2-How does insurance work?
Now that you understand the need for insurance, we can come to how insurance actually works.
We can continue with Anil’s case study. One of the many risks Anil faces is his untimely death but he also faces many other risks – like he will need medical care at some point, his house could burn down.
Anil can address these risks in different ways.
Risk Retention :- (How does insurance work?)
One way to deal with these risks is to avoid any arrangement for protection from them, that is, the risk is borne by the person concerned. This is called risk retention.
Actually this is not a smart choice, because if the timing is good, then nothing unpleasant will happen, so Anil will not need to worry but at any time some unpleasant incident can happen and then Anil will be in trouble. It really wouldn’t be smart to assume, or face, these risks yourself.
Risk Transfer :-(How does insurance work?)
Another way to arrange for protection against these risks is to transfer them to someone who will appropriately bear them. easy
In words, the transfer of risk from one person who does not have the ability to cope to someone else who has the capacity to cope is called insurance.
So now it may be useful for us to return to the definition of insurance-
The contract between the insurance company (insurer) and the policyholder (insured) is called insurance. In exchange for the amount received as consideration (premium), the insurance company undertakes to pay a specified sum of money to the insured on the occurrence of a specified event.
Therefore, in Anil’s case, he can take insurance, pay premium and transfer his risk to the insurance company.
Insurance companies collect premiums from all those people like Anil who face the same risk and put the amount received in the risk pool. Not everyone will face the insured event happening at the same time but those who will face the insured event get compensation from the said risk pool.
So from the above explanation we can see that insurance
- is the process of transfer of risk by the holder (insured);
- to the other party (the insurer) who can bear the risk;
- in exchange for a consideration (premium);
The insurance business is concerned with the protection of the economic value of the property. A property is valuable to its owner because he expects some profit from it. This benefit can be in the form of earning income from property (by renting a car) or convenience (using the car for own travel).
Human beings are also wealth in the sense that they have the capacity to earn income. Every human has a life span and death is certain. But the time of death is uncertain. If a person dies unexpectedly early in his/her working life, his/her family loses the future income that the person would earn in his/her working life. In such a situation, life insurance works to fill the financial shortfall arising due to the untimely death of a person. The timing of each person’s death is uncertain, which is probably why everyone needs life insurance at an early age to protect their future income.
Life insurance protects the family from financial hardship arising out of loss of income due to untimely death of a person.
Note in mind!
Insurance cannot prevent the insured event from happening. It can only provide compensation for loss resulting from the occurrence of the insured event.
Proposed Action :-
Talk to your family members or friends who have insurance. Get to know from them about the points they considered before buying insurance and the reasons why they bought it.
See You in Next Blog….