Explained: What is insurance?.

resr 5paisa Research Team

Last Updated: 15th December 2022 - 07:08 pm

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One of the important components of financial planning is insurance planning as it safeguards an individual financially in case of an unfortunate mishap.

Presently, financial planning has become an essential component of every individual’s life with an increase in spending habits and fulfil various needs and goals. Along with fulfilling the needs and objectives of an individual, it's important for him to protect himself against any financial uncertainty. So the question arises, how to protect ourselves and our family from financial uncertainty? The simple answer to this question is by purchasing insurance. One can transfer his risks to insurance companies. Unfortunate mishaps are unavoidable but financial stress can be avoided by purchasing adequate insurance.

The forces that threaten financial well-being such as untimely death, getting injured in an accident or getting trapped in legal liability; all of these come with great financial stress on an individual and his family. So, insurance companies cover an individual financially in case of such mishaps. It shifts the risk from an individual to a group.

There are two types of insurance companies – Life insurance companies and General insurance companies. The risk covered by each of them is different. Life insurance companies cover the life of an individual whereas, general insurance covers an individual against property, professional liability, car, etc.

An individual who decides to purchase insurance should be aware that insurance policies are based on the law of contracts. Each insurance contract must meet the following essential requirements:

  • Offer and Acceptance: As a legal contract, there must be an offer and acceptance of its terms. In insurance contracts, the person seeking the insurance makes the offer and the insurance company is the one who accepts or declines the offer.

  • Consideration: Consideration is the value that each party to the contract provides to the other. The consideration for the policyholder is premium payments and the agreement to abide by the terms of the policy. For insurance, company consideration is the promise to make payment of the sum insured on the occurrence of a specified event.

  • Competent parties: Each party to the insurance contract must be legally competent to enter into a contract. For the policyholder, this means that he should be an adult of sound mind. For the insurance company, this means it must have a valid license to do insurance business.

  • Common intention: Parties to the contract are said to have a common intention when they understand the same thing in the same manner at the same time.

  • Legality of purpose:  The purpose of the insurance contract should be legal. For instance, a terrorist cannot insure his weapons against theft.

Distinct characteristics of an insurance contract are as follows:

  • Aleatory Contract: Aleatory contracts are those where the value exchanged is not equal but depends on an uncertain event.

  • Unilateral Contracts: Unilateral contracts are those in which only one party makes a legally enforceable promise.

  • Conditional Contracts: Conditional contracts are those which place certain restrictions or limitations on one or both parties.

  • Personal Contracts: An insurance contract is a personal contract. This means that the policy is personal to the policyholder.

  • Contracts of Adhesion: Contracts of adhesion are those that must be accepted in total.

One might not think of an insurance policy as a contract. But in the eyes of law, it is very much a commercial contract so in case of default by any of the parties, action can take place against the defaulter. The insurance policy is a legal document and though it's legal in nature, insurance is also a bond of trust- trust that the policyholder places on the insurance company. Trust that when things go wrong, the insurance company will come and help the policyholder from financial stress and pressure.

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