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Definition of Insurance and Function

Posted At May 11th, 2018

Definition of Insurance and Function

The Definition of Insurance

According to the Law No. 40 in the year 2014, the definition of insurance is an agreement between two parties; the insurance company and the policy holder, which serves as the ground for the insurance company to receive a premium in return of:

  • Giving compensation to the insured or the policy holder due to losses, damages, incurred expenses, losses of profit, or legal liability to a third party, which may be suffered by the insured or the policy holder that is caused by an uncertain incident; or
  • Giving compensation upon the death of the insured, or compensation based on the life of the insured, with the amount of the benefits determined and/or based on the yield of fund management.

 The Main Functions of Insurance

The three main functions of insurance are:

Risk Transfer

Insurance is a mechanism to transfer uncertain, loss-incurring risks. An individual or business entity can transfer risks due to accidents, damages, health problems, death, law suits, and even business problems to a third party (an insurance company) with a certain amount of premium that is relatively low compared to the potential losses.

Common Pool

Pool is first known in marine insurance. The system back then was different than how it is now. Back then, contributions were made by the members after a loss was incurred.

Nowadays, the contribution (premium) is determined at the beginning of the contract in the form of insurance premium. The premiums from all the insured for similar risks are collected in the form of a fund or pool, which is then used to pay claims.

Equitable Premium

Choosing the right method to determine the amount of a fair and proper contribution (premium), that is the premium suitable for the level of risk and type of insured object.


Aside from those main purposes, insurance also has several other functions; subsidiary function and other related function. The subsidiary function comprises of:

  • Stimulus of business enterprise function
  • Prevention and control of loss function
  • Social benefit
  • Saving

Meanwhile, the other related function includes investment funds and invisible earnings.

Understanding the definition of insurance can give you a general comprehension and depiction of the mechanism of insurance. Aside from providing protection, insurance also has various other functions. One of the functions is as an alternative to be an instrument of investment.

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insurance risk