Insurance is an arrangement by which a company or the state undertakes to provide a guarantee of compensation for specified loss, damage, illness, or death in return for payment of a specified premium.
Its primary function is to substitute certainty for uncertainty as regards the economic cost of loss-producing events.
Description: Insurance policies, a contract between the policyholder and the insurance company, are of different types depending on the risk they mitigate. Broad categories include life, health, motor, travel, home, rural, commercial and business insurance.
Insurance relies heavily on the “law of large numbers.” In large homogeneous populations it is possible to estimate the normal frequency of common events such as deaths and accidents. Losses can be predicted with reasonable accuracy, and this accuracy increases as the size of the group expands. From a theoretical standpoint, it is possible to eliminate all pure risk if an infinitely large group is selected.
From the standpoint of the insurer, an insurable risk must meet the following requirements:
1. The possible loss must be accidental in nature, and beyond the control of the insured. If the insured could cause the loss, the element of randomness and predictability would be destroyed.
2. The objects to be insured must be numerous enough and homogeneous enough to allow a reasonably close calculation of the probable frequency and severity of losses.
3. There must be some way to determine whether a loss has occurred and how great that loss is. This is why insurance contracts specify very definitely what events must take place, what constitutes loss, and how it is to be measured.
4. The insured objects must not be subject to simultaneous destruction. For example, if all the buildings insured by one insurer are in an area subject to flood, and a flood occurs, the loss to the insurance underwriter may be catastrophic.
How it works
When you buy an insurance policy, you make regular payments, known as premiums, to the insurer. If you make a claim your insurer will pay out for the loss that is covered under the policy.
If you don’t make a claim, you won’t get your money back; instead it is pooled with the premiums of other policyholders who have taken out insurance with the same insurance company. If you make a claim the money comes from the pool of policyholders’ premiums.