Defined benefit insurance
Also written Defined Benefit plan · Benefit insurance
A policy that pays a pre-fixed sum on the covered event, without trying to measure the actual loss — the opposite of an indemnity policy, and how life insurance itself is structured.
In plain language
Insurance comes in two fundamentally different shapes. An indemnity policy pays out the actual loss suffered, no more and no less. A defined benefit policy instead pays a pre-fixed sum of money, decided in advance, on the happening of the covered event — regardless of what the real economic loss actually was.
Life insurance is the workbook's leading example: a life policy pays the sum assured on death, without any attempt to precisely measure the financial loss the family actually suffers from that death.
How it works
A defined benefit structure is used specifically where it is certain a loss occurred, but either:
- it is difficult to ascertain the exact loss — life insurance is the workbook's example, since the true future loss of income from a death cannot be measured precisely; or
- the loss is real but too small, or too numerous, to individually ascertain — the workbook's example is a daily hospital cash allowance rider within a health policy, paying a fixed sum per day of hospitalisation rather than reimbursing itemised costs.
Table 1.1 of the workbook sorts common products by type:
| Product | Indemnity or Defined Benefit | Why |
|---|---|---|
| Life insurance policy | Defined Benefit | Loss of future earnings is hard to ascertain |
| Health insurance (reimbursement, Mediclaim) | Indemnity | Bills are available to ascertain the actual loss |
| Daily hospital cash benefit | Defined Benefit | Losses too small or numerous for individual ascertainment |
| Critical illness policy | Defined Benefit | Loss of earnings is hard to ascertain |
| Property insurance | Indemnity | The loss is ascertainable |
A single policy can even mix the two: a health policy that reimburses actual hospital bills (indemnity) may also carry a daily hospital cash rider (defined benefit) as an add-on.
A worked example
Illustrative scenario.
Mr Ghosh, 40, buys a term life policy with a sum assured of Rs 75 lakh. He dies in an accident 8 years later. His insurer pays the full Rs 75 lakh, without attempting to compute what his actual future earnings would have been, or what his family's real financial loss is — the pre-fixed sum is paid because the policy is a defined benefit contract.
Contrast this with his fire insurance policy on his warehouse, which suffers Rs 12 lakh of actual fire damage against a sum insured of Rs 50 lakh — an indemnity policy pays only the ascertained Rs 12 lakh loss, not the full sum insured, because indemnity policies pay actual loss, capped at the sum insured, never more.
Why NISM asks about it
Chapter 1 (Basics of Insurance), section 1.3(b), defines defined benefit insurance against indemnity insurance, with Table 1.1 sorting named products into the two categories. Expect a question classifying a named product as indemnity or defined benefit, with life insurance and daily hospital cash benefit as the classic defined-benefit examples.
Common exam traps
- Defined benefit pays a pre-fixed sum, not the actual loss — do not assume every insurance payout is loss-based.
- Life insurance is defined benefit, not indemnity — a very commonly tested classification.
- A single health policy can combine both: reimbursement (indemnity) for actual bills, plus a daily cash rider (defined benefit) for a fixed daily amount.
- The reason for choosing defined benefit is either that the loss is hard to measure, or that it is small and frequent — two different justifications, both used by the workbook.
Where this is taught
Free preparation for NISM Series X-BRelated terms
- Co-payA fixed percentage of every admitted claim that the insured pays out of pocket — a proportional share of the loss, applied after any deductible, in exchange for a lower premium.
- Critical illness insuranceA defined benefit policy that pays a lump sum when the insured is diagnosed with a specified disease such as cancer, heart attack or stroke and survives a minimum period — no payment on death.
- DeductibleThe portion of a claim the insured bears before the insurer pays anything — a fixed rupee threshold that lowers the premium and keeps small claims out of the system.
- Human Life ValueThe present value of the income a person is expected to earn over their remaining working life that is available for dependents — the upper bound on how much life cover is justified.
- Insurable interestThe requirement that the person seeking insurance would suffer a monetary loss if the subject matter were lost or destroyed — the test that separates insurance from a wager.
- Personal accident insuranceA policy paying a defined sum where the insured sustains bodily injury solely and directly from an accident caused by external, violent and visible means — covering three grades of disablement.
- Principle of IndemnityThe principle that insurance should restore the insured to the financial position they were in before the loss — no better — so that insurance can never be a source of profit.
- Indemnity insuranceA policy that pays the actual loss the insured is shown to have suffered, so a claim cannot be settled until that loss has been determined — the opposite structure to a defined benefit policy.
- SubrogationThe insurer's right to step into the shoes of the insured after paying a claim, and to pursue and recover the loss from whoever was actually at fault.