Mrs Girija Varadarasan
Life Planner,
Great Eastern, Singapore
INTRODUCTION:-
Every one of us have an insurance in one way or the other. It may be automobile, life , medical, travel etc. Insurance in general is nothing but a tool for risk management. Insurance in no way prevents the occurrence of calamities or accidents or death or admission into a hospital or other such mishaps. All that it does is mitigating the financial loss resulting from such a happening.
It is essential to have the right kind of insurance that addresses our concern adequately. It is not of much use having many insurance covers, that are not appropriate.
While all of us have insurance, many of us are not aware of the basis of insurance and its appropriateness. So this article will introduce the concepts and explains as how insurance do work.
What is insurance?
Insurance is a contract between an individual (called the Policy Holder) and the insurance company. The most significant provision of the contract is that the insurance company covers the financial loss of the Policy Holder, to a specified amount, resulting from the said causes under certain specified conditions. To obtain this it is also essential that the Policy Holder meets the terms stipulated in the insurance contract.
The Policy Holder should have also paid the agreed premium regularly to keep the policy valid. If the Policy Holder experiences a financial loss due to some issues, then the policyholder can file a claim for reimbursement of the pre-agreed sum with the insurance company.
The basic foundation on which the concept of insurance works is known as the “Law of Large Numbers” .When someone buys an insurance policy, he/she is pooling his/her risk with the risk of everyone else who has purchased similar insurance from the same company.
If the insurance company sells millions of insurance policies, the Policy Holder is joining forces with the millions of owners of similar policy holders to collectively protect each other against the loss. Only a small percentage of the policy holders, in fact will experience losses each year. Thus the payment of compensation for those losses will be relatively small.
The premium is paid by a very large number , (say millions) of Policy Holders ; however the claims are made by relatively a few Policy Holders only ( say in hundreds) . It is this aspect that Insurance is a viable risk management tool.
Insurance companies rely very heavily on the law of large numbers. Using this principle, they are able to estimate the value and frequency of future claims paid out to policyholders, more accurately.
The law of large numbers has its root in the probability theory in statistics. Its basis is that when the number of observations increases, variation around the mean observation declines. In other words, this means that when the sample is very large, the average value can be predicted with more accuracy and it is more likely to represent the expected value.
This can be explained very easily. When you toss a coin, it can land either in heads or tails. The chance of heads or tails appearing as a result of the toss is 50%. However if you toss a coin only 8 times, it is quite likely that heads (or tails) may appear 5 or even 6 times, thus breaking the expectation that on an average in a toss you may end up with 4 times heads appearing and 4 times tails appearing. This is so, because the sample size is small- only 8 tosses. If you toss a coin 100,000 times, then the chances that 50,000 times it is heads and 50,000 times it is tails , is more certain. If you toss the coin 1milloin time, then the chance that it is heads ½ million times and tails the other ½ times is more certain.
It is this Law Of Large Number, which makes insurance a viable tool of risk management.
The insurance policy in general must include the following
- Specifically identify the person who is insured and his/her personal particulars
- The insurance Company which provides the cover
- Specific Risk(s) which is covered
- Term or Duration of the cover.
- The Financial limit of the cover
- Premium and periodicity of payment of that premium
- Exclusions if any
- Terms and Conditions – rules of conduct, duties, and obligations.
(to be continued)