1.3 The Nature of Insurance
One of the basic factors in life and health premiums is the interest earned by the insurance company on the premiums it receives and subsequently invests.
The concept of insurance developed from the need to minimize the adverse effects of risk associated with the probability of financial loss. The function of insurance is to safeguard against financial loss by having the losses of few paid by the contributions of many who are exposed to the same risk.
Insurance is provided through a system which makes large financial losses more affordable by pooling the risks of many individuals and business entities and transferring them to an insurance company or other large group in return for monetary payments (premium payments). Premium payments are collected by insurance companies to cover expenses and the cost of projected losses. The person who undertakes to indemnify another by insurance is the insurer, and the person indemnified is the insured.
Purchasing insurance is one of the best ways of minimizing loss. Loss is the reduction in quality or value of a property (or insured item or person), or a legal liability. The insurance purchaser pays a premium to the insurance company in exchange for financial protection in case of loss. By doing so, both parties have entered into a contract and the insurer issues an insurance policy. The insurance policy stipulates the promises the insurer has made to pay the insured if a loss of the insured subject occurs. If a loss occurs, the insured person files a claim with the insurer. The claim is an official request for the insurer to fulfill the promises of the contract (or policy).
The fundamental principles of insurance include risk pooling and the law of large numbers. A loss could prove to be costly for one individual. However, if the resources of several were combined (pooled) together, the loss could be divided among them and each individual in the group would suffer only a small loss, rather than one individual suffering a large loss.
Pooling of risks is considered the primary principle of insurance and the law of large numbers is categorically fundamental to the process of establishing insurance guidelines.
