What is Insurance?
An insurance contract provides risk coverage to the insuree.
A purchaser of insurance pays a fixed premium in exchange for
a promise of compensation in the event of some specified loss.
Insurance is bought because it gives peace of mind to the
holders. This comfort level is important in personal and business
life. Though the primary purpose of insurance is to provide
risk coverage, when the contract period extends over a long time, as
in the case of life insurance, premium payments comprise of two
components – one for buying risk coverage and the other towards
savings. This bundling together of risk coverage and savings is
peculiar to life insurance and is more common in developing
countries like India. In the industrially advanced countries, this
is not necessarily so and short duration life insurance
contracts without a savings component are equally popular. In the
developing economies because of the savings component and the long
nature of the contract, life insurance has become an important
instrument of mobilizing long-term funds.
The savings component puts the life insurance in direct
competition with other financial institutions and savings
instruments.
Essay About Insurance
Insurance and Growth
Insurance and economic growth mutually influence each other.
As the economy grows, the living standards of people increase. As a
consequence, the demand for life insurance increases. As the assets
of people and of business enterprises increase in the growth
process, the demand for general insurance also increases. In
fact, as the economy widens the demand for new types of insurance
products emerges. Insurance is no longer confined to product
markets; they also cover service industries. It is equally true that
growth itself is facilitated by insurance. A well-developed insurance sector promotes economic growth by encouraging
risk-taking. Risk is inherent in all economic activities. Without
some kind of cover against risk, some of these activities will not
be carried out at all.
Also insurance and more particularly life insurance is a
source of long term savings and life insurance companies are thus able to support infrastructure
projects which require long term funds. There is thus a mutually
beneficial interaction between insurance and economic growth. The
low income levels of the vast majority of population has been one of
the factors inhibiting a faster growth of insurance in India.
To some extent this is also compounded by certain attitudes to life.
The economy has moved on to a higher growth path. The average rate
of growth of the economy in the last three years was 8.1 per cent.
This strong growth will bring about significant changes in the
insurance industry.
At this point, it is important to note that not all activities can
be insured. If that were possible, it would completely negate
entrepreneurship. Professor Frank Knight in his celebrated book
“Risk Uncertainty and Profit” emphasized
that profit is a consequence of uncertainty. He made a distinction
between quantifiable risk and non-quantifiable risk. According to
him, it is non-quantifiable risk that leads to profit. He wrote “It
is a world of change in which we live, and a world of uncertainty.
We live only by knowing something about the future; while the
problems of life, or of conduct at least, arise from the fact that
we know so little. This is as true of business as of other spheres
of activity”. The real management challenges are uninsurable risks.
In the case of insurable risks, risk is avoided at a cost.
Assessment of Risks
An important function of an insurer is to assess the average level
of risk borne while offering a product. This assessment depends upon
a variety of factors and actuarial calculations become necessary.
This is a highly technical area involving theories of probability.
The premium charged by an insurer is based on the calculated average
risk. Obviously this premium will be high for people who perceive
themselves to be in a low risk category. However, for insurance
as an activity to succeed, the population to which a product is
offered must consist of categories with different degrees of risk.
That is why the larger the coverage, the lower the average risk and
lower the premium. Diversification is the way to reduce the average
risk.
Regulatory Framework
As in the case of all financial institutions, insurance is an
activity that needs to be regulated. This is so because the smooth
functioning of business depends on the trust and confidence reposed
by the customers in the solvency of the financial institutions. Insurance products are of little value to customers, if they
cannot trust the company to keep its promise. The regulatory
framework in relation to the insurance companies seeks to take care
of three major concerns –
(a) protection of consumers’
interest,
(b) to ensure the financial soundness of the insurance
industry, and
(c) to help the healthy growth of the insurance market.
So long as insurance remained
the monopoly of the Government, the need for an independent
regulatory authority was not felt. However, with the acceptance of
the idea that there can be private insurance entities, the need for
a regulatory authority becomes paramount. With the passing of the
Insurance Development and Regulatory Act in 2000, the insurance
regulatory authority has become a statutory authority. Protecting
consumer interest involves proper disclosure, keeping prices
affordable, some mandatory products and standardization. Most
importantly, it has to make sure that consumers get paid by
insurers. From the consumers’ point of view, the most important
function of the regulatory authority will be to ensure quick
settlement of claims without unnecessary litigation. With respect to
solvency and financial health, regulations will have to be
introduced to ensure that insurance companies follow
appropriate prudential norms such as solvency margins. Large funds
are under the custody of the insurers and they get invested to
produce additional returns. The management of these funds is
important to the insurer, the insured and the economy. Entry into
the insurance industry must also be regulated with suitable capital
adequacy norms. The third role should be one of development. The
insurance industry in India has a large potential and the
framework of regulation must enable the industry to tap this vast
potential.
IRDA over the last decade has brought into force a number of
regulations which are well conceived. They have received wide spread
appreciation. The recent decision of IRDA to move to a free tariff
regime for several general insurance products is welcome. The
prescription of tariff is contrary to market principles and
insurance products need to be priced based on market forces.
The reform of the insurance sector is part of the overall economic
reform process that is underway. The basic philosophy underlying the
new economic policy is to improve the productivity and efficiency of
the system. This is sought to be achieved partly by creating a more
competitive environment. The growth of the real economy depends upon
the efficiency of the financial sector. A greater element of
competition is being injected into the financial system as well.
All regulators need to keep in mind that there is a fine distinction
between regulations and controls. Regulations lay down norms while
controls have a propensity to micromanage institutions. Regulators
must take care to ensure that regulations do not slide into
controls.
The insurance industry in our country underwent a big change
in 2000 when private participants were allowed into the industry
along with a streamlined regulatory and supervisory regime. There
are at present 14 private life insurance companies along with
LIC and 12 entities in non-life sector. There is evidence to show
that competition has done good to insurance industry. The rate of
growth of the industry in the post liberalization period has been
faster. It has also developed in terms of product innovation and the
use of alternative distribution channels.
Conclusion
The insurance sector has a vast potential not only because
incomes are increasing and assets are expanding but also because the
volatility in the system is increasing. In a sense, we are living in
a more risky world. Trade is becoming increasingly global.
Technologies are changing and getting replaced at a faster rate. In
this more uncertain world, for which enough evidence is available in
the recent period, insurance will have an important role to
play in reducing the risk burden individuals and businesses have to
bear. In the emerging scenario, the insurance industry must
pay attention to
(a) product innovation,
(b) appropriate pricing, and
(c) speedy settlement of claims.
The approach to insurance must
be in tune with the changing times.
Insurance should be extended
to coverage a larger section of the population and a wider
segment of activities. The three guiding principles of the industry
must be to charge premium no higher than what is warranted by strict
actuarial considerations, to invest the funds for obtaining maximum
yield for the policy holders consistent with the safety of capital
and to render efficient and prompt service to policy holders. With
imaginative corporate planning and an abiding commitment to improved
service, the mission of widening the spread of insurance can
be achieved.
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