Are you aware of the principles behind Life Insurance?

Most of us buy a life insurance policy without truly understanding it

Most of us, at some point of time or the other, have probably been forced to read about the principles behind the working of things. Be it as a student in school or as a professional, we try to equip ourselves with the basic understanding of how something works. While we might not necessarily put these principles into practice in real life, it does pay to know them, with it possible for such principles to become extremely handy in certain cases.

Take for example life insurance. Most of us buy a life insurance policy without truly understanding it. We think that just buying it is sufficient, for it does provide financial protection to our loved ones. To be honest, we don’t even bother to take a minute and ponder if there are any principles applied in life insurance. If you belong to the majority of people who are completely unaware of this, it is perhaps time for you to wake up and take note of these principles.
Four major principles applicable to Life Insurance
While there are a number of principles used by the best insurance companies in India, one can narrow these down to four basic universal principles.

Principle of Insurable Interest (PII) – Wouldn’t it look weird if an individual walked up to an insurance company to buy a policy for his neighbour? Sure, one could say that it is perhaps the bond shared by the two which prompted the same but in terms of insurance parlance there is no insurable interest between the two entities. The principle of insurable interest, in simple words, means that an individual looking to buy a policy for someone else should share a bond/connection with him/her.
Insurance companies typically permit one to buy a policy for his/her immediate family (spouse, parent, child, etc.) but are cautious about issuing a policy to someone who is not related to the proposer.

Principle of Good Faith – Investing in a life insurance policy is not merely about financial security. It is also about building a bond between the entities involved. As per this principle, the individual buying the policy and the insurer, should both enter the contract in good faith. Withholding any information could result in the life insurance claim being rejected in the future.
Ensure that you are upright about any health issues you might have. You might think that disclosing these issues could increase the life insurance premium that you pay, and while it might bump up the premium the fact is that hiding the same could be the deal breaker during an emergency.
This principle applies to both parties. The insurer is also expected to be transparent about the policy, stating all terms and conditions before the policy is sold.

Principle of Large Numbers – Life insurance companies are essentially business organisations which provide financial support following the demise of a policyholder. For this they charge a certain premium as well. But predicting when an individual will die is virtually impossible. It is for this purpose that insurers develop an algorithm/death rate which they apply to compute the chance of death at a particular age. Using this principle insurance companies can take the results from a particular sample size and apply it in general.
This principle becomes extremely important in determining the premium amount. It is due to this that the premium for a term insurance policy is much lower compared to the premium for a whole life policy.

Principle of Minimal Risk – We all try to minimise the risks in our lives. Take for instance the risk to our health. We end up buying a good health insurance policy to offset the costs associated with medical treatments. Similarly, insurers also wish to lower their risk factor when they insure you. It is for this reason that they motivate you to lead a healthy lifestyle, exercise, go for regular health check-ups, etc.
This not only reduces their probability of making an early payout, but also benefits the policyholder as well. It is for this reason that non-smokers are offered a higher cover for a lower premium compared to smokers. It is also the reason behind insurers wanting to know the profession of an applicant before offering a policy.

While these principles are typically applied by life insurance companies, it is possible that modified versions of these are applied to other insurance products like motor insurance. Regardless of which kind of insurance you wish to buy, knowing these basic principles can help you get the most out of them.

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