Why line a chimney?
For an old chimney the main reason is that if the chimney has been heavily used it is likely to be past its best with the brick/stone starting to corrode and crumble. The main problem with this is that over time tar from the fire can start to seep through the mortar joints and start to appear in the house usually in the bedroom and is often accompanied by a nasty smell.
All new chimneys constructed after 1969 should be lined in accordance with building regulations. These were often clay liners. these have a tendency to crack as they were often over-fired by users. Another problem with these was they were put in with the joints the wrong way around so all the tar ran out of the joints instead of running back to the fire to be burnt.
Log burners have returned to fashion once again,and lining the chimney will have the effect of making the chimney more efficient by reducing the diameter of the opening so increasing draw. If the liner is insulated the effect is increased further. The purpose of this is to keep the gases from the fire as hot as possible so they can exit the chimney as quick as possible. This reduces the deposits on the liner reducing the risk of a chimney fire. It also makes the fire easier to light as the insulated chimney is naturally warmer than a large un-lined chimney.
With a chimney that is not lined, the fire is trying to heat all the air in the chimney before the gases can exit correctly. This problem is magnified if there is a large cavity above the fire as this can cause a sudden slow down in the gases trying to exit the chimney. As the gases cool down they start to deposit all the solids they are carrying on the inside of the chimney resulting in a build up of soot. This is where the risk of a chimney fire increases. By smoothing the path of the gases and reducing the diameter this minimises that risk.
The single most important thing is to burn the correct fuel. That means that all fuels, including coal must be dry, wood should be below 20% moisture. Any moisture that goes up the chimney risks being deposited on the inside of the chimney/liner where it mixes with soot to form corrosive sulphuric acid that destroys the lining of the chimney. Steel liners are particularly susceptible to this.