Section 2　The concept of insurance

2.1　The meaning of insurance

Insurance can be defined as the “term used to refer to a commercial insurance transaction whereby an insurance applicant, as contracted, pays insurance premiums to the insurer, and the insurer bears an obligation to indemnify for property loss or damage caused by an occurrence of a possible event that is agreed upon in the contract, or to pay the insurance benefits when the insured person dies, is injured or disabled, suffers diseases or reaches the age or term agreed upon in the contract.”10 In simple words, an applicant or an insured pays the premiums to the insurance company; the insurer bears the liability to pay the claims or give the benefit under the terms of the insurance policy.

2.2　The function of insurance

2.2.1　Primary functions

2.2.1.1　Risk transfer

The basic function of insurance is risk transfer. If someone has bought a new energy car with ￥200 000 yuan. The car possibly could be stolen, damaged in an accident because of pileup by another car behind on the expressway, resulting in a serious injury to passengers and other people on the road. Sometimes the car may catch a fire, etc. How will the owner of the car cope with all of these potential risks and their financial loss? We know that the owner of the car can transfer the financial loss to the insurer, by paying premiums.

2.2.1.2　Financial indemnity and insurance benefit

Another function of insurance is to provide financial indemnity and insurance benefit.11 In property insurance, when a subject-matter of insurance is damaged and the loss occurs, the insurer will provide indemnity for the insured under the insurance contract. In life insurance, when an insured person dies, suffer diseases, is disabled or reaches the age under the life contract, then the insurer will give insurance benefit to insured person or his beneficiary.

2.2.1.3　Creation of the common pool

In order to explain the common pool, let us focus on the risk of the owner of a private car being totally stolen by a certain thief. If this happen once in a thousand chance during a year, it has no great value that one car will be stolen in every thousand cars. But if a large number of cars will be stolen, it really begins to mean something. For example, if there were one thousand similar cars, then we could say that one of the thousand cars will possibly be stolen during a year. On average, therefore, the expected total loss would be ￥200 000 yuan. According the calculation, the owners of one thousand cars could all put at least ￥200 yuan into the common pool and therefore there would be enough to pay the car being stolen.

The insurance company receives the insured's premiums and puts them into the pool for different types of risk. They collect premiums from all individuals, administrative units, enterprises, schools and hospitals, etc. They pay the claims and spread the costs of the few losses among all the policyholders.12 The insurance company collect premiums from all the insureds and pay the losses of the few out of the pool. If the pool is very large, it can meet the total losses in any one-year and there are much cash surplus. Even after we take all these operating costs into accounts, insurance companies are still one of the money-making business in the world.13

2.2.1.4　Equitable premiums

We all know that there are several kinds of these pools, each one for each type of risk. A person who has a house to insure would contribute to the house pool, not for the car pool. When the insurance companies operate in this way, they can identify which types of insurance are profitable or non-profitable.

Even when risks of a similar type are brought together in a common pool, they do not all represent the same degree of risk to the pool itself. So the insurance company has to ensure that a fair premium is charged, which reflects the hazard and the value which the policyholders bring to the pool. Besides, the premium must also be competitive. There are so many insurance companies in the market place and hence competition enters into the calculation. If an insurance company charges a premium that exceeds the one quoted by other insurance companies, then he may lose the business. If he charges too little, the contribution to the pool would be less than required and deficit would be made.

The three functions are all interest-dependent. Insurance can provide risk transfer mechanism by means of a common pool and each insured pays an equitable premium.

2.2.2　Subsidiary functions

2.2.2.1　Loss prevention

When risks are proposed to an insurance company, they will carry out a survey in order to assess the degree of risk. They make recommendations as to reduce the possibility of the occurrence of loss. Preventing disasters and losses is the important aspect in the risk management. The insurance itself is also the important aspect of risk management. Insurer plays an active role in participating in the work of preventing disasters and losses with other related departments.

2.2.2.2　Investment of funds

When an insurance premium is received and put into the fund, claims will arise from a few weeks or months until several years. The insurer can make full use of the idle fund to invest in order to gain the best overall return. The insurer can use the fund to buy government security, stock, money market fund or invest it in the real estate.

2.3　The role of insurance

First of all, insurance can ensure the society to carry out the reproduction. By insurance, the risk can be transferred and the social reproduction can be ensured. Secondary, insurance can guarantee the insured to enjoy his financial interest. As long as the insured has taken out insurance, he can get financial indemnity or insurance benefits from insurance company if the damages or losses or injuries are covered by insurance policy. Thirdly, insurance can bring the stability to the society. When a disaster or accident happens, perhaps it will cause damages or losses to property and injuries or death to people. Insurer tries his best to pay claims to individuals or business units and protects their normal life. Therefore insurance stabilizes the society.