Nature of Insurance

There are three schools of thought, which have defined the nature of Insurance as follows:

1) Insurance in terms of the relationship between the insured & the insurer – transfer device

According to this school, Insurance may be defined as the transfer of pure risk from the insured to the insurer.

The insured is the person or firm or company confronted by risk and the insurer is a person or firm or company, which specializes in the assumption of risk. The primary business of the insurer is risk assumption for a fee.

2) Technical

This school of thought defines Insurance in terms of techniques or mechanics it involves. According to Prof Mehr & Cammack, Insurance is a device for reducing risk by combining a sufficient number of exposure units to make their individual losses collectively predictable. The predictable loss is then shared proportionately by all units in the combination. Therefore, it implies both that uncertainty is reduced & losses are shared. Further, it is said that a device will be deemed Insurance if

• (i) it implies the law of large numbers so that the requirement of future funds to cover losses are predictable with reasonable accuracy.
• (ii) it provides some definite method for raising these funds by levies against the units covered by the scheme. In short, the essential features of Insurance are the manner in which losses are predicted & shared.

3) Combination

According to the third school of thought, Prof. Willet defines Insurance as a social device for making accumulations to meet uncertain losses of capital, which is carried out through the transfer of risks of many individuals to one person or to a group of persons.

Wherever there is accumulation for uncertain losses, or wherever there is transfer of risk, there is one element of Insurance, only when these are joined with the combination of risk in a group is the Insurance complete. Another way to state this is to say that “Insurance is a transfer of risk with the added features of (i) combination of risks (ii) an estimate of future losses”.

Although each of the authors have defined Insurance differently but they are all thinking about virtually the same thing when they use the term Insurance. If we sum up all schools of thought then the Insurance can be well defined as follows:

“Insurance is a social device which combines the risks of individuals into a group, using funds contributed by members of the group to pay for losses.”

The essence of the Insurance scheme is that it is a

1. Social science
2. Accumulation of funds
3. It involves a group of risks
4. Transfer of risk to the whole group

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