Insurance is a system to alleviate financial losses by transferring risk of loss from one entity to another.
The entity, which may be an individual or association of any type, including a government or government agency, that is transferring the risk is called the "insured". The entity accepting the risk is called the "insurer". The agreement between the two by which the risk is transfered is called the "policy". The policy is a legal contract that sets out exactly the terms and conditions of the coverage. The fee paid by the insured to the insurer for assuming the risk is called the "premium". The premium is usually determined by the insurer to fund estimated future claims paid, administrative costs, and profit.
For example, let us assume for a moment a couple buys a home costing $100,000. Knowing the loss of their home would bring them financial ruin, they acquire insurance coverage in the form of a homeowner's policy. That policy will pay them the cost of replacing or repairing their home in the event of a catastrophe. The insurance company charges them a premium of $1,000 a year. Risk of loss has been transferred from the homeowners to the insurance company.
The insurer uses actuarial science to quantify the risk they have assumed. Actuarial science uses mathematics, particularly statistics and probability, which can be applied to many covered risks to approximate future claims with reasonable accuracy.
For example, many individual people purchase homeowner's insurance policies and they each pay a premium to an insurance company. If a covered loss occurs, the insurer pays the claim. For some insureds, the insurance benefits they receive will exceed far more money than they have ever paid to the insurer. Others may never make a claim. When averaged out over all the policies sold, total claims even out should be less than total premiums, with the difference being costs and profit.
Insurance companies also earn investment profits. These profits are generated by investing premiums received from the time they receive it until the time they need it to pay claims. This money invested is called the float. And the insurance company may have profits or losses from the value change in the float as well as interest or dividend on the float. In the United States, property and casualty insurance companies have in the recent past made no profit on underwriting (i.e., selling) insurance, with all profits coming from investments.
Some people consider insurance a type of wager or bet that executes over the policy period. The insurance company bets that you or your property will not suffer a loss while you put money on the opposite outcome. The difference in the fees paid to the insurance company vs the amount they can be held liable for if an accident happens is roughly analogous to the odds one might expect when betting on a racehorse, i.e 10:1. For this reason, a number of religious groups including the Amish avoid insurance and instead depend on support provided by their communities when disasters strike. In closed, supportive communities where others will actually step in to rebuild lost property, this arrangement can work. Most societies could not effectively support this type of system and the system will not work for large risks.
Contents [showhide]
1 History of insurance
2 Types of insurance
3 Types of insurance companies
4 Life insurance and saving
5 Criticisms of the insurance industry
5.1 Insurance insulates too much
5.2 Lack of knowledge of policyholders
5.3 Redlining
5.4 Health insurance
6 External links
7 See Also
[edit]
History of insurance
Insurance has been an institution of human society for thousands of years, having been practiced by Babylonian traders as long ago as the 2nd millennium BCE. Eventually it was given legal mention in the Code of Hammurabi, and practiced by early Mediterranean sailing merchants. The Greeks and Romans had "benevolent societies" which acted to care for the families and funeral expenses of members upon death. Guilds in the middle ages served a similar purpose. The Talmud deals with several aspects of insuring goods. Insurance became much more sophisticated in post-Renaissance Europe, and specialized varieties developed. In America, Benjamin Franklin helped to popularize and make standard the practice of insurance, particularly against fire.
In the United States, the insurance industry is highly regulated, primarily by the states, who operate both individually and in concert through a national insurance commissioner's organization.
[edit]
Types of insurance
Any risk that can be quantified probably has a type of insurance to protect it. Among the different types of insurance are:
Automobile insurance, also known as auto insurance, car insurance and in the UK as motor insurance, is probably the most common form of insurance and may cover both legal liability claims against the driver and loss of or damage to the vehicle itself.
Property insurance provides protection against risks to property, such as fire, theft or weather damage. This includes specialized forms of insurance such as fire insurance, flood insurance, earthquake insurance, home insurance or boiler insurance.
Casualty insurance insures against accidents, not necessarily tied to any specific piece of property.
Liability insurance covers legal claims against the insured. For example, a doctor may purchase insurance to cover any legal claims against him if he were to be convicted of a mistake in treating a patient.
Financial loss insurance protects individuals and companies against various financial risks. For example, a business might purchase cover to protect it from loss of sales if a fire in a factory prevented it from carrying out its business for a time. Insurance might also cover failure of a creditor to pay money it owes to the insured. Fidelity bonds and surety bonds are included in this category.
Title insurance provides a guarantee on research done on public records affecting title to real property, usually in conjunction with a search done at the time of a real estate transaction, such as a sale, or a mortgage.
Health insurance covers medical bills incurred because of sickness or accidents.
Life insurance provides a benefit to a decedent's family or other designated beneficiary, to replace loss of the insured's income and provide for burial and other final expenses.
Annuities provide a stream of payments and are generally classified as insurance because they are issued by insurance companies and regulated as insurance. Annuities and pensions that pay a benefit for life are sometimes regarded as insurance against the possibility that a retiree will outlive his or her financial resources. In that sense, they are the opposite of life insurance.
Credit insurance pays some or all of a loan back when certain things happen to the borrower like unemployment, disability, or death.
Terrorism insurance
Political risk insurance can be taken out by businesses with operations in countries in which there is a risk that revolution or other political conditions will result in a loss.
Worker's compensation insurance replaces all of part of a worker's wages and accompanying medical expense lost due to a job-related injury.
A single policy may cover risks in one or more of the above categories. For example, car insurance would typically cover both property risk (covering the risk of theft or damage to the car) and liability risk (covering legal claims from say, causing an accident). A homeowner's insurance policy in the US typically includes property insurance covering damage to the home and the owner's belongings, liability insurance covering certain legal claims against the owner, and even a small amount of health insurance for medical expenses of guests who are injured on the owner's property.
Potential sources of risk that may give rise to claims are known as perils. Examples of perils might be fire, theft, earthquake, hurricane and many other potential risks. An insurance policy will set out in details which perils are covered by the policy and which are not.
[edit]
Types of insurance companies
Insurance companies may be classified as
Life insurance companies, who sell life insurance, annuities and pensions products.
Non-life or general insurance companies, who sell other types of insurance.
In most countries, life and non-life insurers are subject to different regulations, tax and accounting rules. The main reason for the distinction between the two types of company is that life business is very long term in nature - coverage for life assurance or a pension can cover risks over many decades. By contrast, non-life insurance cover usually covers shorter periods, such as one year.
Insurance companies are also often classified as either mutual or stock companies. This is more of a traditional distinction as true mutual companies are becoming rare. Mutual companies are owned by the policyholders, while stockholders, (who may or may not own policies) own stock insurance companies.
Reinsurance companies are insurance companies that sell policies to other insurance companies, allowing them to reduce their risks, and protects them from very large losses. The reinsurance market is dominated by a few very large companies, with huge reserves.
There are also companies which are known as Insurance Brokers. Like a mortgage broker, these companies are paid a fee by the customer to shop around for the best insurance policy amongst many companies.
[edit]
Life insurance and saving
Certain life insurance contracts accumulate cash values, which may be taken by the insured if the policy is surrendered or which may be borrowed against. Some policies, such as annutities and endowment policies, are financial instruments to accumulate or liquidate wealth when it is needed. See life insurance.
In many countries, such as the US and the UK, tax law provides that the interest on this cash value is not taxable under certain circumstances. This leads to widespread use of life insurance as a tax-efficient method of saving as well as protection in the event of early death.
[edit]
Criticisms of the insurance industry
[edit]
Insurance insulates too much
By creating a "security blanket" for its insureds, an insurance company may inadvertently find that its insureds may not be as risk-averse as they should be (since the insured assumes the risk belongs to the insurer). To reduce their own financial exposure, insurance companies have contractual clauses that mitigate their obligation to provide coverage if the insured engages in some kind of behavior that grossly magnifies their risk of loss or liability.
For example, liability insurance providers do not provide coverage for liability arising from intentional torts committed by the insured. Even if a provider was irrational enough to try to provide such coverage, it is against the public policy of most countries to allow such insurance to exist, and thus it is usually illegal.
[edit]
Lack of knowledge of policyholders
Insurance policies can be complex and some policyholders may not understand all the fees, regulation and coverages included in a policy. As a result, people could buy policies at unfavorable terms. In response to these issues, governments often make detailed regulations that set down minimum standards for policies and govern how they may be advertised and sold.
Many individuals purchase policies through an insurance broker. The broker can councel the policyholder on which coverage to purchase and limitations of the policy. A broker generally holds contracts with many insurers which allows the broker to "shop" the market for the best rates and coverage possible.
[edit]
Redlining
Redlining was originally denial of insurance to any area because of the area.
Risk determines premium. Evaluation of risk by the insurer considers every available, quantifiable factor, including location, credit scores, gender, occupation, marital status, and education level. However, some people consider all or some of these factors to be "unfair" and hurl unproven claims such as racist. So, for political reasons, governments may limit the factors that may be used.
An interesting refutation to this is that the job of an insurance underwriter is to properly categorize a given risk as to the likelihood that the loss will occur. Any factor that causes a greater likelihood of loss should in theory, be charged a higher rate. This is a basic principle of insurance and must be followed for insurance companies or groups to operate properly, even for non-profit groups. Thus, discrimination of potential insureds by legitimate factors is central to insurance. Therefore the only thing that can be considered legitimately "unfair" are practices that discriminate against a given group without actual factors that show that the group is a higher risk. So, eliminating real factors discriminates against other insureds by forcing them to bear part of the cost of the disallowed perceived factors.
Health insurance
Health insurance, that is coverage for individuals to protect them against medical costs, is a highly charged and emotional issue in the United States. In theory, it should work as any other insurance policy but the skyrocketing costs of health coverage has polarized the issue. Please see health insurance elsewhere in Wikipedia for a discussion of this category.
The entity, which may be an individual or association of any type, including a government or government agency, that is transferring the risk is called the "insured". The entity accepting the risk is called the "insurer". The agreement between the two by which the risk is transfered is called the "policy". The policy is a legal contract that sets out exactly the terms and conditions of the coverage. The fee paid by the insured to the insurer for assuming the risk is called the "premium". The premium is usually determined by the insurer to fund estimated future claims paid, administrative costs, and profit.
For example, let us assume for a moment a couple buys a home costing $100,000. Knowing the loss of their home would bring them financial ruin, they acquire insurance coverage in the form of a homeowner's policy. That policy will pay them the cost of replacing or repairing their home in the event of a catastrophe. The insurance company charges them a premium of $1,000 a year. Risk of loss has been transferred from the homeowners to the insurance company.
The insurer uses actuarial science to quantify the risk they have assumed. Actuarial science uses mathematics, particularly statistics and probability, which can be applied to many covered risks to approximate future claims with reasonable accuracy.
For example, many individual people purchase homeowner's insurance policies and they each pay a premium to an insurance company. If a covered loss occurs, the insurer pays the claim. For some insureds, the insurance benefits they receive will exceed far more money than they have ever paid to the insurer. Others may never make a claim. When averaged out over all the policies sold, total claims even out should be less than total premiums, with the difference being costs and profit.
Insurance companies also earn investment profits. These profits are generated by investing premiums received from the time they receive it until the time they need it to pay claims. This money invested is called the float. And the insurance company may have profits or losses from the value change in the float as well as interest or dividend on the float. In the United States, property and casualty insurance companies have in the recent past made no profit on underwriting (i.e., selling) insurance, with all profits coming from investments.
Some people consider insurance a type of wager or bet that executes over the policy period. The insurance company bets that you or your property will not suffer a loss while you put money on the opposite outcome. The difference in the fees paid to the insurance company vs the amount they can be held liable for if an accident happens is roughly analogous to the odds one might expect when betting on a racehorse, i.e 10:1. For this reason, a number of religious groups including the Amish avoid insurance and instead depend on support provided by their communities when disasters strike. In closed, supportive communities where others will actually step in to rebuild lost property, this arrangement can work. Most societies could not effectively support this type of system and the system will not work for large risks.
Contents [showhide]
1 History of insurance
2 Types of insurance
3 Types of insurance companies
4 Life insurance and saving
5 Criticisms of the insurance industry
5.1 Insurance insulates too much
5.2 Lack of knowledge of policyholders
5.3 Redlining
5.4 Health insurance
6 External links
7 See Also
[edit]
History of insurance
Insurance has been an institution of human society for thousands of years, having been practiced by Babylonian traders as long ago as the 2nd millennium BCE. Eventually it was given legal mention in the Code of Hammurabi, and practiced by early Mediterranean sailing merchants. The Greeks and Romans had "benevolent societies" which acted to care for the families and funeral expenses of members upon death. Guilds in the middle ages served a similar purpose. The Talmud deals with several aspects of insuring goods. Insurance became much more sophisticated in post-Renaissance Europe, and specialized varieties developed. In America, Benjamin Franklin helped to popularize and make standard the practice of insurance, particularly against fire.
In the United States, the insurance industry is highly regulated, primarily by the states, who operate both individually and in concert through a national insurance commissioner's organization.
[edit]
Types of insurance
Any risk that can be quantified probably has a type of insurance to protect it. Among the different types of insurance are:
Automobile insurance, also known as auto insurance, car insurance and in the UK as motor insurance, is probably the most common form of insurance and may cover both legal liability claims against the driver and loss of or damage to the vehicle itself.
Property insurance provides protection against risks to property, such as fire, theft or weather damage. This includes specialized forms of insurance such as fire insurance, flood insurance, earthquake insurance, home insurance or boiler insurance.
Casualty insurance insures against accidents, not necessarily tied to any specific piece of property.
Liability insurance covers legal claims against the insured. For example, a doctor may purchase insurance to cover any legal claims against him if he were to be convicted of a mistake in treating a patient.
Financial loss insurance protects individuals and companies against various financial risks. For example, a business might purchase cover to protect it from loss of sales if a fire in a factory prevented it from carrying out its business for a time. Insurance might also cover failure of a creditor to pay money it owes to the insured. Fidelity bonds and surety bonds are included in this category.
Title insurance provides a guarantee on research done on public records affecting title to real property, usually in conjunction with a search done at the time of a real estate transaction, such as a sale, or a mortgage.
Health insurance covers medical bills incurred because of sickness or accidents.
Life insurance provides a benefit to a decedent's family or other designated beneficiary, to replace loss of the insured's income and provide for burial and other final expenses.
Annuities provide a stream of payments and are generally classified as insurance because they are issued by insurance companies and regulated as insurance. Annuities and pensions that pay a benefit for life are sometimes regarded as insurance against the possibility that a retiree will outlive his or her financial resources. In that sense, they are the opposite of life insurance.
Credit insurance pays some or all of a loan back when certain things happen to the borrower like unemployment, disability, or death.
Terrorism insurance
Political risk insurance can be taken out by businesses with operations in countries in which there is a risk that revolution or other political conditions will result in a loss.
Worker's compensation insurance replaces all of part of a worker's wages and accompanying medical expense lost due to a job-related injury.
A single policy may cover risks in one or more of the above categories. For example, car insurance would typically cover both property risk (covering the risk of theft or damage to the car) and liability risk (covering legal claims from say, causing an accident). A homeowner's insurance policy in the US typically includes property insurance covering damage to the home and the owner's belongings, liability insurance covering certain legal claims against the owner, and even a small amount of health insurance for medical expenses of guests who are injured on the owner's property.
Potential sources of risk that may give rise to claims are known as perils. Examples of perils might be fire, theft, earthquake, hurricane and many other potential risks. An insurance policy will set out in details which perils are covered by the policy and which are not.
[edit]
Types of insurance companies
Insurance companies may be classified as
Life insurance companies, who sell life insurance, annuities and pensions products.
Non-life or general insurance companies, who sell other types of insurance.
In most countries, life and non-life insurers are subject to different regulations, tax and accounting rules. The main reason for the distinction between the two types of company is that life business is very long term in nature - coverage for life assurance or a pension can cover risks over many decades. By contrast, non-life insurance cover usually covers shorter periods, such as one year.
Insurance companies are also often classified as either mutual or stock companies. This is more of a traditional distinction as true mutual companies are becoming rare. Mutual companies are owned by the policyholders, while stockholders, (who may or may not own policies) own stock insurance companies.
Reinsurance companies are insurance companies that sell policies to other insurance companies, allowing them to reduce their risks, and protects them from very large losses. The reinsurance market is dominated by a few very large companies, with huge reserves.
There are also companies which are known as Insurance Brokers. Like a mortgage broker, these companies are paid a fee by the customer to shop around for the best insurance policy amongst many companies.
[edit]
Life insurance and saving
Certain life insurance contracts accumulate cash values, which may be taken by the insured if the policy is surrendered or which may be borrowed against. Some policies, such as annutities and endowment policies, are financial instruments to accumulate or liquidate wealth when it is needed. See life insurance.
In many countries, such as the US and the UK, tax law provides that the interest on this cash value is not taxable under certain circumstances. This leads to widespread use of life insurance as a tax-efficient method of saving as well as protection in the event of early death.
[edit]
Criticisms of the insurance industry
[edit]
Insurance insulates too much
By creating a "security blanket" for its insureds, an insurance company may inadvertently find that its insureds may not be as risk-averse as they should be (since the insured assumes the risk belongs to the insurer). To reduce their own financial exposure, insurance companies have contractual clauses that mitigate their obligation to provide coverage if the insured engages in some kind of behavior that grossly magnifies their risk of loss or liability.
For example, liability insurance providers do not provide coverage for liability arising from intentional torts committed by the insured. Even if a provider was irrational enough to try to provide such coverage, it is against the public policy of most countries to allow such insurance to exist, and thus it is usually illegal.
[edit]
Lack of knowledge of policyholders
Insurance policies can be complex and some policyholders may not understand all the fees, regulation and coverages included in a policy. As a result, people could buy policies at unfavorable terms. In response to these issues, governments often make detailed regulations that set down minimum standards for policies and govern how they may be advertised and sold.
Many individuals purchase policies through an insurance broker. The broker can councel the policyholder on which coverage to purchase and limitations of the policy. A broker generally holds contracts with many insurers which allows the broker to "shop" the market for the best rates and coverage possible.
[edit]
Redlining
Redlining was originally denial of insurance to any area because of the area.
Risk determines premium. Evaluation of risk by the insurer considers every available, quantifiable factor, including location, credit scores, gender, occupation, marital status, and education level. However, some people consider all or some of these factors to be "unfair" and hurl unproven claims such as racist. So, for political reasons, governments may limit the factors that may be used.
An interesting refutation to this is that the job of an insurance underwriter is to properly categorize a given risk as to the likelihood that the loss will occur. Any factor that causes a greater likelihood of loss should in theory, be charged a higher rate. This is a basic principle of insurance and must be followed for insurance companies or groups to operate properly, even for non-profit groups. Thus, discrimination of potential insureds by legitimate factors is central to insurance. Therefore the only thing that can be considered legitimately "unfair" are practices that discriminate against a given group without actual factors that show that the group is a higher risk. So, eliminating real factors discriminates against other insureds by forcing them to bear part of the cost of the disallowed perceived factors.
Health insurance
Health insurance, that is coverage for individuals to protect them against medical costs, is a highly charged and emotional issue in the United States. In theory, it should work as any other insurance policy but the skyrocketing costs of health coverage has polarized the issue. Please see health insurance elsewhere in Wikipedia for a discussion of this category.
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