Insurance is based on the principle of pooling of risks. It is not possible for an individual to predict or prevent fortuitous occurrences, but through insurance it can be arranged to provide against their financial effects ie. loss of property and/or earnings.

The losses experienced by the unfortunate few are compensated by the contributions, ie. the premiums, of the many who are exposed to the same risk. For the purpose of illustration, it is assumed that the portfolio consists of 1000 houses of identical value, say RM100,000 each, and a premium of RM200 is charged for each house per year.

The contributions from the 1000 houseowners result in the creation of an insurance fund of RM200,000. The insurer uses this amount of money to pay for claims, expenses of management and other outgoes, such as commission, tax etc. The balance, if any constitutes the insurer's profit.

Thus, in the above situation, the fund created is just sufficient to pay for a maximum of two claims and this leaves the expenses and other outgoes of the insurer uncovered. If more than one claims were to arise, the insurance fund would be in deficit and clearly, the insurer would experience a loss on this portfolio.

It becomes clear from the above that for the insurer to operate profitably in a competitive environment, the premiums charged by the insurer will depend on his ability to control outgoing expenses such as management expenses and commission.
Classes of Insurance

Insurance business is broadly classified into Life Insurance and General Insurance.

Life insurance can be defined as a contract, which pays an agreed sum of money on the happening of a contingency (event) or of a variety of contingencies, dependent on human life.

General insurance business can be taken to be all other forms of insurance business (including reinsurance of liabilities under a policy in respect thereof) which is not life insurance business as defined in the Insurance Act 1996. Examples of general insurance business are fire insurance, motor insurance, marine insurance, engineering insurance, etc.