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The business of insurance is related to the protection of the economic values of assets. Every asset has a value. The asset would have been created

through the efforts of the owner. The asset is valuable to the owner, because

he expects to get some benefits from it. It is a benefit because it meets

some ofhis needs. The benefit may be an income or in some other form. In

the case of a factory or a cow, the product generated by it is sold and

income is generated. In the case of a motor car, it provides comfort and

convenience in transportation. There is no direct income. Both are assets

and provide benefits

Every asset is expected to last for a certain period of time during which it

will provide the benefits. After that, the benefit may not be available.

There is a life-time for a machine in a factory or a cow ora motor car.

None of them will last for ever. The owner is aware of this and he can so

manage his affairs that by the end of that period or life-time, a substitute is

made available. Thus, he makes sure that the benefit is not lost. However,

the asset may get lost earlier. An accident or some other unfortunate event

may destroy it or make it incapable of giving the benefits. An epidemic

may kill the cow suddenly. In that case, the owner and those enjoying the

benefits therefrom, would be deprived of the benefits. The planned

substitute would not have been ready. There is an adverse or unpleasant

situation. Insurance is a mechanism that helps to reduce the effects of

such adverse situations. It promises to pay to the owner or beneficiary of

the asset, a certain sum if the loss occurs.

The Brief History of Insurance 

The Greeks had started benevolent societies in the late 7th century AD, to take care of

the funeral and families of members who died. The friendly societies of

England were similarly constituted. The Great Fire of London in 1666, in

which more than 13000 houses were lost, gave a boost to insurance and

the first fire insurance company, called the Fire Office, was started in


The origins of insurance business as in vogue at present, is traced to the

Lloyd’s Coffee House in London. Traders, who used to gather in the Lloyd’s

coffee house in London, agreed to share the losses to their goods while

being carried by ships. The losses used to occur because of pirates who

robbed on the high seas or because of bad weather spoiling the goods or

sinking the ship. In India, insurance began in 1818 with life insurance

being transacted by an English company, the Oriental Life Insurance Co.

Ltd.. The first Indian insurance company was the Bombay Mutual

Assurance Society Ltd, formed in 1870 in Mumbai. This was followed by

the Bharat Insurance Co. in 1896 in Delhi, the Empire of India in 1897 in

Mumbai, the United India in Chennai, the National, the National Indian

and the Hindusthan Cooperative in Kolkata

Later, were established the Cooperative Assurance in Lahore, the Bombay

Life (originally called the Swadeshi Life), the Indian Mercantile, the New

India and the Jupiter in Mumbai and the Lakshmi in New Delhi. These

were all Indian companies started as a result of the swadeshi movement in

the early 1900s. By the year 1956, when the life insurance business was

nationalised and the Life Insurance Corporation of India (LIC) was formed

on 1 September 1956, there were 170 companies and 75 provident fund

societies transacting life insurance business in India. After the amendments

to the relevant laws in 1999, the L.I.C. did not have the exclusive privilege of doing life insurance business in India. By 31.8.2007, sixteen new life

insurers had been registered and were transacting life insurance business

in India.


Assets are insured, because they are likely to be destroyed or made non-

functional before the expected life time, through accidental occurrences.

Such possible occurrences are called perils. Fire, floods, breakdowns,

lightning, earthquakes, etc, are perils. If such perils can cause damage to

the asset, we say that the asset is exposed to that risk. Perils are the

events. Risks are the consequential losses or damages. The risk to a owner

of a building, because of the peril of an earthquake, may be a few lakhs or

a few crores of rupees, depending on the cost of the building, the contents

in it and the extent of damage.

The risk only means that there is a possibility of loss or damage. The damage may or may not happen. The earthquake may occur, but the

building may not have been affected at all. Insurance is done against the

possibility that the damage may happen. There has to be an uncertainty

about the risk. The word ‘possibility’ implies uncertainty. Insurance is

relevant only if there are uncertainties. If there is no uncertainty about the

occurrence of an event, it cannot be insured against. In the case of a human

being, death is certain, but the time of death is uncertain. The person is

insured, because of the uncertainty about the time of his death.. In the

case of a person who is terminally ill, the time of death is not uncertain,

though not exactly known. It would be ‘soon’. He cannot be insured.

Insurance does not protect the asset. It does not prevent its loss due to the

peril. The peril cannot be avoided through insurance. The risk can

sometimes be avoided, through better safety and damage control measures.

Insurance only tries to reduce the impact of the risk on the owner of the

asset and those who depend on that asset. They are the ones who benefit

from the asset and therefore, would lose, when the asset is damaged.

Insurance only compensates for the losses – and that too, not fully.

Only economic consequences can be insured. If the loss is not financial,

insurance may not be possible. Examples of non-economic losses are

love and affection of parents, leadership of managers, sentimental

attachments to family heirlooms, innovative and creative abilities, etc.


The mechanism of insurance is very simple. People who are exposed to the

same risks come together and agree that, if any one of them suffers a loss,

the others will share the loss and make good to the person who lost. All

people who send goods by ships are exposed to the same risks, which are related to water damage, sinking of the vessel, piracy, etc. Those owning

factories are not exposed to these risks, but they are exposed to different

kinds of isks like, fre, hailstorms, earthquakes, lightning, burglary, etc.

Like this, different kinds of risks can be identified and separate groups

made, including those exposed to such risks. By this method, the heavy

loss that any one of them in the group may suffer (all of them may not

suffer such losses at the same time) is divided into bearable small losses

by all the others in the group. In other words, the risk is spread among the

community and the likely big impact on one is reduced to smaller

manageable impacts on all. Insurance helps to spread the costs or risks.

If a Jumbo Jet with more than 350 passengers crashes, the loss would run

into several crores of rupees. No airline would be able to bear such a loss.

It is unlikely that many Jumbo Jets will crash at the same time. If 100

airline companies flying Jumbo Jets, come together into an insurance

pool, whenever one of the Jumbo Jets in the pool crashes, the loss to be

borne by each airline would come down to a few lakhs of rupees. Thus,

insurance is a business of ‘sharing’.Itmakes an unbearable loss, bearable.

There are certain principles, which make itpossible forinsurance to remain

a preferred and fair arrangement. The first is that it is difficult for any one

individual to bear the consequences of the risks that he is exposed to. It

will become bearable when the community shares the burden. The second

is that the peril should occur in an accidental manner. Nobody should be

in a position to make the risk happen. In other words, none in the group

should set fire to his assets and ask others to share the loss. This would be

taking unfair advantage of an arrangement put into place to protect people

from the accidental risks they are exposed to. The occurrence has to be

random, accidental, and not the deliberate creation of the insured person.


A human being is an income generating asset. One’s income generating

ability depends on one’s skills, (manual, professional, problem solving,

entrepreneurial, etc). These are the assets. The value of the asset can be

measured by considering the income that is generated by the person

concerned. The concept of Human Life Values, provides scientific ways

to determine the asset value of the human life and therefore, the amount of

life insurance required.. These techniques, like other techniques related

to selling, will have to be learnt on the job.

These assets also can be lost through unexpectedly early death or through

sickness and disabilities caused by accidents. Accidents may or may not

happen. Death will happen, but the timing is uncertain. Ifithappens around

the time of one’s retirement, when it could be expected that the income

will normally cease, the person concerned could have made some other

arrangements to meet the continuing needs. But if ithappens much earlier

when the alternate arrangements are not in place, there can be losses to

the person and dependents. Those dependent on the income are helped to

overcome their difficulties, by insurance

A person, who may have made arrangements for his needs after his

retirement, also would need insurance. This is because the arrangements

would have been made on the basis of some expectations like, likely to

live for another 15 years, or that children will be able to look after the

aged parents. If any of these expectations do not become true, the original

arrangement would become inadequate and there could be difficulties.

Living too long can be as much a problem as dying too young. Both are

risks, which need to be safeguarded against. Insurance takes care.

Thus, the risks in the case of a human being are related to

Early death

Living too long





Insurance companies are called insurers. The business of insurance is to

(a) bring together persons with common insurance interests (sharing the

same risks), (b) collect the share or contribution (called premium) from

all of them, and (c) pay out compensations (called claims) to those who

suffer from the risks. The premium is determined on the same lines as

indicated in the examples above, but with some further refinements.

In India, insurance business is classified primarily as life and non-life or

general. Life insurance includes all risks related to the lives of human

beings and general insurance covers the rest. General insurance has three

classifications viz., Fire (dealing with all fire related risks), Marine (dealing

with all transport related risks and ships) and Miscellaneous (dealing with

all others like liability, fidelity, motor, crop, engineering, construction,

aviation, personal accident, etc). Personal accident and sickness insurance,

which are related to human beings, is classified as ‘non-life in India, but

is classified as ‘life’, in many other countries. What is ‘non-life’ in ndia is

termed ‘Property and Casualty’ in some other countries.

In India, the IRDA has, in 2005, issued Regulations enabling micro

insurance (broadly meaning insurance for small Sums Assured, like 5 to

50 thousands) to be done by both life and general insurers on the basis of

mutual tie-ups. Apolicy may be issued by a life insurer covering both life

and non-life risks, but premnium on account of the non-life business will

be passed on to a general insurer and the claim amount collected from the



The insurer is in the position of a trustee as it is managing the common fund, for and on behalf of the community of policyholders. It has to ensure

that nobody is allowed to take undue advantage of the arrangement. That

means that the management of the insurance business requires care to

prevent entry (into the group) of people whose risks are not of the same

kind as well as paying claims on losses that are not accidental. The decision

to allow entry is the process of underwriting ofrisk. Underwriting includes

assessing the risk, which means, making an evaluation of how much is the

exposure to risk. The premium to be charged depends on this assessment

of the risk. Both underwriting and claim settlements have to be done with

great care. 


Insurance companies are talking risks. They have to pay claims as and when they occur. They cannot be sure when the claim will occur and how

big the claim may be. This is so because of the very nature of perils. Insurers

normally are financially sound enough to be able to pay claims. But there

are limits. An event like the tsunami or a hurricane may generate claims

amounting to crores of rupees, which may put a very heavy strain on the

reserves of the insurer. Insurers protect themselves from such situations, which may be beyond their capacity, by reinsuring the risk with other insurers. If there is a claim, the burden is shared by the primary insurer and the reinsurers.




Alife insurance policy promises that the insurer will pay to the policyholder

a certain sum of money if the person insured dies or any other specified

contingency happens. It is a contract, within the meaning of the Indian

ContractAct, 1872. Acontract is an agreement between two or more parties

to do, or not to do, so as to create a legally binding relationship. 

A simple

contract must have the following essentials

• Offer and acceptance

• Consideration

• Capacity to contract

• Consensus ‘ad idem’ (genuine meeting of minds)

• Legality of object or purpose

• Capability of performance

• Intention to create legal relationship

Insurance is a contract between the insurer and the policyholder. The

policyholder can be different from the person whose life is insured, as

will be seen later. Insurance is a specialised type of contract. Apart from

the usual essentials of a valid contract, insurance contracts are subject to

two additional principles viz. Principle of Umost Good Faith and the

Principle of Insurable Interest. These apply to all insurances, both life

and non-life.


Commercial contracts are normally subject to the principle of :caveat emptor”

i.e. “let the buyer beware”. It is assumed that cach party to the contracto

examine the item or service, which is the subject matter of the conte

Each party can verify the correctness of the statements of the other nt

There is no need to take the statements on trust. Proof can be asked for.

In the case of insurance contracts, this principle does not apply. Most of the facts relating to health, habits, personal history, family history etc.

which form the basis of the life insurance contract, are known only to the

proposer. The insurer cannot know them, if the proposer does not disclose

them. The underwriter can ask for a medical report. Yet there may be

certain aspects, which may not be brought out even by the best medical


As the underwriter knows nothing

and the man who comes to him to ask for insurance knows everything, itis

the duty of the assured to make a full disclosure to the underwriter., without

being asked, of all material circumstances. This is expressed by saying

that it is a contract of utmost good faith”.

The law imposes a greater duty on the parties to an insurance contract

than in the case of other commercial contracts, to disclose relevant

information. This duty is one of utmost good faith or Uberrimae Fides.

It is the duty of the proposer to make a full disclosure to the insurer. The

implication is that, in the event of failure to disclose material facts, the

contract can be held to be void ab initio.


All risks are not insurable. Otherwise, an insurance contract would be no

different from a wagering contract or betting. It was explained earlier

that speculative risks are not insurable. A wagering contract is speculative

in nature and is illegal in terms of Section 30 of the Indian Contract Act.A

subject matter of a valid contract has to be legal. What distinguishes an

insurance contract fromawagering contract and makes it non-speculative,

is that the insured musthave an insurable interestin the subject of insurance.

In simple terms, it means that the proposer must have a stake in the

continuance of the subject matter insured and could suffer a loss, if the

risk occurs. What is insured is the financial or pecuniary interest in the

subject matter of insurance. The insured must be in a relationship with the subject matter of insurance, whereby he benefits from it’s safety and well-being and would be prejudiced by its loss or damage.


In the case of life insurance policies, insurable interest must exist at the

inception of the policy. There is no requirement for insurable interest at

the time of a claim under the life insurance policy. In the case of Marine

a ib policies insurable interest must exist at the time of the claim. This implies

that there need not be insurable interest at the inception of the policy.

When an importer asks for insurance cover on goods which he has ordered,

he is still not the owner and therefore, has no insurable interest. In other

insurances, insurable interest must exist at the time ofinception as well as

at the time of claim.


Insuranceis meant to compensate losses. By implication, the mechanism

of insurance cannot be used to make a profit. This broadly is the Principle

of Indemnity. The amount paid out as a claim cannot exceed the amount

of loss incurred. Insurance should place the insured in the same financial

position after a loss as he enjoyed before it, not better.

There is a link between indemnity and insurable interest. It is the interest

of the insured in the subject matter of insurance, that is insured. Therefore,

the amount of claim cannot exceed the extentof interest. In the case of life

insurance however, because the insurable interest (on own life) is assumed

to be unlimited, the principle of indemnity does not apply. In health

insurance covers, which are part of general insurance, the principle of

indemnity will apply.

Because of the principle of indemnity, there could be difficulties in settling

claims in general insurance. Assessments of losses made by qualified

surveyors, are often disputed. The damaged parts that have been replaced,

called salvage, may have some resaleable value. The insurer may have

the option to settle the claimby way of repair, reinstatement or replacement.

In the case of liability or damages (for pain and mental agony etc.), the level of indemnity is vague and indeterminable. Such problems do not exist in life insurance.


The life insurance business deals with risks relating to life of human beings.

The circumstances (perils) that create the loss or damage (risks) are mainly

two, death and old age. Insurance does not prevent either. It can mitigate

the consequences in those circumstances.

Human beings also run the risk of sickness (medical costs can be very

burdensome), accidents (causing disability) and unemployment. These

are insurable in non-life insurance. Sickness and accident risks, including

disability, are insurable as supplementary benefits, also called riders, under

life insurance policies. These are explained in the chapter on life insurance


As a rule, risks are managed in three ways, viz.,

Prevention or Avoidance



Death and Old Age are not preventable at all. Accidents, sickness and

unemployment are also perhaps not avoidable despite being careful.

Accidents may be caused by someone else being negligent. Surroundings

can create sickness. Economic conditions lead to unemployment…

Retention of the risk is an alternative. This is possible by having one’s

own resources to take care of the needs, like puting aside savings to be

used for the rainy day’. Big organisations like the State Road Transport

Corporation or the Railways may find it cheaper to bear the risks

themselves, as they have the benefit of large numbers. One might think of

joint families as systems that can manage the risks themselves. Strictly,

however, inajoint family system, there is sharing by others in the family.

That is the principle of insurance.

The third option is the transfer of the risk to another person.One common

‘transfer’ is when the State, being a welfare State, takes over the

responsibility for medical care of its citizens, or pays benefits to the elderly

and the unemployed. This happens in some countries in Europe, USA

and Canada. Insurance is a mechanism for transfer.

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