Insurance enables those who suffer a loss or accident to be compensated for the effects of their misfortune. The payments come from a fund of money contributed by all the holders of individual insurance policies. In other words, individual risks are pooled and shared, with each policyholder making a contribution to the common fund.

The importance of Insurance in present life

The contribution is known as the premium. Premiums are paid to insurers - these are institutions which accumulate the money into the fund from which claims are paid. The loss is in fact paid for by the policyholder making the claim and by all the other policyholders who have not suffered in the same way.

Insurers are professional risk takers. They know the probability of different types of risk happening. They can calculate the premiums needed to create a fund large enough to cover likely loss payments. Clearly, only a proportion of policyholders will require compensation from the fund at any one time.

There are two different kinds of insurance -

Life Insurance and General Insurance

With life insurance you don't renew your policy each year. Instead, you agree to pay a fixed premium for a set number of years. In other words you enter a long-term commitment when you buy a life insurance policy.

General Principles

Insurance can provide compensation only for the actual value of property. It cannot cover the loss of sentimental value, for example. There must be a large number of similar risks so that the likelihood of a claim can be spread among other policyholders. It must be possible for insurers to calculate the chance of loss so that a premium can be set which matches the risk. Losses must not be deliberate and not inevitable. Clearly, you could not buy fire insurance for a house which was already burning nor life insurance for someone on his or her deathbed.

Lastly, there are some risks which have financial implications so vast that they can be dealt with only by the state. These risks (mainly those arising from war or the major escape of nuclear or radioactive material) are normally not insurable. Insurance takes the risk away from people's lives and businesses. It brings peace of mind to the policyholder. In return for paying premiums the policyholder knows that, if the unexpected happens, financial compensation will be available from the fund of premiums.