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Advantages of insurance

Publish date 25 April 2018
Advantages of insurance image

The awareness that insurance exists to meet the financial consequences of certain risks provides some form of peace of mind. This is important for private individuals when insuring their car, their house, their property, etc., but we see that it is also of paramount importance in industry and commerce.

Easily accessible and reliable risk financing acts as an incentive for the business environment. This is done by releasing funds to invest in the productive part of the business, which would otherwise have to be kept as (easily accessible) reserves to cover any future loss. Medium and large companies could certainly create reserves for extraordinary circumstances - fires, thefts or serious accidents. This money, however, must be available and therefore the interest that the company could receive for it will be small. In addition, the money will not be able to be used to invest in the business itself. Due to the effect of the common pool, every non-insurance business is able to purchase insurance for a premium less than the funds that the company itself should keep to self-finance the risk. The premium can be seen as a certain "loss" for the business, but in this way the company is free to continue its business knowing that some risks are already covered.

Insurers' interest in loss control is not just transient. If they can help customers reduce their frequency and extent, it increases their own profitability and also contributes to an overall reduction in the economic cost of such losses.

Another crucial economic role of insurance companies is their role as investors. For this reason, many governments are reluctant to allow foreign owners to control the insurance business in their territories.

Insurance companies have huge amounts of money at their disposal. This is due to the fact that there is a time difference between receiving a premium and paying a claim. The premium could be paid in January, and a claim may not be filed until December, if one is filed at all. The insurer has this money and can invest it. In fact, the insurer has accumulated premiums from all insured over a long period of time.

The advantage is in the application that this money finds. Insurers use a wide range of investment forms. Through the allocation of investments, the insurance industry assists national and international institutions in their lending operations. Industry and trade are also supported through the granting of loans in various forms and the purchase of shares that are offered on the open market. Insurers are part of the so-called institutional investors. Others are banks and pension funds. Investments are also made in real estate. Sometimes huge signs in front of new construction sites announce that the project is funded by a large insurer.

It is important to note that this money accumulates as a result of premiums paid by thousands of different people and organizations. In a sense, the existence of an insurance market does cause some form of forced saving. A person who insures his house may not have enough free funds to be able to buy shares, real estate or give loans. However, when this person's premium is added to the premiums of several thousand other people, it provides significant investment funds.

Insured risks

There are limits to the extent to which this risk financing mechanism can be provided. For example, it would not be reasonable to allow people to benefit from their own criminal activities. This could happen if it is possible for a person to insure their house and then set it on fire in order to obtain insurance compensation.

Therefore, we need to get an idea of ​​what can and cannot be insured. We will do this by looking at the characteristics or nature of the risks against which insurance can be taken out. There is one important element to note at this point: it is not possible, nor even reasonable, to be dogmatic about these classifications of insured risks. The business world is not a static environment. It changes in order to adapt to the circumstances as they are perceived. What may not be an insurable risk today could easily be insured tomorrow, especially if insurers are under pressure from alternative risk financing (ARF) providers.

Accidental loss

In order to meet the legal requirements for insurance, the insured event must be completely accidental as far as the insured is concerned. It is not possible to take out insurance for an event that is certain to occur, as it does not contain loss uncertainty and therefore the risk event is unlikely to occur.

This excludes unavoidable events such as damage caused by wear and tear, depreciation and impairment. Any damage or loss intentionally caused by the insured is also excluded. Intentional actions by other people are not excluded, as long as they are completely accidental as far as the insured is concerned.

One case that seems to go beyond this rule, but for which insurance can still be taken out, is the occurrence of death. We all think that it is possible to buy life insurance, although death is probably one of the few things that are certain. What is uncertain, however, is determining the exact moment of death, and this is what life insurance is all about.

Financial measurability

The essence of insurance is to act as a mechanism for financing the risk. It provides financial compensation for losses incurred. Insurance does not eliminate the risk, but it definitely tries to provide financial protection against the consequences. If this is the case, then the risk for which the insurance should be taken out must lead to a loss that can be measured financially.

This is easily seen in cases of property loss or damage. The monetary value of the lost property can be determined and compensation can be provided in accordance with the terms of the insurance policy. The exact value of the loss will be known only after the event. All material damage to the property or its theft falls into this category according to the limits set in the original terms of the policy.

In life insurance, the level of financial compensation is agreed at the beginning of the contract. It is impossible to determine the value of the life of a spouse or child, but the financial amount to be secured can be determined at the beginning of the insurance.

Source: David E. Bland "Insurance: Principles and Practice"