Understanding Insurance

The primary function of insurance is a risk transfer mechanism (risk transfer mechanism), which can transfer one party (the insured) to another party (the insurer).  Risk aversion is by no means eliminates the possibility of evil, but the insurer for financial security (financial security) and peace (peace of mind) to the insured. In return, the insured pays the premium in a very small number compared to the potential losses that may be suffered (Morton, 1999).

Basically, an insurance policy is a contract that is a valid contract between the insurer (in this case, the insurance company) with the insured, the insurer was willing to bear losses that may occur in the future payment (premium) an insured individual.

According to the law no. 2 of 1992, which refers to the insurance or coverage is an agreement between two or more parties in which the parties are committed to the insured, by accepting the insurance premiums for the reimbursement to the insured in case of loss, damage or loss of anticipated profits, or legal obligation third parties which may be suffered by the insured arising out of uncertain events or to provide based on the life or death of an insured person payment.

For a potential loss (which can happen) can be assured (insured) then it must have the following characteristics:

1. Loss of uncertainty,

2. The losses should be limited,

3. Loss must be meaningful,

4. The loss ratio can be predictable and

5. The loss is not catastrophic (catastrophe) for the insurer.

The question is, death is a sure thing, why be insured ?.

Even if it's something that contains certainty, but when exactly when someone's death is beyond the control of that person. So that when the time of death actually contain uncertainty is what causes insurable.

There are two forms of contract in determining the amount of the payment at maturity of insurance, namely: Value of the contract (contract value) and the compensation contract (contract of indemnity).

1. Value of the contract is an agreement by which the payment amount has been determined in advance. For example, the value of the sum insured (UP) in life insurance.

2. Contract of indemnity is based on the amount of help number of actual financial loss agreement. For example, the cost of hospital care.

In the case of insurance companies trying to remove the possibility of loss / fatal wide, so it can transfer the risk to another insurance company. This is called reinsurance companies that accept reinsurers appointed.

In addition to the five characteristics above, before it can be insured, the insurance company must take account of insurable interest and anti-selection. Insurable interest in the relationship between the insured and the beneficiary of compensation / benefits - in terms of potential loss. Thus, the insurance company will not sell fire insurance policy to parties other than the owner of the building is provided.

Insurable interest in this example is the property of an eye something that is insured. Similarly, family relationships, financial ties are unjustified, is also a form of insurable interest. The definition of anti-selection (against the selection) refers to the existence of a greater tendency to take insurance because it has a higher level of average risk. Example, people who have a record of poor health risk dangerous jobs or tend to want to buy insurance.

To reduce adverse selection effect, the insurance company should be able to identify and classify risks and potential losses. The identification and classification of the level of risk process is called underwriting or risk selection. But that does not mean anti-selection led to the filing of insurance was denied, because the risk of loss to the insured than the average premiums may be (special bonus) subtype due to sub-standard risk (specific) risk unless the risk of loss is much higher, perhaps the insurance proposal was rejected.

Keyword: understanding, insurance, understanding insurance.

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