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 FUNCTIONS OF INSURANCE... 

If we recall the definition of insurance, we can sense the major functions it performs. The primary function of insurance is to protect policyholder individuals and corporations from adverse events. By accepting premiums, insurance companies promise policyholders compensation if certain specified events occur. In this process, the insurance does the following: 

1.Risk transfer

2.Creation of common pool 

3.Equitable premium 

Risk transfer 

The most important function of insurance is risk transfer. Insurance transfers the risk borne by the insured to the insurer. For example, think of your house and the shop your family run in your own house. Think of the car your family has purchased recently. Your house and the shop may catch fire and the car may be stolen. The potential risk of fire and theft may bring severe financial consequences to your family. By insuring your house and business against fire, and the car against theft; you can transfer the risk of fire and theft to the insurance company. But note that insurance will not, in itself, prevent any of the above potential risk from occurring; what it will do is provide some form of financial security. You can transfer the financial consequences of the risk to the insurer, in return for paying a premium. 

Creation of common pool 

Creation of common pool is another important function of insurance. Every insurance company creates and operates such pool. They take contributions, in the form of insurance premiums, from many people and create the pool, and use the pool to pay the losses of the few. Let us illustrate how insurance creates common pool. Assume that there are 20,000 bikes in Biratnagar area. The past experience shows that on an average 20 bikes are stolen annually. It means on an average one bike is stolen per .one thousand bikes. In percentage term it is 0.01 percent. If we further assume that per bike loss is Rs 100,000, the total loss of stolen bike in a year comes to Rs 2,000,000. If an insurance company charges Rs 100 from each bike and creates a pool of Rs 2,000,000 (20,000 bikes multiplied by Rs 100) it would be able to compensate the loss of all bikes stolen in a year. This is the idea behind creating pool. 

This information (data on stolen bike) has little value to an individual, but it bears great significance to an insurance company. If you think of accumulating Rs 100 each year how long will it take to collect Rs 100,000? One hundred years! You will be able to compensate yourself only in 100 years. But if you pay that Rs 100 to the insurance company, it would pay you instantly in case your bike is stolen. 

Equitable premium 

Equitable premium means fair and reasonable premium. The insurer must charge fair premium to the insured. Insurers determine equitable premium by considering the hazard and value of the property. For example, a timberbuilt house represents a different risk from one of standard brick construction. The insurer, therefore, charges different premium to the owners of timber-built house and the house built on bricks. Charging equal premium for houses with different level of risk would not be equitable. Similarly, an employee working in a factory is exposed to higher level to risk than an employee working in an office. Therefore, they too should be charged differently to make the premium equitable. Moreover, the insurer considers the value of the property as well for premium determination. A person with a Rs 2,000,000 house would have to pay more than someone with a Rs 500,000 house. 

 BENEFITS OF INSURANCE... 

Insurance is beneficial to an individual as well as to the society. It protects individuals from different types of losses and brings peace of mind to them. The same protection benefits the society in a number of ways. It has been observed by many writers that insurance plays important role in the economic development of a nation. In this section, we point out important benefits of insurance. We first present the benefits of insurance to individuals/ businesses and then present the benefits to the society. 

Benefits to Individuals/ Businesses 

Provides security through indemnification of loss 

An important benefit of the insurance is that it provides sense of security to individuals, families and businesses. In case of loss due to events like fire or accidents, insurance indemnifies the loss to the insured. In other words, the insured is restored to his / her former financial position. For example, if your insured car is damaged in an accident the insurance company pays for the repair of your car. Similarly, if your factory is insured and if it is destroyed by fire, the insurance company indemnifies the loss caused by fire. This way insurance provides security to individual and businesses. 

Peace of mind 

Peace of mind is closely related to the feeling of security through indemnification of loss provided by insurance. When individuals insure their house, car, possessions and so on, they feel secured against financial loss associated with events like fire, theft, etc. It reduces their worry and fear, and gives them immense peace of mind. The life insurance also provides peace of mind to the insurer as well as his/her dependents. For example, if the family heads have adequate amounts of life insurance, they are less likely to worry about the financial security of their dependents in the event of premature death. In organizations as well, when the workers and employees are insured, they feel secured. It not only gives them peace of mind, but it also enhances their productivity and loyalty towards the organization. 

Encourages saving 

This benefit is available only in life insurance. In most life insurance policies, the insured is required to pay premium for a long period of time. In the event of premature death the insured sum is given to the dependent. If the insured survives till the end of the term of insurance, the policy amount along with bonus is returned to the insured. Since the money paid by way of premium is returned to the insured or to the dependent, people consider life insurance as a scheme of protection as well as saving and are encouraged for saving. 

Enhancement of credit 

An important benefit of insurance is that it enhances creditworthiness of a person and of a business. For example, when an individual or a business applies for bank loan to purchase a property, the borrower is required to insure the property to get the loan. The property insurance protects the bank’s financial interest if the property is damaged or destroyed. 

Benefits to Society/ Economy 

Prevention of loss 

We have noted earlier that insurance protects the insured from financial loss due to events like accidents and thefts. In this case, there is mere transfer of loss from the insured to the insurer; there is no reduction of loss. However, in order to reduce the occurrence of loss, insurance companies engage in different activities. Some important loss-prevention activities that insurance companies strongly support include programs related to (i) highway safety that reduces road accidents, (ii) fire prevention, (iii) educational programs on loss prevention, etc. These programs conducted by insurance companies prevent loss to some extent. Prevention of loss even at individual levels is the prevention of loss of the society because individuals are the members of the society. 

Promotes economic growth 

It is argued that insurance promotes economic growth of an economy. It does so by (i) offering the protection against loss, and (ii) by availing investible fund. The benefit of protection against loss has been discussed earlier. Here we describe how insurance promotes economic growth by availing investible fund. Insurance companies, particularly life insurance companies, generate long-term funds in the form of premium. Long-term funds can be utilized in the process of capital formation. In other words, they can be used to finance infrastructure projects like construction of roa ropeways, factories, hospitals, etc. These projects promote‘economic growth and employment in an economy. This way the development of insurance promotes economic growth of an economy.

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