Definition of Insurance

Insurance is a contractual agreement between an individual (or business) and an insurance

company, where the insurer provides financial protection against specified risks in exchange for
a premium. It helps individuals and businesses recover from unexpected losses such as
accidents, illness, death, or property damage.

An insurance contract is a legal agreement between the policyholder (the insured) and the
insurer (the insurance company), where the insurer agrees to provide financial protection against
certain risks in exchange for a premium.

Basic terminologies:

1. General Terms

 Insurance: A contract where an insurer provides financial protection or reimbursement

to the insured against losses.
 Insurer: the Company providing insurance coverage.
 Insured: The person or entity covered by the insurance policy.
 Policyholder: The individual or entity that owns the insurance policy.
 Premium: The amount paid by the insured to the insurer for coverage.
 Underwriting: The process of evaluating risks and determining the premium.
 Actuary: A professional who assesses risks and determines insurance pricing using
statistical methods.

2. Types of Insurance

 Life Insurance: Provides financial benefits to beneficiaries after the policyholder’s

death.
 Health Insurance: Covers medical expenses for illnesses, surgeries, or hospital stays.
 Auto Insurance: Covers damages or liabilities related to vehicles.
 Home Insurance: Protects against damage or loss to a home due to disasters or theft.
 Liability Insurance: Covers legal liabilities for damages caused to others.
 Reinsurance: When an insurance company transfers part of its risk to another insurer.

3. Policy-Related Terms

 Policy: The contract outlining terms, coverage, and conditions of insurance.

 Coverage: The amount and type of protection provided by the insurance policy.
 Deductible: The amount the insured must pay out of pocket before the insurer covers the
remaining costs.
 Sum Assured: The maximum amount payable under a life insurance policy.
  Exclusions: Specific conditions or events not covered by the policy.
 Endorsement (Rider): An addition or modification to an existing policy.

4. Claims & Benefits

 Claim: A request by the policyholder for the insurer to cover a loss.

 Claim Settlement: The process of paying out a claim by the insurer.
 Beneficiary: The person or entity that receives benefits from an insurance policy.
 Grace Period: A short period after a missed premium payment where coverage remains
active.
 Lapse: When a policy is terminated due to non-payment of premiums.
 Surrender Value: The amount the policyholder gets if they cancel a life insurance policy
before maturity.

5. Risk & Legal Aspects

 Risk: The uncertainty of loss or damage.

 Moral Hazard: The tendency of the insured to take higher risks because they are
covered.
 Adverse Selection: When high-risk individuals buy insurance more than low-risk
individuals.
 Insurable Interest: The insured must have a financial stake in what is insured.
 Subrogation: The right of an insurer to recover the amount paid from a third party
responsible for the loss.
 Indemnity: Ensures that an insured person is restored to the same financial position

Reinsurance: Definition & Explanation

Reinsurance is the process by which an insurance company transfers part of its risk to another
insurer (called a reinsurer) to protect itself from large financial losses. It helps insurance
companies manage risk, stabilize profits, and ensure financial security in case of high claims

Example of Reinsurance in Action

 A home insurance company has issued policies worth $500 million.

 A major hurricane causes losses of $200 million.
 If the company has reinsurance covering 50% of losses over $100 million, the reinsurer
will pay:
o 50% of ($200M - $100M) = $50M, reducing the insurer’s burden.

Double insurance: occurs when the same asset or property is insured under two or more
policies with different insurers, covering the same risk or loss.
Example:

 A homeowner insures their house for $300,000 with Insurer A and for $200,000 with
Insurer B. If the house suffers $400,000 in damages, the insurers will share the payout
based on the proportion of their coverage (i.e., Insurer A pays 60% and Insurer B pays
40%).

Functions of Insurance

The functions of insurance can be studied into two parts. Such as follows:

A. Primary Functions, and

B. Secondary Functions

A. Primary Functions: The primary functions of insurance are as follows:

i) Insurance provides Certainty: Insurance provides certainty of payment at the certainty of

loss. The uncertainty of loss can be reduced by better planning and administration. Insurance
removes all these uncertainty and the assured is given certainty of payment of loss. The insurer
charges premium for providing the said certainty.

ii) Insurance provides Protection: The main function of the insurance is to provide protection
against the probable chances of loss. The time and amount of loss are uncertain are at the
happening of risk, the person will suffer loss in absence of insurance. The insurance guarantees
the payment of loss and thus protects the assured from sufferings.

iii) Risk-Sharing: The risk is uncertain, and therefore, the loss arising from the risk is also
uncertain. When risk takes place, the loss is shared by all the persons who are exposed to the
risk.

B. Secondary Functions: Besides the above primary functions the insurance works for the
following functions:

i) Prevention of Loss: The insurance joins hands with those institutions which are engaged in
preventing the losses of the society because the reduction in loss causes lesser payment to the
assured and so more saving is possible which will assist in reducing the premium.

(ii) Insurance provides Capital: The insurance provides capital to the society. The accumulated
funds are invested in productive channel. The death of capital of the society is minimized to a
greater extent with the help of investment of insurance. The industry, the business, and the
individual are benefited by the investment and loans of the insurers.

iii) Insurance improves Efficiency: The insurance eliminates worries and miseries of losses at
death and destruction of property. The carefree person can devote his body and soul together for
better achievement. It improves not only his efficiency, but the efficiencies of the masses are also
advanced.

iv) Insurance helps Economic Progress: The insurance by protecting the society from huge
losses of damage, destruction and death, provides an initiative to work hard for the betterment of
the masses. The next factor of economic progress, the capital, is also immensely provided by the
masses. The property, the valuable assets, the man, the machine and

Elements of an Insurance Contract:

1. Agreement (Offer & Acceptance) – A policyholder applies (offer), and the insurer
approves (acceptance).
2. Consideration – The insured pays a premium, and the insurer provides coverage.
3. Legal Capacity – Both parties must be legally competent to enter the contract.
4. Insurable Interest – The policyholder must have a financial stake in the insured subject.
5. Utmost Good Faith – Both parties must disclose all material facts honestly.
6. Indemnity Principle – The insured is compensated only for the actual financial loss
suffered, preventing any possibility of making a profit from an insurance claim. (except
life insurance)
7. Subrogation – The insurer has the right to recover the amount paid to the insured from a
third party who caused the loss.
8. Proximate Cause – Proximate cause refers to the direct cause that sets in motion a chain
of events leading to a loss, which is covered by the insurance policy. It is the primary
cause of damage, without which the loss would not have occurred. The insurer covers
only losses directly caused by covered risks.
9. Loss Minimization – The insured must take reasonable steps to prevent losses.

Principles of Insurance

1. Disclosure of materials.

2. Insurable interest.

3. Principle of indemnity.
 4. Principle of subrogation.

1. Disclosure of materials: There are two parties involved in insurance contract. These are
Insured and Insurer. Before entering into the insurance contract both parties have the
responsibilities to disclose all information relating to the insurance contract. A material fact is
one which affects the judgment or decision of both parties in entering into the contract. You may
or may not enter into the contract. Insured and insurer are both the same responsibilities relating
to the insurance contract. Here one party is reliable to another party hundred percent. This is also
known as utmost good faith.

2. Insurable Interest: Insurable interest is the financial or emotional stake a person has in the
subject of an insurance policy, such that they stand to suffer a financial loss if the insured event
occurs. Without insurable interest, an insurance contract is considered void.

Example:

 A business owner has an insurable interest in their company’s building because if it

were destroyed, they would face a financial loss due to the damage.
 A parent has an insurable interest in the life of their child, as the child’s death could
result in emotional and financial hardship.

Existing of insurable interest is different in different types of insurance.

a) Life Insurance: Insurable interest should be present when you take the policy.

b) Marine Insurance: Insurable interest should be present when you make the claim.

c) Fire Insurance: Insurable interest should be present when you take the policy and make
the claim.

3. Principle of Indemnity: Insurable contract is a contract of indemnity. Insurance will never

allow making any profit but insurance will simply to make good the loss. Two terms are
important here.

a) Over Insurance, and

 b) Under Insurance.

a) Over Insurance: Over insurance occurs when the insurance coverage on an asset or property
exceeds its actual value or the financial loss that could occur, leading to the potential for
excessive compensation in case of a claim.

Example: A person insures their house for $500,000, but the actual market value is only
$350,000. If the house is damaged, the insurer will only pay the actual loss, not the $500,000.

b) Under Insurance: Under insurance occurs when the insurance coverage on an asset or
property is less than its actual value, meaning the insured amount is insufficient to cover the
full financial loss in the event of a claim.

Example: A property is worth $500,000, but the owner insures it for only $300,000. If the
property is damaged and the loss is $200,000, the insurer may only pay $120,000 (60% of the
loss, based on the proportion of insured value).

4. Principle of Subrogation: Subrogation is the legal principle that allows an insurer who has
paid a claim to the insured to step into the shoes of the insured and pursue recovery from a
third party responsible for the loss or damage. The insurer has the right to recover the amount
paid to the insured from a third party who caused the loss.

Example:

 If an insured's car is damaged in an accident caused by another driver, the insurer pays
for the repairs.
 Through subrogation, the insurer can then seek recovery from the at-fault driver's
insurance company or the driver themselves.

Legal Obligation – The contract must comply with applicable insurance laws.

Types & Nature of Insurance Business in Bangladesh

On the basis of nature insurance business in Bangladesh is of the following types.

 Life Insurance
 General Insurance
Life Insurance:
Life insurance is different form of insurance in the sense that, here, the subject matter of
insurance is life of human being. The insurer will pay the fixed amount of Insurance at the time
of death or at the expiry of certain period. At present life insurance enjoys maximum scope
because the life is the most important property or an individual. The insurance is not only a
protection but is a short investment because a certain sum is returnable to the insured at the death
or at the time of expiry of the contract. In the primitive age of insurance, life insurance virtually
had not any scientific basis.
General Insurance:
General insurance is a form of insurance where, the subject matter of insurance is the property of
individual human being or the society. The insurer will pay nothing the fixed amount of
insurance at the time of the expiry of certain period if there is nothing happened to the subjected
property. However, if there is any loss occurred to the property then, after proper evaluation of
the loss insurance company pays the whole amount if the loss is less than the sum of the insure
amount. If the loss is much higher than that then, the company will pay the whole amount of the
sum insured. At present general insurance enjoys maximum scope because the social & business
properties are the most important fact to the development of the country's commerce & industry.
In the primitive age of insurance, general insurance virtually had the scientific basis.

Types of Policies Offered by the Insurance companies

There are different types of policies offered to the market by the insurance companies in our
country. The policies offered are discussed in the following lines:
General Insurance:
In the general insurance practice, which is more common in the business world the policies
offered can be presented as under three different categories:
 Marine Insurance- primarily provides financial protection to the ship owners, cargo
owners or he freight owners in respect of any loss or damage to their interest caused
by maritime perils.
 Fire Insurance- Financial protection to the insured in respect of loss or damage
sustained by him to his property caused by fire or other named perils.

Life Insurance:
Life insurance has the maximum scope of selling policies to the market. The different types of
policies under life insurance have been shown in details in next chapter.
Role and importance of Insurance:

1. Ensures Financial Security – Protects individuals and businesses from financial shocks.
2. Encourages Investment – Insurance companies invest in financial markets and
infrastructure.
3. Protects Wealth – Safeguards assets from unforeseen risks.
4. Economic Stability – Supports businesses and individuals in financial crises.
5. Encourages Savings – Life insurance promotes disciplined saving
6. Reduces Uncertainty – Provides peace of mind to policyholders.
7. Aids in Crisis Recovery – Helps rebuild lives after disasters and losses.
8. Boosts Economic Growth – Contributes to national development.
9. Provides Health Coverage – Reduces medical expenses and improves access to
healthcare.
10. Facilitates International Trade – Marine and cargo insurance protect global
transactions.
11. Enhances Social Welfare – Supports families through life and pension plans.
12. Encourages Entrepreneurship – Allows business expansion with risk mitigation
13. Employment Generation – Creates jobs in the insurance and finance sectors.