How insurance works

Every business faces the risk of loss from fire, theft or accident. Insurance cannot stop these from happening, but it spreads the loss of a few over many. Many people each pay a small, known amount (the premium) into a common fund, and the few who suffer a loss are paid from it. A small, certain cost replaces a large, uncertain one.

Insurance is a contract: the insurer agrees to make good the insured's loss if a stated event happens, in return for the premium.

Functions of insurance: providing certainty of payment for a loss; protection against the financial effects of a loss; risk sharing among many; and help in capital formation, as the premiums collected are invested in the economy.

The principles of insurance:

• Utmost good faith: both sides must tell each other every important fact honestly. When taking life insurance, you must tell the company about your health and your work.
• Insurable interest: you can insure only something whose loss would cause you loss: your own property, or your own and your family's lives.
• Indemnity: the insurer pays only the actual loss, putting the insured back where he or she was before, never better off. If goods worth ₹10 lakh are insured for ₹25 lakh and they burn, only ₹10 lakh is paid. A human life cannot be valued in money, so indemnity does not apply to life insurance.
• Proximate cause: the loss must be caused mainly by the risk insured against. A fire policy does not pay for flood damage.
• Subrogation: once the insurer has paid for the loss, the insured's rights in the damaged property pass to the insurer. You cannot be paid and also keep and sell the damaged goods.
• Contribution: if the same property is insured with several insurers (double insurance), they share the loss in proportion to the sums each has insured, and together pay no more than the actual loss.
• Mitigation: the insured must do everything possible to reduce the loss, just as if there were no insurance.