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Meaning and definition of Insurance with its characteristics.

MEANING AND DEFINITION OF INSURANCE... 

What is insurance? Why do people insure? What does an insurance company do? After studying this article you will have answers to these and many other similar questions. Suppose your father purchased a bike for you. When you drive the bike you follow the traffic rules; when you park in the parking space you lock the bike.Why do you follow the traffic rule? The reason is obvious- you want to avoid accident causing loss to you and your bike. why do you love the bike? you want to protect the buy from being stolen. But unfortunately, your efforts reduce the risk of meeting accidents and the risk of the bike being stolen, but they don't eliminate the chances these events taking place. Here lies the role of insurance. To protect from the loss from these events you can insure your bike with an insurance company. For that you will have to approach an Insurance Company, request to get your bike insured and pay money for that. In return, the insurance company agrees to compensate the loss in case you meet an accident or your bike is stolen. To formalize these processes, you and the insurance company enter into a legal agreement. In insurance terminology, you are known as insured, the insurance company is known as insurer, the money you pay to insurance company is known as insurance premium and the legal agreement is known as a contract. With this background, we can define insurance as a contract whereby the insured pays premium to the insurer for covering a loss that arises due to loss of life, or damage or destruction of some property. Accordingly, the insurance is:
* a contract between two parties-the insured and the insurance company
* the insured must pay a sum of money known as premium to get the insurance done. 
* in case of loss, the insurance company Indemnifies it. 

Thus, insurance is the mechanism to protect against the loss of life and property. Note that insurance, in the above example, doesn't reduce the chances of accident or the chances of the bike being stolen. What it does is that it protects you against the loss that arises due to those events. 

According to the Commission on Insurance Terminology of the American Risk and Insurance Association, insurance is defined as the pooling of fortuitous losses by transfer of such risk to insurers, who agree to indemnify insured for such losses, to provide other pecuniary benefits on their occurrence, or to render services connected with the risk. This is definition highlights the followings:
* Insurance is the pooling of casual losses. 
* Insurance transfers the risk from insured to the insurer. 
* The insurer agrees to provide pecuniary benefits on the occurrence of the loss. 

BASIC CHARACTERISTICS OF INSURANCE... 

The above definition highlights the following characteristics of insurance:
1. Pooling of losses
2. Payment of fortuitous loss
3. Risk transfer
4. Indemnification

1. Pooling of losses

To illustrate this concept let us take an example. Suppose that there are 1000 houses in a small town. For simplicity, let us further assume that each house costs Rs. 1,000,000 and on average, one house burns each year. The owner of the burnt house will have to bear a loss of Rs. 1,000,000; and other 999 owners will not bear any loss. Instead of this, all owners may agree to pool the loss i.e share the loss of one owner by all owners. In this care, each owner will have to bear a loss of Rs. 1000(Rs.1000000/1000), and none will have to bear a loss of 1000000. This way an owner's loss is shared by many owners. This idea of sharing of loss incurred by entire members of the group is pooling of loss. It is an important concept of insurance. 

2. Payment of fortuitous loss

A fortuitous loss means the loss that happens by chance. In other words, it is unforeseen and unexpected and occurs as a result of chance. Insurance policies cover only fortuitous loss; they don't cover intentional loss. For example, if you have insured your house against fire and if the house is destroyed by fire by chance, you are Indemnified for the loss. But if you intentionally put the house on fire and claim for the loss, you aren't Indemnified because the loss is intentional. 

3. Risk Transfer

Insurance always involves risk transfer. Risk transfer means trasnfering risk from insured to the insurer. For example, if you insure your house with an insurance company against fireworks, the risk of fire is borne by the insurance company. 

4. Indemnification

Indemnification is another important characteristics of insurance. It means that the insured compensated for the financial loss and restored to position prior to the occurance of loss. For example, if your house is damaged by fire to the extent of Rs. 500,000;the insurance company with which you had insured your house Indemnifies you to the extent of the loss i.e Rs. 500,000.

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