How the idea and workings of life insurance. A risk (the possibility of loss or damage) is unavoidable, but the impact of such risks can be minimized. Avoiding risk can be done by eliminating habits or activities that may pose a risk. For example, someone who is worried about lung cancer due to smoking habits, can avoid it by stopping the habit. Risk control can be done by reducing the frequency and impact of losses that may arise. For example, a motorist must wear a helmet and take care of his bike regularly, to control the losses that may arise. Accepting risk is done by maintaining existing risks. For example, a rich man with a lot of wealth may not feel the need to buy health insurance because he thinks he can afford a doctor if he is sick. Risk-shifting can be done by transferring risk from an individual to a company. For example, a head of family who is worried that her family loses her income if she is sick or dies can buy insurance products from a life insurance company. In the insurance business, the risks faced by each individual are transferred to the insurer (life insurance company), which agrees to indemnify the amount specified in the policy contract. To compensate for this loss, the insurer sets the premium to be paid by the insured individual. Mistakes in measuring these factors can cause losses for life insurance companies, such as setting a smaller premium than they should.
We assume there are 1000 people who are 50 years old and in good health. But it is estimated, 10 of them will die this year. For example, the economic value of losses incurred by an abandoned family is about 200 million, so the total loss of 10 families is about 2 billion. If each person from the group (1000) contributed 5 million rupiah per year to the mutual fund, then the funds collected amounted to 5 billion rupiah. The amount would be enough to compensate 200 million rupiah to each family left behind. That is, the risk faced by 10 people was spread to 1000 people who are members of the group. The insurance company acts as a representative, managing the funds collected on behalf of the group's community. Life insurance companies must also arrange in such a way that no one feels disadvantaged. Life insurance, as a tool to spread risk, can only work if a life insurance company is able to bear the same risk in large numbers. Here apply what is called the law of large number. The law of large numbers states that if the amount of exposure to losses increases, then the prediction of losses will be closer to the actual loss amount. The use of the large number of laws allows the number of losses to be predicted better. Life insurance business is nothing but sharing. It aims to spread the losses suffered by a person to all group members who risk the same risk.