Insurance

Insurance is a system under which a large number of people pay a regular sum of money into a common pool, the money being used for the purpose of compensating those of them who suffer a loss. In other words, insurance is a scientifically planned method of sharing a financial risk.

Suppose that in a given year 10,000 people buy new bicycles each costing £80. No purchaser, let us say, is willing to risk having his bicycle stolen and having to find the money to buy another one. To meet this problem an organisation has been set up whereby each owner may pay into a fund £1 a year, and in return the fund will pay out £80 to any subscriber whose bicycle gets stolen in that year. If all 10,000 people join the scheme the total annual contributions, called 'premiums', will amount to £10,000. And if, in one year, 100 bicycles are stolen then the total compensation paid to the owners will amount to £8,000; in addition the organisation will have to meet its operating costs. It will probably make a small profit, and the bicycle owners will all have enjoyed peace of mind.

Premiums

Calculating the proper amount for the premium payable for insuring against any risk is very complex. It involves measuring the degree of risk, which itself requires an assessment to be made of the likelihood of a certain event, such as theft, arising in a given period, usually a year. Insurance companies employ expert staff called actuaries and underwriters who, from analyses of past records and current trends, calculate the probabilities of an event occurring, and the average number and sizes of claims likely to arise. Where risk is high the premium will be high. Thus, the premium for insuring a hundred-year-old firework factory against fire will be higher than for a modern brick-built toy factory equipped with automatic sprinklers. The cost of insurance (the premium) bears a direct relationship to the risk.

Insurance can be divided into two main kinds, general (or nonlife) insurance, and life insurance. There is a difference in the essential objectives of the two types, and the basic distinction will be more readily comprehended if we first of all describe general insurance.

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