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The economic nature, functions and principles of insurance

The economic essence of insurance is the creation of insurance funds at the expense of contributions from parties concerned in insurance and intended to compensate for damage (most often – from those involved in the formation of these funds). Since the possible damage is probabilistic in nature ( insurance risk ), the insurance fund is redistributed both in space and in time. It can be said that the compensation of damage to the affected persons comes from the contributions of all those who participated in the formation of these insurance funds.

There are three main forms of organizing an insurance fund :

  1. Centralized insurance (reserve) funds, created at the expense of budget and other public funds. The formation of these funds is carried out both in kind and in cash. State insurance (reserve) funds are at the disposal of the government.
  2. Self-insurance as a system for creating and using insurance funds by business entities and people. These decentralized insurance funds are created in kind and in cash. These funds are designed to overcome temporary difficulties in the activities of a particular commodity producer or person. The main source of formation of decentralized insurance funds is the income of the enterprise or individual.
  3. Actually insurance as a system for creating and using funds of insurance organizations at the expense of insurance premiums of the parties interested in insurance. The use of funds of these funds is carried out to compensate for the resulting damage in accordance with the terms and conditions of insurance.

There are the following functions of insurance, expressing its public purpose:

  1. Risk function, which is to provide insurance protection against various kinds of risksrandom events leading to losses. As part of this function, there is a redistribution of monetary resources between all participants of insurance in accordance with the current insurance contract, after which insurance premiums (money) are not returned to the insured. This function reflects the main purpose of insurance – protection against risks.
  2. The investment function, which is that at the expense of temporarily free funds of insurance funds ( insurance reserves ) the economy is financed. Due to the fact that insurance companies accumulate large amounts of money in them, which are intended to compensate for damage, but until the insured event has occurred, they can be temporarily invested in various securities, real estate, and other areas. The volume of investments of insurance companies in the world is more than 24 trillion US dollars [1].In the second half of the 20th century, in countries with developed insurance, the income received by insurance companies from investments began to prevail over the income received from insurance activities [2].
  3. The precautionary function of insurance is that measures to reduce the insured risk are funded from a portion of the funds of the insurance fund. For example, at the expense of part of the funds collected from fire insurance, fire prevention measures are funded, as well as measures aimed at reducing the possible damage from a fire.
  4. Savings function. In life insurance, insurance comes closest to credit as it accumulates certain insurance sums under insurance contracts. Saving money, for example with the help of survival insurance, is connected with the need for insurance protection of the achieved family wealth. Thus, insurance may have a savings function.

The modern state makes extensive use of insurance mechanisms in the form of social insurance and pensions for public insurance protection of citizens in case of illness, loss of ability to work (including age), loss of the breadwinner, and death. At the same time, the organization and activities of state social insurance funds and pension funds are regulated by special legislation, different from the legislation regulating the activities of specialized insurance organizations.

Insurance activity is based on the principles of equivalence and randomness.

The equivalence principle expresses the requirement of a balance between the income of an insurance organization and its expenses. The risk threatens many people, but only a few of them are really affected by insurance claims. Payments for insured events are covered by contributions from many insurers who have avoided this risk.

Revenues from insurance activities consist of insurance premiums paid by policyholders. The costs are represented by insurance payments and expenses for the maintenance of the insurance company. When income exceeds expenditure, the insurance organization (SO) has a profit from insurance activity. If losses arise, this leads to the impossibility of fulfilling obligations to policyholders.

The principle of chance is that only events with signs of probability and chance of their occurrence can be insured. Deliberately carried out actions are not insured, as they lack the principle of randomness.


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