Punpes and Pactice ot insurance

Meaning of lusurance
The dea ot msurance is as old as civilhzation itself, in any comnmunity. it s
by a fire or the death
sutthe practice to helpa family visited by adversity as

of a breadw mner, the assistance may be in cash or in kind, with theotpurposeo

insurance
41atng or
heljping to compensate the loss, which is the concept
surance is a social device n which a group of individuals (insureds) transfer
S k to another party (imsurance company o insurer) in order to combine loss

losses and provides tor payment

which pemts statistical prediction of
etence,
of losses from funds contributed (premiums) by all members who transferred risk

An example will make the concept of insurance moe ciearer

the college on bikes. By
nacollege, let suppose that 500 students come to
us
Thus it can be
past epeience. it is found that every year, say two bikes are lost.
bikes, but who those two
Said that
out of 500 students, any two will lose their element of
students would be is not hnown in advance. Hence, with this
risk of losing his bike
uncertanty. each one of the 500 students is exposed to the
the cost of which may be Rs. 37,500. The total cost of two bikes will
be Rs. 75,000
topa
lo sateguard against this loss, all the 500 students may contribute equally
are lost, the
Tund of Rs. 75,000 by paying Rs. 150 each and whenever the bikes
fund. Every student
Sullerers will be paid Rs. 37.500 each out of the common
undertakes to bear a definite monthly loss of Rs. 12.50 in exchange for a probable
loss of Rs. 37.500 a year. Thus, insurance makes it possible
for a student to
is probable, n
bargain an annual loss of Rs. 37.500, which though uncertain, very
exchange 1ora definite monthly loss ofRs. 12.50,. Rs. 150 to conpensale a loss ol
miracle
Rs. 7.500. What an ingenious device, it is! Prima facie it seems almost a
but to the students of insurance. it will be an unadulterated tact.

Definition of Insurance
Difterent authors/ authorities have defined the term 'Insurance' differently.
Some of the popular definitions are as follows
Ghosh and Agarwal: Insurance is a co-operative fornm of distributing a
certain risk over a group of persons who are exposed to it.
D.S. Hunsell: Insurance is a social device providing financial compensation
for the effects of misfortune, the payments being made from the accumulated
contribution of all parties participating in the scheme.
E. W Patterson: Insurance is a contract by which one party (the inurer) for
a compensation called the premium assiumes particular risk of the other party (the
insured) and promises to pay to him or his nominee a certain or ascertairnable sum
of money on a specified contingency.
 mtroduction to lnsurance
ren ti. Hület: Insurance is that social device for making accumulations
c e t uncertain losses which is carried out through the transfer of the t i

any individuals person or to a group of persons.

to one

and Blan Chard: Insurance is a social device for

eliminatng
Owbray
reducing the cost to society of certain types of risk.
icTionary o f Business and Finance : Insurance is a form of contrac
g T c e m e n t u n d e r w h i c h o n e p a r t y a g r e e s in r e t u r n for a consideration to Pay

to make good for a loss, damage, o

Teed amount of money to another party interest as a

y y tO Something of value in which the insured has a pecuniary

result of some uncertain events.
of individual
D. W.A. Dinsdale: Insurance is device for transfer of risks
a
to
the premium)
o an insurer, who agrees for a consideration (called
assume to a specified extent losses suffered by the insured.
transfer to an insurer
en Mayerson: Insurance is a device for the
certain risks of economic loss that would otherwise come to the insured.

Nature of Insurance
one can observe
On the basis ofthe definitions of insurance discussed above,
the following characteristics:
and
( Contract Insurance is a contract between the insurance company
the policyholder wherein the policyholder (insured) makes
an offer and
contract of
the insurance company (insurer) accepts his offer. The

e insurance is always made in writing

consideration
1i) Consideration: Like other contracts, there must be lawful
in insurance also. The consideration is in the form of premium which the
insured agrees to pay to the insurer. oobeo
(iii) Co-operative Device: All for and one for all" is the basis for
one

co-operation. The insurance is a system wherein large number of persons,

exposed to a similar risk, are covered and the risk is spread over among
the larger insurable public. Therefore, insurance is a social or
co-operative method wherein losses of one is borne by the society.
(iv) Protection of financial risks: Insurance offers protection to those
risks which can be measured in terms of money ie, financial risks. AS
such insurance compensates only financial or monetary loss or risks.
(v) Risk sharing and risk transfer: Insurance is a social device for division
of financial losses which may fall on an individual or his
family on the
happening of some unforeseen events. The events may be the death of
e a bread winner of a
family in the case oflife insurance, marine perils in
marine insurance, fire in fire insurance and other events in
general
 14 Principles and Practice of Insurance
in motor insurance,
nsurance eg. theft in burglary insurance, accident
are shared by all the
cc The loss arising from these events if insured
transferred from one
ansured in the form of premium. Hence, risk is
individual to a group
BaSed upon certain principles The insurance is based upon certain
principles like insurable interest, utmost good faith, indemnity,
Subrogation, causa-proxima, contribution, etc.
(vi) Regulated by Law: In almost all the countries in the world, statutory
laws are being enacted to regulate the functioning of insurance
companies. In India too, life insurance and general insurance are
regulated by Life Insurance Corporation ofIndia Act l1956, and General
Insurance Business (Nationalisation) Act 1972, and IRDA Regulations
etc.
(viii) Value of Risk Before insuring the subject matter of the insurance
contract, the risk is evaluated in order to determine the amount of
premium to be charged on the insured. Several methods are being adopted
to evaluate the risks involved in the subject matter. If there is an
expectation of heavy loss, higher premiums will be charged. Hence, the
probability of occurrence of loss is calculated at the time insurance.
(ix) Payment at
contingency: An insurer is liable to pay compensation to
the insureds only when certain
the
contingencies arise. In life insurance,
contingency the death or the expiry of the term will
certainly
Occur. In such cases, the life insurer has to
pay the assured sum. In
other insurance contracts, the
contingency-a fire accident or the marine
perils, may or may not occur. So, if the contingency occurs,
made, otherwise no payment need to be made to the payment is
In some life policies,
policyholders.
payment is not certain due
particular contingency within a particular period. For uncertaintyin term
to of a
example,
insurance, the payment is made only when death of the assured
within the occurs
specified term, may be one or two years. Similarly, in
endowment, payment is made only at the survival of pure
the assured at the
expiry of the period.
(x) Amount of
the
payment: The amount to be paid to the policyholders depends
upon value of loss occurred due to the
insurance cover is there upto that amount. In particular risk, provided
life insurance, the assurer
has to pay the agreed amount on the
happening of an event.
or
contingency takes place, the payment does fall due if theIf an event
valid and in force at the time
of the event. The amount of loss atpolicy
is
of the time
contingency is immaterial in the case
of life insurance. But in
of property and
general insurance, the amount of loss as the case
occurrence of loss are well as the
required to be
proved.
 1.5
Introduction to Insurance
insurance cheape
In order to make
(a) S e nu2mber of Iasured persons
number of persOns D
and attordable, it is necessary to insure larger
insurance and
of So,
Property because the lesser would be cost u
or m u t u a t
Ower would be premium. In past years, tariff
associations ratc.

found to share the loss at a cheaper

nsurance associations w e r e a

the insurance should be joined Dy

ln order to function successfully,
larger number of persons. De
insurance cannot
The contract of
1 S urance is not gambling is assured to get
his
Tos3
Considered as gambling as the insured
such uncertain event as stipulatecu
ndemnified oaly on the happening of eithner
whereas the game of gambling may
contract of insurance,
n
tne
result into profit or loss.
the policyholders
Premium collected from
( lASUrance is not a charity:
under an insurance is the cost so covered.
of risk
Hence, it cannot be
and
contract of indemnity
taken as charity. Charity lacks the element of
makes it.
compensation of loss to the person whosoever
to
Since insurers' liability to pay compensation
(iv) mvestment portfolio uncertain event, the
Lne insured arises the happening of certain
on
with them. They
insurers do not have to keep the collected premium
and
securities and earn interest
nvest the premium received in selected
sources of income:
the
dividend on them. Thus, the insurers have two
interest/ dividend)
insurance premium and the investment income (i.e.
which occurs over time.
Functions of Insurance
the
provides a variety functions which are beneficial
to comman
Insurance
insurance can be divided into
man, directly or indirectly. As such, functions of
threecategories
) Primary functions
(i) Secondary functions
ii) Other functions
(i) Primary Functions: The following are the main functions performed
bythe insurance
(a) Provides protection : Providing protection to the insured against the
probable chances of loss is one of the main functions of insurance.
The insurance guarantees the payment of loss and thus protects the
insured from suffering) The insurance cannot check the
the event but can compensate for losses
happening of
arising at the happening of
the risk event.
 of Insurance
L.6 Principles and Practice
1or the risk
(0)
Provides certainty: Insurance offers certainty of payment Whether the
different types of uncertainty in risk.
a
There
O loss. are
will be there. In
TISk will occur or not, when will it occur, how much loss
other words, there is uncertainty of happening of
time and amount of
the insured is given
loss) Insurance removes all these uncertainty and
for
certainty of payment of loss. The insurer charges premium
providing the said certainty.
(c) Distributes Risk: All business concerns face the problem of risk and
r the concern is big enough, handling of risks becomes a specialised
function. Risk and insurance are interwomen with each other.
Insurance, as a device, is the outcome of the existence of various risks
in our day-to-day life.)lt does not eliminate risks but it reduces the
Insurance the whole loss over
spreads
Tmancial loss caused by risks.
the larger number of persons who are exposed by a particular risk.

(1)Secondaryfunctions : Some functions of insurance are categorised as

secondary functions. Such functions are as follows
(a) Prevention of loss: The insurers assist financially to the health
organsations, fire brigade, educational institutions and other
organsations which are involved in prevention of losses ofthe general
public from death or damage) The insurance joins hands with these
institutions in preventing the losses of the society because the
reduction im loss causes lesser payment to the insured and so more
saving is possible which will assist in reducing the premium. Lesser
premium invites more business and more business causes lesser share
to the insured. The reduced premium will stimulate more business and
more protection to the general public.
(b) Provides capital: Insurance provides capital to the industries in
various forms. First, it reduces financial risks and losses
by providing
facilities of core capital investments in various
big organisations.
Secondly, the amount of premiums collected by the insurers is made
available for the industrial development of the
country in various
financing forms such as by providing of share capital, providing long
term loans to companies and term loans and loans
to the state to
ai invest in the country's public sector
industries.Thirdly, insurance
e makes the company or organisation to avail loáns on each
term by
hypothecating the insurance policies. Now-a-days, banks and other
efinancial institutions insist that the assets must be insured if one
wants to get loan against those assets.
 Introduction to Insurance business
Insurance increases
the efficiency of the
of s e c u r i t y
n c r e a s e s Eficiency: losses. It provides a sense
the risks or fear of for the grOwn
source
Oyreducing becomes a the
world, which in turn relieved of
In the business
Management
is
due
and diversification of the industry.) able to give
becomes

Various risk involved

in uncertainties, efficiency
or
the
the total
factors which affect
attention to other marketing
force, material management,
O r g a n i s a t i o n such
as labour
Iet
etc. is largely
Financial cover: The necessity of insurance
backward
classes
(a) Adequate economically
a cover to the rural a r e a s and and provide
give
to
persons
in the country
insurable
with a view to reach all death at a reasonable
cOst.)
financial c o v e r against insurer
tnem adequate Generally the
projects:
viability ofmajor
before

elpsinjudging the
whole
as a
the assets or project
c o n d u c t s an investigation of
the project.
the profitability of
e Insuring the same with a view to judge of insurance.
Hence,
the benefit
are denied order to
advance in
Unprofitable projects units in
6h5 drop such projects
or

y management may
Ronpe functions, the
prevent losses.) and secondary
Functiohs: Apart from primary which are beneficial to the
(i) Other functions
perform various others A few of
insurers as a whole.
the nation
business community and
c o m m o n man,

them are as follows

is considered
as one of the
Life insurance and is
(a) Encourages savings paid is accumulated
of savings. The premium
mportant forms date of maturity.
Certain
survives till the
returned to the assured
if he
Income Tax Act to
under Sec.8OC of the
tax exemptions are given Payment
of thrift and savings among the masses.)
inculcate the habit
becomes a habit and promotes
sávings.
of a life policy premium
insurance.
Trade: Foreign trade fully depends on
(b) Promotes Foreign discount the marine trade bils
banker will not come forward to
The been made
insured. In India, insurance has
unless the cargo is fully
from thee
mandatory for foreign trade.)lt relieves entrepreneurs
uncertainties of foreign trade
(c) Checks Inflation:
Insurance plays a key role in checking inflation. It
circulation of money and saves it from its ill
effects.
Curbsthe
h a r i a h- C u r k

Compulsory savings in the form of premium reduces the disposable

income ofthe individual and this scarce source of production is utilised
in a better way by investing for the national development.
(d) Social Security: Insurance offers an instrumental force to fight against
social evils like poverty, unemployment, disease, old age, fateful
 Principies and Fractice of Insurane
acidents ofperon and propety and similar other calamities of na
sof nature
H hielips in creatng awarenis a n g the general public regard
Rdeglion uf technigues for minimising the happening of controllat rding
laible
uneertain events j has also helped in a greter way by designi
Vafivus types f insurance in our counitry like Employees Stes g
suraoe Pa, Provident Fund Act, Woarkameni's Compensation Act
c.
(e) Credin Facilities usiTESCT are able 1o ralse loans from banke
nd other financial institutions by pledgmg their imsurance
policies
with fhem. In case, the businessmen are unable to return the loan
anount, the financinl institutions can recover tieir amount out of the
policy's surTSnder value
Classification of insurance
Inaurance can be broadly divided into classes
two
L Tint and Third party Insurance: First
party insurance Is the insurance
ufider wlhich one insures one's own life,
house, factory or car, etc., whereas third
party insurance is insuring against one's
to another The law reflects polential iability in law to pay damages
his difference by demanding that some
inisurance should be third-party
compulsory
and also by rccognising that in
practice, third
party insurance involves the third
party as much as the insured
IL Life and person.
other nsurances: This classification which is well
law and
meaningful in insurance circles, distinguish between life recognised in
one hand and all
other insurances on the
insurance on
in the figure other. This classification is highlighted
given below
Types of Insurance

LifeInsurance Non-life (General)

lnsurance

Fire Insurance Marine Miscellaneous

Insurance insurance
Figure 1.1-Types of Insurance
 Introduction to Insurance
fo
discussed in the pages con
The above mentioned types of insurance are
"

1. Life Insurance: It is a contract in which

the insurance companY, 0
undertakes
either in lumpsum or instalments,
Constderation ofa premium paid a certain
sum of moneyO
lor whose benefit the policy is undertaken,
the person whichever occurs
first.Fror

of the insured or on the expiry of the policy,

the death is death. The life insurance company pay
risk covered against
nsurance, the
e life insurance enjoys maximun
the sum assured in the event of death. At present,
or an indivIaua
asset to the society
Scope because life is the most important
Each and every person requires this insurance.
This insurance provides proteclon
old age
adequate amount at the
to the tamily at the premature death or gives but

The insurance is not only a protection

reduced.
when earning capacities are is returnable to the insured
al the
1sa sort of investmentbecause certain sum
a
death or at the expiry of a period.
contain the
does not
h contrast to fire or marine insurances, life insurance cannot
of indemnity because the loss arising
of the death of a person
out
element is taken is assured
to be paid,
be estimated. Since the sum for which a policy
referred to as
contract of life insurance
is also often
whether there is death or not, or l i e
have look at some interesting aspects
Life Assurance". Let us now a

insurance in one, two, three method.

One
care of
method of taking
is undoubtedly the one and only
Life insurance
problems arising out of dying early and living too long
a life insurance policy is
One year is perhaps the minimum period for which for shorter
issued through theoretically, it is possible to issue policy
a a
usually
term.
insurance policy is
The 'suicide clause' which is usually contained in a life
insurance claim if the
for one year. That is, an insurance company will not pay the
policy holder commits suicide within one year taking the policy. This is only an
of
arbitrary figure because it is impossible to say how long a person contemplate
suicide. So, insurance companies fix a period of one year hoping that a person
may not plan to commit suicide for such a long time. This has been the practice
with the LIC. But it is understood that some private insurance companies have
longer duration for the suicide clause. Some others have adopted the practice of
refunding the premiums instead oftotally denying the claim.
making complaints to the ombudsman is one year.
The time limit set for
Some new companies have made it a condition that bonus will accrue
only-
after the policy completes one year.
p b gdoeo o
 Endowment insurance policies
Whole life insurance
Joint life policies
Children's policies
Women's policies
Convertible policies
Interest sensitive plans
o d
Annuities
Ten
AS per recent amendment to the Insurance Act 1938, 10% of the surplus
declared in the valuation has to go to the shareholders of the new insurance
in the form of bonus
companies after providing 90% to the policyholders
(In case of LIC, however, the percentage going to the shareholders namely

Govt. of India, is only 5%).

Sec. 10 of the Income tax 1961, exempts certain types of income from
income tax. As regards life insurance monies, Sec. 10 (10D) states that any
money received from any life insurance company will be completely exempt
from income tax (ofcourse, subject to some exceptions like keyman
nsurance, partnership insurance and policies which have premium

exceeding 20% of the Sum Assured in any year).

2. GeneralInsurance: General insurance business refers to fire, marine and
miscellaneous insurance business whether carried on singly or in combination
with one or more of them. Let us see each of the components of General insurance
in the pages to come:
() Fire Insurance : It is a contract of indemnity under which the insurance
company undertakes to pay the insured for the damage or loss caused
to the property insured against fire for consideration of premium.
Nomally, the fire insurance policy is for a period of one year after which
it is to be renewed from time to time. A claim for loss by fire must satisfy
the following two conditions
(a) There must be actual loss; and
(b) Fire must be accidental and non-intentional
Introduction to Insurancee
1.13
resulting irom
The risk covered fire insurance contract is the loss
by a
cause ofthe loss.
If damage
fire or some cause which is the proximate as a
without ignition, it will not be regarded
is caused by overheating be
fire loss within the meaning of fire insurance
and the loss will not
recoverable from the insurer.
which means
In fire insurance, principle of indemnity is paramount eventuality or
only in the
that the insured is entitled to compensation
subject tothe maximum
loss by fire to the actual amount of the loss
that the insured
limit of the amount ofthe policy. It is, therefore, clear
insurance policy. For
example, tne
IS no way make profit out of the
can
and the owner o thne
market value of the goods insured is Rs. 40,000 tne
In the fire occurs,
goods takes a fire policy for Rs. 30,000. case,
in any case.
insured can a claim of not m o r e than Rs. 30,000
get marine
form of
lnsurance its birth in the
nsurance took
(1) Marine several sea
hazards
earlier days w a s full of
i n s u r a n c e . Foreign trade in
or capture oy
storms, seizure
IKe sinking of the ship, fire to the vessel, conceived
was
Marine insurance
the enemy or sea pirates, collision, etc.
of the sea.
to safeguard the traders from these evils undertakes to
Marine insurance is a whereby the insurer
contract
agreed
and to the extent thereby
indemnifty the insured in the m a n n e r which
insurance is an arrangement by
Marine
against marine losses. or cargo for
the o w n e r of a ship
the insurer undertakes to compensate
Generally, the
Complete or loss at sea and also the loss of freight.
partial marine insurance
are soughtto be insured under
TOIlowing objects
is taken by the
Insurance : When a marine insurance policy
(a) Cargo in the
owner to be compensated for loss caused to his cargo
cargo insurance.
course otits transmission, it is known as cargo
insurance is taken to guard against
(b) Freight'insurance : Marine
insurance.
recovery of freight is called freight
it is termed as
When the ship is insured as a whole,
(HullInsurance :
hull insurance bng\
the
Insurance: The process of fast development in
(i) Miscellaneous
or hazards. To provide security
society gave rise to a number of risks
of insurance also have been
against such hazards, many other types miscellaneous
developed under the head miscellaneous insurance)The
insurance includes Motor insurance, public liabikty insurance, product
workmen
liability insurance, professional indemnity insurance,
individual
compensation insurance, personal accident insurance,
Chonouog
 mediclaim policy Groupmediclaim policy, overseas mediclaim policy,
Kalyan Bima
ashree chikd welfare policy, Raja Rajeswari Mahila Jewellers block
d , Burglary insurance, shopkeepers' insurance,
nsurance, Money insurance, Fidelity guarantee insurance, Neon sign
policy, Duty insurance, Electronic Equipment insurance, Boiler Explosion
nsurance, Machinery breakdown insurance, Erection all rISks insurance,
Contractors' all risks insurance, Refrigeration plant insurance,
achinery loss of profits policy, Mobile phone insurance, Baggage
insurance, Allrisks insurance, Amartya Siksha Yogana insurance policy
anana safer insurance, Householders' insurance, Pedal cycle insurance,
late glas insurance, Advance loss of profits policy, Marine -cum-
Erection policy, Sports insurance, special contingency policy, students
sarety insurance, credit insurance, Pet insurance and Rural insurance.