Need for Insurance

From cave age till date, the story of evolution of mankind is in fact a saga of continuous search for security. His problems have remained the same through the centuries though the form has changed with the changes in economic and social circumstances.

When men lived in caves, he searched for security against animals, because they could kill him while asleep. He was not sure, he could hunt every day and get his food. He lived in a group or tribe so that other members of the tribe could come to help in times of crisis. The system of family was the product of a similar need and to seek comfort and security against sickness.

Protecting ones asset has been a continuous search not only of individuals but also of groups of people. Theft, fire, flood etc. have been a scourge against mankind. Man earns investing his time, strength and intelligence. He also needs other instruments like vehicles, factories, ship for transportation, production and trade. Each of these resources are valuable and augment the creation of further wealth.

But when such aspects are lost or destroyed much before the expected date, the calamity is suffered. Human being is an income generating asset. He expects to earn during his life time sufficiently so as to provide for his old age. But when he dies at a young age, the family remains unprovided for. A motor vehicle is to last, say 15 years.

During this period, the owner makes sufficient saving as to replace it with a new one. But if the vehicle is totally damaged due to an accident, the entire capital is lost and the owner cannot replace it. It is so with any other asset.

Individual’s income is dependent upon the investment of his time. Over a period of time, he saves sufficiently to provide for the time, when he is too old to earn. But nobody can guarantee him this time. This uncertainty of time leads him to the invention of insurance.

The story goes off a news paper hawker boy who used to go on cycle to distribute news papers to earn his livelihood. One day, when he left his cycle outside a house and went in to deliver the news paper, his cycle got stolen. He had thereafter no means to run around. Walking would be a slow process and his income would dwindle. The boy was a smart one.

He called his other brother hawkers and narrated his story. Many others in the same job had similar stories to tell. They just hit upon an idea. A cycle say would cost Rs. 100/- There were almost 100 hawkers. Almost every year one cycle was getting stolen. Only if they could have a fund of Rs.100/- such a loss suffered by any of them could be compensated.

And the creation of a fund of Rs.100/- merely means a contribution of Rs.1/- per person per year. The concept of insurance was born. A cooperative society was created, where each member of the family contributed a small portion  to provide for a possible big loss which was too big for anyone to bear.

This crude beginning could later on be applied to varied circumstances. The traders, who sailed on the uncharted high seas, faced the risk of damage or total loss due to storm on the high seas. House  owners found the risk of fire to their house to ruinous to bear.

Life being the most precious of the productive assets similarly needed to be protected. Insurance, let it be noted, does not prevent the loss to occur. It cannot prevent, theft fire, sinking of a ship due to storm or even death of the bread winner. Far from it, if they could be prevented, there would be no need for insurance.

It is only the damages beyond the control of men, purely accidental, or due to fury of nature, which are subjects for insurance. An intentional damage caused by the insured is an act of sabotage and is therefore a criminal action. In case of human life, even suicide, at least during the short period of one year, is beyond the scope of insurance.

Such huge funds could not be made available but for the pooled resources of the entire society. As we have said in the above example of the newspaper hawker, one rupee contribution made it possible to have a fund of rupees one hundred. The risks of the loss of the cycle for each hawker boy was too great to bear. But when the hundred hawkers pooled their resources, they distributed their risks in bearable proportion.

The aero planes cost hundreds of crores of rupees. Say there are one lakh aero planes, and each one cost one hundred crore. If the probability of loss is ten aero planes out of one lakh aero planes every year, then all that you need is the annual contribution of one lakh premium from each aero- plane owner. The probable loss would be 10 x 100 crore, divided by one lakh to each one contributing towards premium.

The same theory of probability applies to life insurance also. Let us say we insure 1000 people, all are say of 20 years of age. The insurer’s previous experience tells him that at this age, only 4 out of 1000 are likely to die within one year. Now supposing we want to insure each one of them, say for one thousand rupees, all are need is only Rs.4000/- to pay as claim.

Thus we need to collect only 4 rupees from each member of the insurance cooperative. The above is only an illustration to explain the mechanism as to how insurance is only a system of pooling risks and resources.