Insurance companies perform important functions as financial intermediaries and they collect and invest large amounts of premiums. They offer protection to the investors, provide means for accumulating savings, and invest funds in the government and other sectors.
They compensate the individuals and the policyholder if a pre-specified event occurs in exchange for the remaining amount paid, Insurance companies have developed into an integral part of the economic development of every country.
The functions of insurance are as follows:
a. The insurance company turns the loss of uncertainties into certainty by taking premiums from persons or institutions to compensate in case of events occurring.
b. The insurance companies provide protection taking the burden of compensation for the loss that may take place at any time by spreading risk among themselves.
c. Insurance companies provide a scheme of distributing risks among the persons or institutions that are engaged in the insurance risk-sharing business.
d. Insurance companies are financial intermediaries as they collect a small amount of money in the form of premiums from various persons and organizations and they invest the capital and utilize it in different productive sectors of the country in combining both aspects of protection and investment.
Basic functions of Insurance:
a. Collecting premiums:
The basic function of an insurance company is to collect premiums sufficient to cover the interest of the risk in the life and properties of the persons. Premium is charged not on an ad-hoc basis but on proper estimate and following of the details. Insurance cannot be done without collecting premium otherwise it will be declared legally invalid.
b. Distributing risks:
The other significant function of insurance lies in the distribution of risks to minimize the burden on the value and content of risk. Insurance companies usually follow the diversification of risks through appropriate risk-sharing devices because of their connections with leading reinsurance companies in the world. In our country, insurance companies are able to diversify risks in cases value insured is greater than the worth of assets they hold.
c. Compensate against risks of loss:
Insurance companies have an important function to compensate for the losses incurred as a result of risks that occur. The claims made are evaluated and compensation is provided through proper investigation of the events that have occurred.
d. Providing benefits to society:
Insurance companies are the most important type of contractual savings institutions. In general insurance companies benefit society by bearing risk from parties who wish to avert risk by transferring it to the insurance companies. The society seeking to transfer the risk pays an insurance premium to the insurance company.
e. Insurance companies pay the insured amount if the event occurs:
For example, people buy life insurance to protect the risk of lives. If a person earning Rs. 100,000 per~year and agrees to pay Rs.3000-per year and if the event occurs, the insurance company has to pay the whole of the insured amount agreed to say the policy amount is Rs. 500,000. If the person survives the year, the premium is a net expense, but if the person dies, the rest of his families such as his wife, children, father, and mother can continue to enjoy the lifestyle.
f. Insurance companies significantly reduce risk:
Insurance companies offer, in various degrees, a valuable combination of protection and investment. However, many people feel that the element of protection and investment should not be combined in one contract.
The rate of return on that part of the premium, which represents an investment commitment, is substantially below that which an individual would have secured better investment opportunities and return. Therefore, insurance companies are an effective set of institutions to manage risk and provide a valuable service to society.
g. Providing protection:
Insurance companies have a basic function to provide protection against risks of losses to save the people from facing serious financial disasters. The function of insurance is to put the people to its usual status Without effect on their financial position. Invest in a portfolio of assets. Insurance companies provide not only elements of protection against risks but also the element of ample scape for the portfolio of assets.
h. Acting as an effective financial intermediaries:
insurance companies have been investing in various securities to earn more for providing higher returns to policyholders. They have adequate study and analysis to choose high yield portfolios.
i. Utilize funds in productive assets:
Insurance companies have another significant function to perform in diverting their investible funds to finance in turnkey projects to help in enhancing productive assets of the economy. They act as the engine of economic growth as they support various development projects having long-term beneficial implications.
j. Matching risk and return:
Insurance companies have dual functions to perform as they diversify. risk on one hand and enhance return on the other hand. They make appropriate trade-offs between risk and return. So the funds are made available whenever risks occur as well as returns are accumulated With adequate investible funds to increase further return.
Risk is defined as the possibility of suffering some form of loss or damage. It IS the chance of an unfavorable event. Insurance companies are ready to accept the risk of the individual. The important function of insurance companies is to diversify the risk over a large number of persons who have agreed to co-operate with each other at the time of loss.
Hence, insurance companies accept risk from parties who wish to avert risk by transferring it to the insurance companies. The party seeking to transfer the risk pays an insurance premium to the insurance company as compensation to match risk with protection. Insurance companies have used funds to construct the well-diversified portfolios.
Basically, much of their investment in corporate bonds, government securities, common stocks and loans and then the risk of the portfolio are significantly lower. To formalize these ideas, we use the concepts of risk and return introduced.