Life Insurance: The Elements of Protection and Investment

Life insurance is a contract in which an insurer, in return for a stated payment called the premium, agrees to pay a fixed sum of money — the sum assured — either on the death of the person whose life is insured or on the expiry of a fixed number of years, whichever the policy provides. The person whose life is covered is the life assured, the person who pays the premium and owns the contract is the policyholder (often the same person), and the person who receives the money is the nominee or beneficiary.

Life insurance is different from every other kind of insurance in one basic way. In fire, marine or motor insurance the event insured against may or may not happen — a house may never catch fire. In life insurance the event insured against — death — is certain to happen; only its timing is uncertain. Because of this, a life policy is not merely a promise to make good a loss; it can also be a way of building up money over time. This gives life insurance its two distinct elements.

The element of protection. From the very first day a policy is taken and the first premium is paid, the family of the life assured is protected for the full sum assured. If the breadwinner dies the next month, having paid only one small premium, the family still receives the entire sum assured. Life insurance therefore guarantees a large, certain amount of money at exactly the moment a family's earning member is lost — something ordinary saving can never do, because savings grow only to the amount actually put aside. This immediate, full protection against the financial consequences of an early death is the protection element.

The element of investment. Most life policies (except pure term policies) run for many years and are designed so that the policyholder gets money back even if he survives the whole term. Part of each premium, after meeting the cost of protection and the insurer's expenses, is set aside and allowed to earn interest year after year. Over a long period this accumulated fund grows into a sizeable amount, which is returned to the policyholder on maturity, often with bonuses. In this sense a life policy also works as a disciplined, long-term saving and investment plan.

A single life insurance contract thus does two jobs at once: it protects the family against the risk of an untimely death, and it invests the policyholder's money for an assured return on survival. Different types of policies (studied later in this chapter) simply change the balance between these two elements — a pure term plan is almost all protection, while an endowment or money-back plan combines protection with a strong investment element. This CHSE +2 Commerce syllabus draws on the same well-established principles of commerce and insurance law that are common to the study of insurance across India.