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Insurance Defined

In Finance, Insurance, Legal on May 3, 2012 at 8:05 am

Insurance is a form of risk management primarily used to hedge against the risk of contingent loss. Insurance is a contract between two parties where in exchange of premium, the risk is transferred from one party to another party.

Insurance classical definition

Insurance is an agreement where, for a stipulated payment called the premium, one party (the insurer) agrees to pay to the other a defined amount upon the occurrence of a specific loss.  The party who pays the amount to the party on occurrence of specified loss is called Insurer. The party who pays a stipulated payment is called Insured. A defined amount which insured pay to Insurer is called Premium.

Financial definition of Insurance

Insurance is the financial mechanism by which cost of unexpected loss is redistributed. Here, loss expenses transferred to insurance pool and loss is redistributed to the members of pool.

We see losses at many stages in our day to day life whether it is corporate or individual. Losses may be of high or low severity, may affect single or group of persons. It may involve single region or multiple region and even countries. Sometimes losses are too low which can be ignored but on the other hand, it can be so severe that it can eat up whole life saving of a person.

For example:

Let’s take an example of Fire insurance pool where losses are redistributed among masses.

In the Mumbai Trombay area, many oil refining and petroleum units have high risk of fire. They transfer their fire risk by paying Rs 50,000 in fire pool. In total 50 units agreed and pool reached to the (Rs 2500, 000). Fire broke out in one of the unit of Trombay area and it affected the one adjoining unit also which resulted loss of Rs 2500,000. Now loss expense of 2 units can be paid from fire insurance pool. If no insurance pool existed, the unfortunate victims will loose 2500,000. Here loss expense incurred by two units will be redistributed among 50 corporates.

Legal definition

Insurance definition under Indian law: “Insurance is legal contract where one party agrees to pay another party an agreed amount to compensate its unfortunate losses.” Here ‘amount’ is called premium and contract is called policy.

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