Insurance is not a new protection mechanism; in fact, it is one of the oldest known commercial institutions.
Insurance has been developing for hundreds of years as a consequence of the search for security against any unforeseen event.
This has allowed the insurance business to mature and expand to what it is today, a key guarantee in the functioning of industry and commerce throughout the world. Its principles are, therefore, well established and guarantee its proper functioning.
Principle of human solidarity
Insurance is based on sharing damage among a very large number of people who are threatened by the same hazard and who respond to it in a solidarity-based manner.
By paying an insurance premium, the insurer guarantees to protect people and property against damage caused by the occurrence of a specific situation (for example, a traffic accident), or a certain circumstance (for example, reaching retirement age).
The insurer receives premiums from a number of people who insure themselves against the same situation; therefore, when a foreseen circumstance occurs, all the people who have paid the premium contribute to the solution to the problem affecting the person concerned.
The “social effectiveness” of insurance lies in:
- The collection of premiums: it makes it possible to raise significant funds that contribute to generating a country’s wealth.
- Indemnities: these enable a person, as far as possible, to recover the way of life they had before suffering an accidental loss.
The payment of the premium guarantees the receipt of compensation (indemnity) when the event against which the insurance contract protects the policyholder occurs, in accordance with the characteristics of that contract. Therefore, insurance is an indemnifying activity.
The purpose of indemnity is to restore the policyholder to the initial situation. In other words, by paying an insurance premium one buys a promise, a future benefit.
This means that insurance is not a material product, it only materializes when the loss occurs, but the indemnity guarantee always exists, it is there from the first day the insurance comes into force.
When an individual pays an insurance premium, they do not receive anything material in return; what they receive is a commitment to future service at the time when the situation established in the contract occurs. For this reason, insurance activity is fundamentally a service activity.
In turn, the insurance business uses many other professional services, such as, for example, repairers, doctors, lawyers, experts, drivers, consultants, and so on.
For example, a person who takes out a health insurance policy will receive medical care when needed: a check-up, a diagnosis, a surgical operation, among other things.
Or a person who takes out a car insurance policy that includes travel assistance or replacement vehicle coverage will receive these services if necessary.
Economic and financial activity
Insurance activity is an economic and financial activity:
- The insurer receives premiums from a number of people who are insured for the same situation; therefore, when a circumstance foreseen in the policy occurs, all the people who have paid the premium contribute to resolving the problem of the affected party.
- It achieves a capital redistribution, that is to say, it uses the financial resources generated by all the policyholders in those situations of individual need.
- It invests its funds, under legal control, to obtain profits, improve policyholder benefits and become stronger as a company. Some of the insurance company’s commitments are long-term (e.g., to provide retirement income) and it will have to make appropriate investments to pay the benefit in the future.
It is very important to emphasize that the insurance company cannot just make investments however it wishes; it must comply with a series of legal requirements in order to guarantee its commitments and, in addition, its operations are subject to control by government agencies.