What is insurance?
Insurance enables those who suffer a loss or accident to be compensated for the effects of their misfortune. The payments come from a pool of money contributed by all the holders of individual insurance policies. In other words, individual risks are pooled and shared, with each policyholder making a contribution to the common fund.
The contribution is known as the premium. Premiums are paid to insurers — these are institutions which accumulate the money into the fund from which claims are paid. The loss is in fact paid for by the policyholder making the claim and by all the other policyholders who have not suffered in the same way.
Insurers are professional risk takers. They know the probability of different types of risk happening and can calculate premiums needed to create a fund large enough to cover likely loss payments. Only a proportion of policyholders will require compensation from the fund at any one time.
Risk & Premium
Two important factors arise when calculating the premium: firstly, the general likelihood that a loss will occur; secondly, whether the particular policyholder is above or below average in risk.
Example: In motor insurance a young person with a high-powered car will usually pay a higher premium than a mature experienced driver in a modest car.
Two kinds of Insurance
There are two different kinds of insurance — Life Insurance and General Insurance. With life insurance, you agree to pay a fixed premium for a set number of years. In other words you enter a long-term commitment when you buy a life insurance policy.
What is the Difference?
General insurance pays out:
- If a car has an accident or is stolen.
- If a house catches fire or is burgled.
- If a holiday has to be cancelled.
- If someone is careless and damages other people's property.
Life policies, on the other hand, pay out when:
- Someone dies.
- Someone survives beyond a specific date (endowment policies).
Anyone can buy life insurance but the premium depends on your age, health and occupation.
Insurable Interest
Insurable interest is a fundamental principle of insurance. It means that the person willing to take out insurance must be legally entitled to insure the article, the event, or the life. In other words, the happening of the event insured against must cause the policyholder or his family a financial loss.
For example, husbands and wives can insure each other's lives. However you cannot insure the lives of other people unless you have a financial interest in their life. This principle prevents insurance being used as a wager.