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Insurance Explained
By Rajwardhan Sagare | Insurance Advisor
What is Insurance?
Insurance simply means to ensure someone of something, it is the monetary aid provided for the losses incurred by the insured person.
In the financial world, an insurance policy is a contract between the insurer and the insured. It is an undertaking taken by the insurance company to provide monetary compensation for the risks covered under the policy.
For Example, Let’s say a person (Ram) has an insurance policy that covers his medical expenses in case of an operation.
Ram one day gets sick and goes to the doctor and gets diagnosed with appendicitis, doctor suggests that he should get it removed. In this case, he has no need to worry about the expenses of the operation because he has got it covered with an insurance policy so the insurance company pays off his medical bills. He can take care of himself without thinking about how much money it will cost him.
This was just the company’s side of the agreement, there is also the policyholder’s side of the agreement, which the insured has to stick to. The insured has to pay a fixed monthly, quarterly or yearly amount to the insurance company to get cover for the risk they are insured against.
How do insurance companies work?
We have to pay the insurance companies a relatively low amount over a period of time to get compensated with a higher amount, so how do these companies stay in business?
They do this by risk pooling, which means they group people with similar risks and who contribute their money to get covered for the risk with a certain amount. By doing so, the risk gets diversified amongst the insured.
Let us understand this with an example.
A society has 100 houses, which are worth 1 crore rupees each. According to a survey 1 in every 100 houses, may gets destroyed in a fire accident every year.
Now as 1 house costs Rs.1 crore each homeowner must have a security deposit of Rs. 1 CR. at all times, in case there is a fire. Although the probability of that happening is only 0.01%.
A better alternative to this is, every house owner in society saves up a little amount for that one house that may get destroyed. So how much will that “little amount” be? To save Rs. 1 Crore by 100 homeowners each must keep aside Rs. 1 Lakh per year. Which approximately is Rs 8,333 per month.
The money contributed by the people for their safety to the company gets invested by the company in short-term assets to gain interest over the money.
In this particular way, insurance companies cover people for a low premium and a higher cover or sum assured.
Premium? Sum Assured? Don’t worry it’s not that complicated.
Insurance Terminologies
Insured: The person who is being covered against a risk.
Insurer: Generally the insurance company.
Premium: It is the amount paid by the insured per year to the insurer.
Sum Assured: The promised amount which the insured receives after the maturity of the policy.
Maturity: The age of the policy at which the sum assured is received.
Nominee/ Beneficiary: The person nominated by the insured who receives the covered amount or the sum assured in case of the demise of the insured.
Note that the Nominee must be a family member of the insured.
Mode: Refers to the mode of installment i.e. Monthly, Quarterly, or Yearly.
