Mechanism of insurance is very simple. People exposed to same risk come together and agree, any one of them suffer a loss, others will share the loss and make good to the person who lost.
People using marine transport for goods are exposed to same set of risks like storms, ship sinking, and vessel damages. Others like manufacturer don’t share same risks but are exposed to different risks like fire, earthquake. Accordingly different risk can be identified and separate groups can be formed exposed to such set of risks. By doing this, Heavy loss may suffered by one out of the group is apportioned into bearable small losses by whole group. (Considering the fact that all members of the group may not suffer such losses at the same time).
People using marine transport for goods are exposed to same set of risks like storms, ship sinking, and vessel damages. Others like manufacturer don’t share same risks but are exposed to different risks like fire, earthquake. Accordingly different risk can be identified and separate groups can be formed exposed to such set of risks. By doing this, Heavy loss may suffered by one out of the group is apportioned into bearable small losses by whole group. (Considering the fact that all members of the group may not suffer such losses at the same time).
The risk is spread among the community and the likely big impact on one is reduced to smaller manageable impacts on all.
Insurance is a business of ‘sharing’.
Insurance follows certain principles, making possible insurance to remain a ‘Fair Arrangement’.
I) It’s difficult for any one individual to bear consequences of the risks, he is exposed to. Becomes bearable when community shares the burden.
II) Peril should occur in accidental manner. The occurrence has to be random, accidental, and not the deliberated creation of the insured person.
The manner in which the loss is to be shared can be determined before-hand. It may be proportional to risk that each person is exposed to. This would be indicative of benefits to be received if the peril befell him. The likely share is collected in advance, at the time of admission to the group.
Insurance companies collect in advance and create a fund from which the losses are paid. (In Life Insurance such fund is called as Life Fund).
To understand phenomena let see an example,
Example 1
In a village of 500 hundred households, each valued at Rs. 1,00,000. Every year, on an average, 5 houses get destroyed due to Peril. Aggregating total loss to Rs. 5,00,000. A fund of Rs. 5 lacs can be gathered, if each household contributes Rs.1000. This is adequate to pay Rs. 1,00,000 each to 5 disaster struck house owners.
Thus, the risk of 5 owners is spread over 500 owners.
Insurance is a business of ‘sharing’.
Insurance follows certain principles, making possible insurance to remain a ‘Fair Arrangement’.
I) It’s difficult for any one individual to bear consequences of the risks, he is exposed to. Becomes bearable when community shares the burden.
II) Peril should occur in accidental manner. The occurrence has to be random, accidental, and not the deliberated creation of the insured person.
The manner in which the loss is to be shared can be determined before-hand. It may be proportional to risk that each person is exposed to. This would be indicative of benefits to be received if the peril befell him. The likely share is collected in advance, at the time of admission to the group.
Insurance companies collect in advance and create a fund from which the losses are paid. (In Life Insurance such fund is called as Life Fund).
To understand phenomena let see an example,
Example 1
In a village of 500 hundred households, each valued at Rs. 1,00,000. Every year, on an average, 5 houses get destroyed due to Peril. Aggregating total loss to Rs. 5,00,000. A fund of Rs. 5 lacs can be gathered, if each household contributes Rs.1000. This is adequate to pay Rs. 1,00,000 each to 5 disaster struck house owners.
Thus, the risk of 5 owners is spread over 500 owners.
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