Useful functions of insurance

Insurance performs three useful functions:

a) Pooling of risks. Each policyholder pays a small premium into a pool, to be used to pay for the losses suffered by a some policyholders and the expenses of operating the pool.

b) Settlement of claims. The insurance company is experienced in handling the settlement of claims on behalf of the policyholders.

c) Loss control measures. The insurance company can advise the policyholders on measures to reduce the occurence of losses and their severity.

For these valuable functions, the policyholders are willing to pay a fair loading (of up to 35%) over the cost of claims to buy the insurance.

For example, if the average share of the claim per policyholder is $300, the policyholder is usually willing to pay $400 to buy the insurance. This allows $100 to be used to pay the expenses of operating the pool, including the useful services of claim settlement and loss control.

If the loading is more than 35% of the amount of claim, many people will find the insurance to be too costly and will prefer to be un-insured. This benchmark applies to motor, medical, fire and accident insurance.

In the case of life insurance, a different benchmark applies.