Primary and Secondary Functions of Insurance with Real-Life Examples
The functions of insurance are essential for understanding how individuals and businesses manage risk. This topic is frequently asked in Commerce board and competitive exams. Knowing the functions of insurance helps with exam scores, financial planning, and making real-world decisions in personal and business life.
| Function of Insurance | Explanation | Example |
|---|---|---|
| Financial Protection | Provides money to policyholder after an insured loss | Health insurance covers hospital bills after an accident |
| Risk Transfer | Shifts risk from insured to insurance company | Fire insurance transfers the risk of fire from owner to insurer |
| Risk Pooling | Collects premiums from many to pay losses of a few | Car insurance pools premium from all car owners to pay for those who have accidents |
| Certainty | Offers peace of mind by reducing financial uncertainty | A business owner is assured of business continuity after loss |
| Encourages Savings | Promotes regular saving through life and endowment policies | Life insurance matures to provide funds for children’s education |
| Legal Compliance | Fulfils statutory or legal insurance requirements | Third-party motor insurance required by law |
Definition of Insurance
Insurance is a legal contract between an insurance company (insurer) and an individual or business (insured). The insured pays a fixed amount (premium) to the insurer, who promises compensation if a specified risk or loss occurs. The core idea is to provide financial security and peace of mind by managing uncertainty.
Primary Functions of Insurance
Insurance has several primary functions that address direct needs for financial security, loss compensation, and risk management. These functions are vital for both exam preparation and practical understanding.
- Provides Financial Protection—compensates the insured against covered losses.
- Transfers Risk—moves risk from policyholder to insurer for a premium.
- Pools Risk—collects small premiums from many to cover large losses for few.
- Ensures Certainty—offers assurance about dealing with future risks and losses.
Example of Primary Functions
If a shopkeeper buys fire insurance and fire damages the shop, the insurance company pays for the loss. This shows financial protection, risk transfer, and risk pooling working together.
Secondary Functions of Insurance
Apart from the main functions, insurance also serves important secondary roles that benefit individuals, businesses, and the economy.
- Promotes Regular Savings—life and endowment policies build habits of saving.
- Supports Investment and Economic Growth—funds collected by insurers are invested in the economy.
- Helps with Business Continuity—insurance helps businesses recover and restart after losses.
- Meets Legal and Social Requirements—fulfils statutory rules (like vehicle insurance) and protects employees and families.
Role of Agents and Regulators in Insurance
Insurance agents help customers select policies and assist through the claim process. Regulators like IRDAI (Insurance Regulatory and Development Authority of India) set rules, protect customer interests, and ensure company practices are ethical. The insurance ombudsman addresses customer complaints fairly.
Examples and Use Cases of Insurance Functions
| Use Case | Insurance Function at Work |
|---|---|
| Life insurance for a family’s breadwinner | Financial security on policyholder’s death; encourages savings |
| Third-party motor insurance for car owners | Legal compliance; risk transfer for damages to others |
| Fire insurance for factories | Risk pooling, risk transfer, supports business recovery after fire |
| Health insurance for employees | Provides financial certainty; helps employee wellbeing |
Why Learning the Functions of Insurance Matters
Understanding the functions of insurance helps in exams, everyday financial planning, and business management. It supports protections against uncertainty, fosters savings, ensures legal compliance, and strengthens economic stability. At Vedantu, we make such Commerce concepts easier for self-study and quick revision.
For deeper insights into risk concepts, students can also refer to Business Risk, and for the foundational rules follow Principles of Insurance. To see practical use in the financial sector, read about Financial Institutions in India (ICICI).
Summary
The functions of insurance include providing financial protection, transferring and pooling risk, ensuring certainty, and encouraging savings. Secondary roles add economic and social benefits. These concepts help students with exams, business understanding, and daily financial planning. Mastering this topic builds confidence for all major Commerce studies.
FAQs on Functions of Insurance: Meaning, Types, and Examples
1. What are the main functions of insurance?
Insurance primarily provides financial protection against unforeseen losses. Its core functions include risk transfer, risk pooling, and offering certainty. These functions ensure individuals and businesses can mitigate financial impact from unexpected events.
2. What are the primary and secondary functions of insurance?
The primary functions of insurance focus on managing risk: risk transfer, risk pooling, providing financial protection, and establishing certainty. Secondary functions relate to broader economic and social impacts, such as encouraging savings, promoting investment, stimulating economic growth, and fulfilling legal requirements.
3. How does insurance provide financial protection?
Insurance offers financial protection by compensating for losses covered by the policy. When an insured event occurs (like an accident or illness), the insurance company pays a pre-determined amount (claim) to the policyholder, reducing the financial burden. This protection promotes stability and reduces risk.
4. What is the role of an insurance agent?
An insurance agent acts as an intermediary between insurance companies and potential customers. Their key roles include:
- Explaining insurance policies
- Helping clients choose suitable plans
- Processing applications
- Assisting with claims.
5. Which law regulates insurance in India?
In India, the Insurance Regulatory and Development Authority of India (IRDAI) is the primary regulatory body overseeing the insurance sector. The IRDAI sets standards, licenses insurers, and ensures fair practices within the industry, protecting policyholders' rights.
6. What are the functions of insurance banks?
Insurance banks offer a range of financial services combining banking and insurance products. Their functions often include:
- Providing banking services such as deposits and loans
- Offering various insurance products (life, health, etc.)
- Managing risk through insurance products
- Offering integrated financial solutions.
7. What are the 7 characteristics of insurance?
The characteristics of insurance are numerous. Key characteristics include:
- Pooling of risks
- Payment of premiums
- Risk transfer
- Contractual agreement
- Large number of similar risks
- Indemnity
- Utmost good faith.
8. What are the two functions of life insurance?
Life insurance primarily serves two functions:
- Providing financial security to dependents in case of the insured person's death.
- Creating a savings/investment vehicle through policies that accumulate cash value.
9. How does pooling of risk work in insurance contracts?
Risk pooling is a fundamental principle of insurance. It involves spreading risk among a large group of policyholders. Premiums collected from many individuals are used to pay claims for those who experience insured losses. This diversification reduces the financial impact on any single person or entity.
10. In what ways does insurance enhance economic development?
Insurance significantly contributes to economic development by:
- Providing financial stability for individuals and businesses, enabling investment and growth.
- Facilitating risk-taking and innovation, promoting entrepreneurial activity.
- Reducing economic uncertainty and encouraging long-term planning.
- Supporting job creation and other economic opportunities within the industry itself.
