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Principles of Insurance

The insurance is based upon (i) Principles of co-operation, and (ii) Principles of Probability.

(i) Principle of cooperation. 
  • Insurances a cooperative device. If one person is providing for his own losses it cannot be strictly insurance because in insurance the loss is shared by a group of persons who are willing to cooperate. In ancient period persons of a group were willingly sharing the loss to a member of the group. They used to share the loss at the time of actual damage. 
  • They collected enough funds from the society and paid to the dependents of the deceased or the persons suffering property losses. It is said those in ancient times in India if any member of the Agawam Community whenever suffered a heavy loss each member of his community subscribed generously to help the unfortunate member of the Community as to bring him again in a state of financial solvency. 
  • Thus the principle of cooperation was applied to solve the day to day economic problems. The mutual cooperation was prevailing from the very beginningunto the area of Christ in most of the countries. 
  • The cooperation took another form where it was agreed between the individual and society to pay a certain sum in advance to be a member of the society. The accumulation of funds enables the society to guarantee payment of certain amount at the time as loss to any member of the society. The accumulation of funds and charging of the share from the member in advance become the job of one institution caller 'insurer'. 
  • Now it becomes the duty and responsibility of the insurer to obtain adequate funds from the members of the society to pay them at the happening of the insured risk. Thus the shares of loss took the form the present 'Premium'. Today all the insured pay a premium to join the scheme of insurance. 
  • Thus the insured are cooperating to share the loss of an individual by payment of a premium in advance. Thus insurance is based upon the fundamental principle of cooperation. 

Principles of Insurance


(ii) Theory of probability. 
  • The loss in the shape of premium can be distributed only on the basis of probability. The chances of loss are estimated in advance to affix the amount of premium. Since the degree of loss depends upon various factors, the affecting factors are analyzed before determining the amount of loss. With the help of this principle, the uncertainty of loss is converted into certainty. 
  • The insurer will not have to suffer loss as well have to gain windfall. Therefore, the insurer has to charge only so much of amount which is adequate to meet the losses. The probability tells what the chances of losses are and what will be the amount of losses. 
  • The inertia of large number is applied while calculating the probability. The larger the number of exposed persons, the better and the more practical would be the findings of the probability. Therefore the law of large number is applied in the principle of probability. In each and every field of insurance the law of large number is essential. These principles keep in account that the past events will incur in the same inertia. The insurance on the basis of past experience, present conditions and future prospects, fixes the amount of premium. Without premium, no cooperation is possible and the premium cannot be Calculated without the help of theory of probability and consequently no insurance is possible, so, these two principles are the two main legs of insurance.

Points At a Glance

1. Definition of insurance - 'Insurance is a cooperative form of distributing a certain risk over a group of persons who are exposed to it'.

2. Importance of insurance
  • Safeguards against risk of loss,  
  • Affords financial helps,  
  • Helps the development of trade and commerce. 
  • Provides scope for employment,  
  • Ensures peace of mind  
  • Protects capital,  
  • Encourages overseas international trade,  
  • Ensures social responsibility,  
  • Makes saving possible. 
3. Nature of Insurance  

  • Sharing of risk,  
  • Co-operative device,  
  • Value of risk,  
  • Payment at contingency,  
  • Amount of payment 
  • Large number of insurers, 
  • Insurance not gambling or charity. 
4. Brief History of Insurance - The origin of insurance is not known with certainty and evidence. Marine insurance was the first which originated in 12th century. Life Insurance and Fire Insurance gradually developed one after another. All other forms of insurance are grouped as miscellaneous are progressing of a slow speed.

5. Definition of Risks - As an uncertainty of financial loss with an occurrence of an unfortunate event.

6. Loss Prevention - Prevention is better than cure. When prevention fails other methods are adopted. Insurance is a device by which risks can be minimised.It is a social device whereby the uncertain risk of individuals can be transferred and combined and chose who suffer loss they are to be reimbursed.

7.Classification of Risks -  
  • Risks - when there is a chance of loss but no chance of gain, e.g. loss br fire,  
  • Speculative Risks - When there is a chance of gain as well as a chance of loss,  
  • Insurable Risks - risks which can be transferred and insured against,  
  • Non insurable Risks- risks which cannot be insured. 
8. Risks, Perils and Hazards - Risk is the uncertainty of loss, perils is the source of loss[fire, flood etc.], Hazards is a condition that increases the occurrence of loss.

9. Principles of Insurance - 1. Principle of cooperation and 2. Principle of Probability.

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