Written by Insurance is a form of risk transfer mechanism where the insurer agrees to indemnify the insured against a specified or known risk.
It is a contract between two parties in which one party, the insurer, agrees to provide financial protection or compensation for the losses incurred by the other party, the insured, in exchange for regular payments known as premiums.
Insurance may also be defined as a social scheme that provides financial compensation for the effect of a misfortune from the pool of accumulated contributions of all members participating in the scheme.
The main purpose of insurance is to protect the insured from financial losses that could arise from unexpected events, such as accidents, fire, or medical emergencies.
Insurance allows individuals and businesses to manage their potential losses and protect themselves from financial losses by pooling the risks of many individuals.
Functions of Insurance
The functions of insurance can be divided into primary and secondary functions.
Primary functions of Insurance
1. Spreading risk: This is one of the main functions of insurance.
Insurance is a means of sharing risk because it allows a large group of people to pool their money together to pay for any losses that might be incurred by an individual within the group.
This way, the financial burden of a loss is shared among all members of the group, rather than falling on just one person.
2. Risk protection: Insurance also serves as a risk protection mechanism.
Insurance provides financial compensation to individuals or businesses that suffer a loss.
For example, if a person has car insurance, and their car is damaged in an accident, the insurance company will pay for the cost of repairing the car.
This helps shield individuals from the financial burden of having to pay for the repairs themselves.
Similarly, if a business has property insurance and a fire destroyed its building, the insurance company will pay for the cost of rebuilding the building.
This helps protect the business from the financial consequences of a catastrophic loss.
3. Risk evaluation: Another primary functions of insurance is that it serves as a risk evaluation mechanism.
Insurance serve as risk evaluation by allowing insurance companies to assess the likelihood and potential cost of insuring a particular individual or entity, and to develop strategies to manage and mitigate risk.
Secondary Functions of Insurance
1. Loss prevention: Insurance serves as a loss-prevention mechanism in various ways.
First and foremost, insurance companies often provide their policyholders with loss-prevention guidance in the form of safety advice and rules.
For example, a car insurance company may provide its policyholders with information on how to avoid car accidents, or a homeowner’s insurance company may provide information on how to prevent burglaries.
By providing this information, insurance companies help policyholders to take steps to prevent losses.
Secondly, Insurance can also serve as a means of providing individuals and businesses with the financial means to recover from a loss.
For example, if a business suffers a major loss, such as the destruction of its factory, the insurance compensation can provide funds necessary to rebuild the factory and resume operations.
This can help to prevent the loss of jobs and economic disruption in the community.
In this way, insurance can help to prevent the negative consequences of losses for individuals and businesses.
2. Stimulus to business: Insurance also serves as a stimulus to business by providing a financial safety net that allows businesses to take risks and invest in their future growth.
Without insurance, businesses would have to bear the full financial burden of any losses that may incur by setting aside contingency fund to meet emergencies.
This could make businesses hesitant to take risks because they would be afraid of losing a large amount of money if the venture failed.
However, with insurance, businesses can be more confident in taking risks, because they know that their insurance coverage will provide them with financial compensation if things don’t go as planned.
As a result, firms would be able to take risks, grow, and prosper, which in turn stimulates economic growth and the creation of new jobs.
In this way, insurance stimulates business activity.
3. Security: Insurance provides security by offering financial protection against potential losses.
When you buy insurance, you are essentially transferring the risk of certain potential losses to the insurance company.
In exchange for a small premium, the insurance company agrees to pay for any covered losses that you may occur.
This can provide a sense of security by giving you peace of mind and protecting you from financial hardship.
For example, if you have health insurance, you don’t have to worry so much about paying for medical treatment if you get sick or injured, because the insurance company will cover some or all of the cost.
4. Savings: Insurance can serve as a means of savings in several ways.
First, by purchasing insurance, you are protecting yourself and your assets against potential financial looses due to unexpected events, such as accidents, natural disasters, or illness.
This can help you save money in the long-run by avoiding the financial burden of paying for these unexpected expenses out of pocket.
Second, a lot of insurance plans, such whole life insurance and variable universal life insurance, provide both insurance protection and investment opportunities, enabling you to save money for the future.
These policies typically have a cash value component that accumulates over time and can be used as a source of funds for future expenses, such as education, retirement, or emergencies.
Overall, insurance can serve as a means of savings by helping you protect against financial losses, and by providing investment opportunities.
5. Social welfare: Insurance can also provide a safety net for individuals and families who are struggling financially.
For example, health insurance can cover the cost of medical treatment, which can be especially important for those who may not have the means to pay for it themselves
Conclusion
We have discussed the meaning and functions of insurance. let’s do a brief recap.
Insurance can be defined as a social scheme and a risk transfer mechanism where one party, the insurer agrees to indemnify another party, the insured, against a specified risk.
The functions of insurance can be grouped into primary and secondary functions of insurance.
Primary functions of insurance include risk sharing, risk protection and risk evaluation.
The secondary functions of insurance are loss prevention, business stimulation, security, serving as a means of saving, and social welfare.
