Purpose and Need of Insurance

Assets are insured, because they are likely to be destroyed or made non-functional before the expected life time, through accidental occurrences. Such possible occurrences are called perils. Fir, floods, breakdowns, lightning, earthquakes, etc, are perils. If such perils can cause damage to the asset, we say that the asset is exposed to that risk. Perils are the events. Risks are the consequential losses or damages. The risk to a owner of a building, because of the perils of an earthquake, may be a few lakhs or a few crores of rupees, depending on the cost of the building, the contents in it and the extent of damage.

The risk only means that there is a possibility of loss or damage. The damage may or may not happen. The earthquake may occur, but the building may not have been affected at all. Insurance is done against the possibility that the damage may happen. There has to be an uncertainty about the risk. The word ‘possibility’ implies uncertainty. Insurance is relevant only if there are uncertainties. If there is no uncertainty about the occurrence of an event, it cannot be insured against. In the case of a human being, death is certain, but the time of death is uncertain. The person is insured, because of the uncertainty about the time of his death… In the case of a person who is terminally ill, the time of death is not uncertain, though not exactly known. It would be ‘soon’. He cannot be insured.

Insurance does not protect the asset. It does not prevent its loss due to the peril. The peril cannot be avoided through insurance. The risk can sometimes be avoided, through better safety and damage control measures. Insurance only tries to reduce the impact of the risk on the owner of the asset and those who depend on that asset. They are the ones who benefit from the asset and therefore, would lose, when the asset is damaged. Insurance only compensates for the losses – and that too, not fully.

Only economic consequences can be insured. If the loss is not financial, insurance may not be possible. Examples of non-economic losses are love and affection of parents, leadership of managers, sentimental attachments to family heirlooms, innovative and creative abilities, etc.