Source: Insurance, Banking & Negotiable Instruments Law Teaching Material
Insurance as a mechanism of transfer of risk has great economic and social benefits to the individual insured, his family and the country in general. The following are some of the major benefits.
Indemnification for Losses
Payment of compensation by the insurer for losses permits individuals and their families to be restored to their original financial position after a loss has occurred. As a result, they can maintain their financial security. Since they are restored either in part or in whole after a loss occurs, they are less likely to seek financial assistance from relatives and friends. It also allows businesses to remain in business and employees to keep their jobs, suppliers will continue to receive orders, and customers can still purchase the goods and services they desire. The community also benefits because its tax base is not eroded. Businesses and families who suffer unexpected losses are restored or at least moved closer back to their previous economic position.
The advantage to these individuals is obvious. The society also gains because these persons are restored to production and tax revenues are increased. In short, the indemnification function contributes greatly to family and business stability and therefore is one of the most important social and economic benefits of insurance.
Reduction of Worry and Fear
Another benefit of insurance is that it reduces worry and fear, both before and after loss. For instance, if family heads have life insurance for adequate amount to cover the future needs of their families, they are less likely to worry about the financial security of their dependents in the event of their premature death. Persons insured for long-term disability do not have to worry about the loss of earnings if a serious illness or accident occurs. Property owners who are insured enjoy greater peace of mind since they know that they are covered (they would be compensated) if loss occurs to their property.
Source of Investment Funds
The insurance industry is an important source of funds for capital investment and accumulation. Premiums, which are collected by the insurer in advance, usually at the time of conclusion of the contract and other funds which are not needed to pay for immediate losses and expresses, can be loaned to businesses or invested in manufacturing, real estate... sectors. These investments increase the society's stock of capital goods and promote economic growth.
Insurance, through compensation of losses, also encourages new investment. For instance, if an individual knows that his or her family will be protected by life insurance in the event of premature death, his or her and the family's financial resources are protected by various types of property insurances, he/she may be more willing to invest savings in a long-desired project such as a business venture, without feeling that the family is being robbed of its basic income security. In a way a better allocation of resources is achieved, i.e., idle funds/deposits are used for a more productive purpose. As insurance is an efficient device to reduce risk, investors may also be willing to enter fields they would otherwise reject as too risky, and the society benefits from increased services and production.
Means of Loss Control
Although the main function of insurance is not to reduce loss but merely to spread/distribute losses among members of the insured group, insurers are nevertheless vitally interested in keeping losses at a minimum. Insurers know that if no effort is made to prevent or minimize occurrence of insured risks, losses and hence premium would have a tendency to rise. It is human nature to relax vigilance when they know that the loss will be fully paid by the insurer.
The following illustrations are some of the areas in which insurance companies play a very important role in loss prevention and control:
- Development of fire safety standards and public education
- Recovery of stolen properties
- Investigation of fraudulent insurance claims and thereby deterring intentional destruction of property and life
- The insurance industry also finances programs aimed at reducing premature deaths, accidents and illness.
Insurance enhances a person's credit, i.e., it makes the borrower/debtor a better credit risk because it guarantees the value of the borrower‘s collateral/mortgage or pledge/, and gives the creditor /lender greater assurance that the loan will be repaid. For instance, when a house is purchased on credit provided by a lending institution, the lender normally requires a property insurance on the house before the mortgage loan is granted.
The property insurance protects the lender's financial interest if the property is damaged or destroyed. Similarly, if a purchase of an automobile is financed by bank or other lending institution motor vehicle insurance may be required before the loan is given. It also enhances small businesses‘ competitiveness. Small businesses would not be able to compete with big businesses without an insurance to which they transfer risks to their assets. This is true because in cases where risks occur they would be compensated and the business remains in the market. However, in the absence of insurance, the occurrence of a certain loss may destroy the business and put it out of the market. Big businesses on the other hand, may safely retain some of such losses even in the absence of insurance.
Hence, insurance through payment of compensation for losses will keep small and medium businesses in the market and enable them to maintain their competitiveness.