What is insurance?

Most of us consider life insurance to be a complicated arrangement. But it is not so. It is like many other subjects that are lost in interpretation. Subjects that could be explained in one simple sentence are made complex through interpretations by ‘experts’. Let us endeavour to understand the subject in its simplest explanations. Indian laws will be kept in mind while we proceed. This method will be followed in all the topics.

Assume that your six year old daughter is going for her Class 1 exam. Her mother sends one more additional pencil with her. If the lead of the first pencil breaks the child should not return without completing her exam. The mother fears that there is a chance for breaking of the lead of the first pencil. An additional pencil takes care of the fear of the mother and the loss the child may suffer in the form of not-able-to-write-the-exam-fully. Mother’s fear is called risk. If a risk takes place there occurs a loss. The additional pencil provides a relief from the loss. This is the essence of insurance.

An additional pencil costs one rupee. If there are one hundred students in Class 1 in the school one hundred rupees are spent on additional pencils by one hundred mothers. The School Attendant has learnt from experience that generally five children need additional pencils during the exam.  He suggests to the mothers that if each mother gives him ten paise he shall provide an additional pencil for those students who need additional pencils. In the process he collects rupees ten and purchases five pencils at a cost of rupees five. In the process each mother saves ninety paise, each needy student gets a pencil and the attendant makes a gain of rupees five. All participants in the arrangement are gainers. This is the economics of insurance.

The Attendant makes it clear to all that he shall provide an alternate pencil only when lead of the original pencil breaks unexpectedly. In other words if two boys quarrel and in the process pencils are broken he will not supply new pencils. Or if a student deliberately breaks the pencil the Attendant is not going to give new pencil. In other words benefits and conditions for getting the benefits etc are specified. Here law steps in    and these things are put on paper. And we call it a Policy or policy bond.