Working of Insurance

Don't how insurance works let us see the working of insurance practically with examples:

Consider the first situation:

In a village there are 400 houses, each valued at Rs.20,000. Every year on an average, 4 houses get burnt, resulting into a total loss of Rs. 80,000. If all the 400 owners come together and contribute Rs.200 each, the common fund would be Rs.80,000. This would be enough to pay Rs.20,000 to each of 4 owners who houses got burnt. Thus the loss of Rs.20,000 each of 4 owners is shared by 400 house-owners of the village bearing Rs.200 each. This works out to 1% of the value of the house, which is the same as the probability of risk(4 out of 400 houses).

Consider the second situation:

There are 1000 persons who are all aged 50 and are healthy. It is expected that, on an average, 1% of persons aed 50, or 10 persons, may die within one year. If the economic value of the loss suffered by the family of each dying person is teken to be Rs.20,000.If eac person in the group contributed Rs.200, the common fund would be Rs.2,00,000.This would be enough to pay Rs.20,000 to the family of each of the ten persons who die. Thus, the risks are shared by 1000 persons, although 990 of them did not suffer any loss.

In the first example, assume that are 400 houses but of different values. In that case, the contribution of each house owner would be 1% of the value of the house. If the assumption was that 8(2%) out of 400 houses are likely to get damaged, the contribution would be 2%(probability of risk) of the value for each house. The probability of risk does not depend on the value of the house. The probability of risk would depend on factors like the nature of construction of the house(concrete or thatch work) or the location in which it is(residential,commercial or industrial area).The risk is measured in terms of percentages and the contribution would be that same percentage.Similarly in the case of human beings, the probability of risk(death or disablity)will vary according to age,profession,life styles and habits,health conditions,heredity etc.

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