Definition of Insurance

Insurance is defined as a co-operative device to spread the loss caused by a particular risk over a number of persons who are exposed to it and who agree to ensure themselves against that risk.

Risk is uncertainty of a financial loss. It should not be confused with the chance of loss which is the probable number of losses out of a given number of exposures.

It should not be confused with peril which is defined as the cause of loss or with hazard which is a condition that may increase the chance of loss.

Finally, risk must not be confused with loss itself which is the unintentional decline in or disappearance of value arising from a contingency.

Wherever there is uncertainty with respect to a probable loss there is risk.

Every risk involves the loss of one or other kind. The function of insurance is to spread the loss over a large number of persons who are agreed to co-operate each other at the time of loss.

The risk cannot be averted but loss occurring due to a certain risk can be distributed amongst the agreed persons.

They are agreed to share the loss because the chances of loss, i.e., the time, amount, to a person are not known.

Anybody of them may suffer loss to a given risk, so, the rest of the persons who are agreed will share the loss.

The larger the number of such persons, the easier the process of distribution of loss.

In fact; the loss is shared by them by payment of premium which is calculated on the probability of loss. In olden time, the contribution of the persons was made at the time of loss.

The insurance is also defined as a social device to accumulate funds to meet the uncertain losses arising through a certain risk to a person insured against the risk.

The definition of insurance can be made from two points:

  • Functional Definition and,
  • Contractual Definition

Functional Definition

Insurance is a co-operative device to spread the loss caused by a particular risk over a number of persons, who are exposed to it and who agree to insure themselves against the risk.

Thus, the insurance is :
(a) a co-operative device to spread the risk;
(b) the system to spread the risk over a number of persons who are insured against the risk;
(c) the principle to share the loss of each member of the society on the basis of probability of loss to their risk; and
(d) the method to provide security against losses to the insured.

Similarly another definition can be given.

Insurance is a co-operative device of distributing losses, falling on an individual or his family over a large number of persons, each bearing a nominal expenditure and feeling secure against heavy loss.

Contractual Definition

Insurance has been defined to be that in which a sum of money as a premium is paid in consideration of the insurer’s incurring the risk of paying a large sum upon a given contingency.

The insurance, thus, is a contract whereby
(a) certain sum, called premium, is charged in consideration,
(b) against the said consideration, a large sum is guaranteed to be paid by the insurer who received the premium,
(c) the payment will be made in a certain definite sum, i.e., the loss or the policy amount whichever may be, and
(d) the payment is made only a upon a contingency.

More specific definition can be given as follows :

Insurance may be defined as a consisting one party (the insurer) agrees to pay to the other party (the insurer) or his beneficiary, a certain sum upon a given contingency (the risk) against which insurance in sought.