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Why do you need Life Insurance?

Mr. C.S. Sudheer | Posted On Saturday, February 21,2009, 03:54 PM

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Why do you need Life Insurance?




Life is full of uncertainty. In today’s costly World expenses are everywhere. You don’t have to look for them. If you were to die young who would take care of your family. Life insurance provides for your family if something untoward happens to you.

Life insurance policies are of 2 types:

Term life policy where you don’t get any money if you survive the term of the policy.This is a pure risk cover.There are no survival benefits.

An endowment life policy provides for your family on your death. It also gives you an amount (and a bonus) on the maturity date of the policy. There is a sum assured as well as a maturity amount in this policy.

A person has an insurable interest in something when loss or damage to it would cause that person to suffer a financial loss or certain other kinds of losses. For example, if the house you own is damaged by fire, the value of your house has been reduced, and whether you pay to have the house rebuilt or sell it at a reduced price, you have suffered a financial loss resulting from the fire.

By contrast, if your neighbor's house, which you do not own, is damaged by fire, you may feel sympathy for your neighbor and you may be emotionally upset, but you have not suffered a financial loss from the fire.

You have an insurable interest in your own house, but in this example you do not have an insurable interest in your neighbor's house.

Characteristics of Insurable Interest

The property that is subjected to insurance must have some features that are mentioned below;

1. Large number of homogeneous exposure units

The huge majority of insurance policies are offered for individual members of very large classes. The existence of a huge number of homogeneous exposure units allows insurers to benefit from the so-called “law of large numbers,” which in outcome states that as the number of exposure units increases, the real results are increasingly likely to become close to expected results. Large commercial property policies may insure exceptional properties for which there are no ‘homogeneous’ exposure units. In spite of failing on this criterion, many exposures like these are generally considered to be insurable.

2. Definite Loss

The event that gives rise to the loss that is subject to insurance must, at least in principle, take place at a known time, in a known place, and from a known cause. Fire, automobile accidents and worker injuries may all effortlessly meet this criterion. Other kinds of losses may only be definite in theory. Occupational disease, for example, may involve prolonged exposure to injurious conditions where no specific time, place or cause is identifiable. Ideally, the time, place and cause of a loss must be clear enough that a reasonable person, with adequate information, could objectively verify all three elements.

3. Accidental Loss

The event that constitutes the trigger of a claim must be accidental, or at least outside the control of the beneficiary of the insurance. The loss must be ‘pure,’ in the sense that it results from an event for which there is only the opportunity for cost. Events that contain speculative elements, like ordinary business risks, are generally not considered as insurable.

4. Large Loss

The size of the loss must be meaningful from the perspective of the insured. Insurance premiums required to cover both the expected cost of losses, plus the cost of issuing and administering the policy, adjusting losses, and supplying the capital needed to reasonably assure that the insurer will be able to pay claims. For small losses these latter costs may be many times the size of the expected cost of losses. There is little point in paying such costs unless the protection offered has genuine value to a buyer.

5. Affordable Premium

If the probability of an insured event is so high, or the cost of the event so large, that the resulting premium is large relative to the amount of protection offered, it is not likely that anyone can buy insurance, even if on offer. Further, as the accounting profession formally identifies in financial accounting standards, the premium cannot be so big that there is not a reasonable chance of a significant loss to the insurer. If there is no such chance of loss, the transaction may have the form of insurance, but not the substance. There are two elements that should be at least estimable, if not formally assessable: the probability of loss, and the attendant cost. Probability of loss is normally an empirical exercise, while cost has more to do with the ability of a reasonable person in possession of a copy of the insurance policy and a proof of loss coupled with a claim presented under that policy to make a reasonably definite and objective evaluation of the amount of the loss recoverable as a result of the claim.

6. Limited risk of catastrophically large losses

The crucial risk is often aggregation. If the same event can cause losses to many policyholders of the same insurer, the ability of that insurer to issue policies becomes constrained, not by factors surrounding the individual distinctiveness of a given policyholder, but by the factors surrounding the sum of all policyholders so exposed. Normally, insurers prefer to limit their exposure to a loss from a single incident to some small portion of their capital base. Where the loss can be aggregated, or an individual policy could produce remarkably large claims, the capital constraint will limit an insurer's appetite for additional policyholders.


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