savings. Economic
activity and growth are greatly facilitated by the existence of the market in mobilizing the
saving and allocating them amongst the competing users.
An economy needs institutions that impartially enforce property rights and contracts. Economic
growth of a country depends on the existence of a well functioning financial infrastructure. It is
essential, that the financial infrastructure be developed sufficiently so that the market operates
in an efficient manner.

Insurance as a part of the financial system provides valuable services to those affected by various
risks or contingencies.
It takes care of the financial consequences of certain specific contingencies but in insurance
terminology, such contingencies are called risks and they cause losses when they occur.
The effect of these losses on the financial system is not only negative but may be disastrous and
catastrophic also. It results in substantial burden on the financial well being of those affected.
Insurance sector supports the financial system in several ways, a few have been enumerated
below:
1. It accepts the risk from people and corporate bodies who are exposed to them.
2. It collects small amounts of premium, which are pooled together to be called an insurance
fund. This fund is used for investment purpose.
3. It organizes compulsory insurance in certain areas as per the provisions of the law.
4. It sells voluntary insurance covers through its sales force.
5. It settles claims arising out of insured losses. Neither the insurance company nor the
insured are allowed to make profits out of insurance. If insurance company gets a surplus
after meeting claims, it distributes it among its policyholders in the form of bonus or
reduction in premium.
6. It follows the principles of Indian Contract Act which helps to prevent its misuse or abuse.
Figure 8.1 explains the key functions of insurance:

Figure 8.1: Functions of Insurance

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