What is Insurance?
This is a question that is top of the mind of every person who wants to buy an insurance policy or for an agent who wants to sell you an insurance policy for the first time.
Why do you need insurance?
You need insurance so that you can take care of your family in case anything happens to you.
The agent who comes to sell the policies might be your uncle, neighbour ,friend or a relative who just showed up at your door and wants to sell you a policy so that you can get them commission.
So what is insurance really and how does it help a person especially a person in India. We are going to concentrate on Insurance in India as India is one of the countries which has the least insurance cover either for people or for industries or properties.Therefore let us first start by defining what is insurance.
In lay mans terms Insurance is the sharing of losses which can be compensated by monetary means by people who pay into a pool of funds that will be used to compensate the loss of a few who lose within the time frame where in the fund was supposed to be used.
Well that was a not lay men terms you say, in that case let me elaborate.
Assume that in a city there are one thousand shops. Each owner of a shop has Rs. One lakh worth of stocks in his shop.Suppose one of the shops were to have a fire and the stocks were destroyed then that shop owner will be left with no stocks and a heavy loss to bear.Further more the workers will be left without a job.
Thus in order to mitigate such losses that could happen to any one of these shops then about 1000 shop owners join together and pool one lakh rupee s by contributing Rs. 100 each, and when the loss happens next to one shop the pool of Rs. one lakh is given to the shop owner who has lost his stock so that he can buy back the stocks and restock himself.
All is well again. Thus by contributing just Rs. 100 each the city shop owners have insured themselves against a catastrophe which might affect any one of them. This is the essence of insurance.
The next question arises what happens when the next fire occurs, and the pool is now empty. Well the shop owners should immediately contribute to the fund once they have used the funds to pack the first loss, since every one of the 1000 shop owners might not have Rs. 100 left to contribute the funds again and someone in the group might not feel like paying right at that time, or what if two losses happened at the same time and there was no money to pay the second loss, such scenarios make the above system impractical for most purposes.
To make a more formal setup Insurance Companies are formed.
Insurance companies make it a point to collect insurance premiums from a lot of people (a lot more than the 1000 people) usually in the millions so that the chance of the pool getting depleted by a few members leaving at a time, or from multiple losses happening at the same time does not arise. They also study the pattern of losses that happen over time and decide what is the least amount of share that each member of the pool has to contribute so that the losses happening are covered (this is done by people who know a lot of math and have specialized in the study of Probability – more on that latter).