Sunday, October 5, 2008

What is an Insurance?

Insurance works on the concept of pooling of risk. In the ancient times, merchants started this concept by poling the risk of their cargoes being sunk in the sea. They started pooling money which would be used to compensate the damages occurred to the merchant whose cargo sunk.

The same concept has been carried forward to the modern day insurance, where one can insure not only his cargo/vehicle but also his health and life!

In India, insurance can be broadly classified into 2 categories:
  1. Life Insurance: Financially covers the family against the death of the insured.
  2. General Insurance: Protects several areas including health, property, professional liability and many more.
Striking a balance between the cover needed and the premium paid for the cover is very critical to get the optimum value.

Here are certain factors that should be considered before deciding ona particular insurance policy:

The probability and impact of the event to be covered:

Before taking a particular insurance, one should assess the probability of the event and its possible impact on the individual and family.

Suppose, you own a shop in Mumbai, and want to cover the shop against earthquake! This is a rare event and might not happen very frequently. But the damage would be significant in case it occurs. So, you may go for an insurance. As the event is infrequent in nature and the probability is low, the premium may be very low.

But the same event will have a high premium in JAPAN, as the earthquakes there are frequent and the probability is high.

For life insurance, the impact varies based on the age of the person and the number of dependents.

Adequate Insurance:

That you have a cover is not enough. You should make sure the cover is adequate enough to cover the damage. You should evaluate your future worth in case of a life casualty and then go for the cover depending on that.


This is a major factor while taking an insurance cover. Too much premium would be a burden on your purse an too low premium will not serve the purpose. You should do some calculations to get the adequate cover with the most affordable premium.

Income Tax:

While the premium paid can be used to reduce the tax liability under 80-C, one should not be guided by this. By doing so, you would not consider what is best for you and go for the one with maximum premium.

Do not treat Insurance as an Investment:

This is a fallacy that is present in almost everyone's mind. Treat insurance as a safety net in case of you not being there for the family and invest separately to make your money grow!

Several studies have proved that un-bundling of insurance and investment aspects lead to a better overall result. This will however call for the investing discipline on the part of the policyholder.

Watch this space for more on insurance basics.


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