Insurance is a contract between two parties whereby one party agrees to undertake the risk of another in exchange for consideration known as premium and promises to pay a fixed sum of money to the other party on happening of an uncertain event (death) or after the expiry of a certain period (in case of life insurance) or to indemnify the other party on happening of an uncertain event (in case of general insurance).
Insurance is designed to protect the financial well-being of an individual, company or other entity in the case of unexpected loss. Some forms of insurance are required by law, while others are optional. Agreeing to the terms of an insurance policy creates a contract between the insured and the insurer. In exchange for payments from the insured (called premiums), the insurer agrees to pay the policy holder a sum of money upon the occurrence of a specific event. In most cases, the policy holder pays part of the loss (called the deductible) and the insurer pays the rest. The party bearing the risk is known as the ‘insurer’ or ‘assurer’ and the party whose risk is covered is known as the ‘insured’ or ‘assured’.
The underlying concept behind insurance is sharing of risks by pooling of funds. As such a group of people sharing similar risk come together and make contribution towards a pool and the money so collected is used towards compensating for any losses suffered by members of the pool. When the pool is managed by the individuals it is called mutual insurance and when it is managed by a company it is called life/general insurance.
Taking an example of a city with 100,000 people, 100 people died in a year while they were in a good physical condition. Considering economic value of the loss suffered as 500,000, the total annual loss due to 100 deaths comes to 5 crs. As such contribution from each person in the city arrives at Rs. 500. As such risk of 100 people gets distributed to 100,000 people.
