Post No. 8: Insurance
Insurance is a means of protection from financial loss. It is a form of risk management primarily used to hedge against the risk of a contingent, uncertain loss.

An entity which provides insurance is known as an insurer, insurance company, or insurance carrier. A person or entity who buys insurance is known as an insured or policyholder. The insurance transaction involves the insured assuming a guaranteed and known relatively small loss in the form of payment to the insurer in exchange for the insurer’s promise to compensate the insured in the event of a covered loss. The loss may or may not be financial, but it must be reducible to financial terms, and must involve something in which the insured has an insurable interest established by ownership, possession, or preexisting relationship.

The insured received a contract, called the insurance policy, which details the conditions and circumstances under which the insured will be financially compensated. The amount of money charged by the insurer or the insured for the coverage set forth in the insurance policy is called the premium. If the insured experiences a loss which is potentially covered by the insurance policy, the insured submits a claim to the insurer for processing by a claims adjuster.

Methods for transferring or distributing risk were practiced by Chinese and Babylonian traders as long ago as the 3rd and 2nd millennia BC, respectively. Chinese merchants travelling treacherous river rapids would redistribute their wares across many vessels to limit the loss due to any single vessel’s capsizing. The Babylonians developed a system which was recorded in the famous Code of Hammurabi, c. 1750 BC, and practiced by early Mediterranean sailing merchants.

Insurance became far more sophisticated in Enlightenment era Europe, and specialized varieties developed.
Property insurance as we know it today can be traced to the Great Fire of London, which in 1666 devoured more than 13,000 houses. The devastating effects of the fire converted the development of insurance “from a matter of convenience into one of urgency, a change of opinion reflected in Sir Christopher Wren’s inclusion of a site for the “the Insurance Office” in his new plan for London in 1667. In 1681, economist Nicholas Barbon and eleven associates established the first fire insurance company, the “Insurance Office for Houses”, at the back of the Royal Exchange to insure brick and frame homes. Initially, 5,000 homes were insured by his insurance Office.

The first life insurance policies were taken out in the early 18th century. The first company to offer life insurance was the Amicable Society for a Perpetual Assurance Office, founded in London in 1706 by William Talbot and Sir Thomas Allen. Edward Rowe Mores established the Society for Equitable Assurances’ on Lives and Survivorship in 1762.

It was the world’s first mutual insurer and it pioneered age based premiums based on mortality rate laying ‘”the framework for scientific insurance practice and development” and “the basis of modern life assurance upon which all life assurance schemes were subsequently based.”
“In the late 19th century, “accident insurance” began to become available. The first company to offer accident insurance was the Railway Passengers Assurance Company, formed in 1848 in England to insure against the rising number of fatalities on the nascent railway system.

By the late 19th century, governments began to initiate national insurance programs against sickness and old age. Germany built on a traditiojn of welfare programs in Prussia and Saxony that began as early as in the 1840s. In the 1880s Chancellor Otto von Bismarck introduced old age pensions, accident insurance and medical care that formed the basis for Germany’s welfare state. In Britain more extensive legislation was introduced by the Liberal government in the 1911 National Insurance Act. This gave the British working classes the first contributory system of insurance against illness and unemployment. This system was greatly expanded after the Second World War under the influence of the Beveridge Report, to from the first modern welfare state.

Insurance involves pooling funds from nay insured entities (known as exposures) to pay for the losses that some may incur. The insured entities are therefore protected from risk for a fee, with the fee being dependent upon the frequency and severity of the event occurring. In order to be an insurable risk, the risk insured against must meet certain characteristics. Insurance as a financial intermediary is a commercial enterprise and a major part of the financial services industry, but individual entities can also self-insure through saving money for possible future losses.

Risk which can be insured by private companies typically shares seven common characteristics:
1.  Large number of similar exposure units
2.  Definite loss
3.  Accidental loss
4.  Large loss
5.  Affordable premium
6.  Calculable loss
7.  Limited risk of catastrophically large losses.

When a company insures an individual entity, there are basic legal requirements and regulations. Several commonly cited legal principles of insurance include:
1.  Indemnity
2.  Benefit insurance
3.  Insurable interest
4.  Utmost good faith
5.  Contribution
6.  Subrogation
7.  Causa proxima, or proximate cause
8.  Mitigation.

To “indemnify” Means to make whole again, or to be reinstated to the position that one was in, to the extent possible, prior to the happening of a specified event or peril. Accordingly, the life insurance is generally not considered to be indemnity insurance, but rather “contingent” insurance. (i.e. , a claim arises on the occurrence of a specified event). There are generally three types of insurance contracts that seek to indemnify an insured:
1.  A “reimbursement” policy
2.  A “pay on behalf” or “on behalf of policy
3.  An “indemnification “policy.

From an insured’s standpoint, the result is usually the same: the insurer pays the loss and claims expenses.
The most complicated aspect of the insurance business is the actuarial science of rate making (price-setting) of policies, which uses statistics and probability to approximate the rate of future claims based on a given risk. After producing rates, the insurer will use discretion to reject or accept risks through the underwriting process.
There are several types of Insurance as:
1.  Auto insurance
2.  Gap insurance
3.  Health insurance
4.  Income protection insurance
5.  Casualty insurance
6.  Life insurance
7.  Burial insurance
8.  Property
9.  Liability
10.  Credit
Other types are:
  • All-risk insurance
  • Bloodstock insurance
  • Business interruption insurance
  • Defense Base Act (DBA)
  • Expatriate insurance
  • Legal expenses insurance
  • Livestock insurance
  • Media liability
  • Nuclear incident insurance
  • Pet insurance
  • Pollution insurance
  • Purchase insurance
  • Tax insurance
  • Title insurance
  • Travel insurance
  • Tuition insurance
  • Interest rate insurance
  • Divorce insurance
Insurance companies are generally classified as either mutual or proprietary companies. Mutual companies are owned by the policyholders, while shareholders (who may or may be not own policies) own proprietary insurance companies.

Insurance companies are rated by various agencies such as A.M. Best. The ratings include the company’s financial strength, which measures its ability to pay claims. It also rates financial instruments issued by the insurance company, such as bonds, notes, and securitization products.

Captive insurance companies may be defined as limited-purpose insurance companies established with the specific objective of financing risks emanating from their parent group or groups. This definition can sometimes be extended to include some of the risks of the parent company’s customers. In short, it is an in-house self insurance vehicle. Captives may take the form of a “pure” entity (which is 100% subsidiary of the self-insured company): of a “mutual” captive ( which insures the collective risks of members of an industry); and of an “association” captive ( which self-insures individual risks of the members of a professional, commercial or industrial association). Captives represent commercial, economic and tax advantages to their sponsors because of the reductions in costs they help create and for the ease of insurance risk management and the flexibility for cash flows they generate. Additionally, they may provide coverage of risks which is neither available nor offered in the traditional insurance market at reasonable prices.” (Wikipedia)


This is a complicated matter and is not easy to understand. That is one of the reasons it is convenient to hire an expert to disclose the terminology and clarify policies.

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