Principles of insurance
Commercially insurable risks typically share seven common
characteristics.[1]
- A large number of homogeneous exposure units. The
vast majority of insurance policies are provided for
individual members of very large classes. Automobile
insurance, for example, covered about 175 million
automobiles in the United States in 2004.[2]
The existence of a large number of homogeneous exposure
units allows insurers to benefit from the so-called ¡°law
of large numbers,¡± which in effect states that as the
number of exposure units increases, proportionally the
actual results are increasingly likely to become close to
expected proportions. There are exceptions to this
criterion.
Lloyd's of London is famous for insuring the life or
health of actors, actresses and sports figures. Satellite
Launch insurance covers events that are infrequent. Large
commercial property policies may insure exceptional
properties for which there are no ¡®homogeneous¡¯ exposure
units. Despite failing on this criterion, many exposures
like these are generally considered to be insurable.
- Definite Loss. The event that gives rise to the
loss that is subject to the insured, at least in principle,
take place at a known time, in a known place, and from a
known cause. The classic example is death of an insured
person on a life insurance policy. Fire, automobile
accidents, and worker injuries may all easily meet this
criterion. Other types of losses may only be definite in
theory. Occupational disease, for instance, may involve
prolonged exposure to injurious conditions where no specific
time, place or cause is identifiable. Ideally, the time,
place and cause of a loss should be clear enough that a
reasonable person, with sufficient information, could
objectively verify all three elements.
- Accidental Loss. The event that constitutes the
trigger of a claim should be fortuitous, or at least outside
the control of the beneficiary of the insurance. The loss
should be ¡®pure,¡¯ in the sense that it results from an event
for which there is only the opportunity for cost. Events
that contain speculative elements, such as ordinary business
risks, are generally not considered insurable.
- Large Loss. The size of the loss must be
meaningful from the perspective of the insured. Insurance
premiums need to cover both the expected cost of losses,
plus the cost of issuing and administering the policy,
adjusting losses, and supplying the capital needed to
reasonably assure that the insurer will be able to pay
claims. For small losses these latter costs may be several
times the size of the expected cost of losses. There is
little point in paying such costs unless the protection
offered has real value to a buyer.
- Affordable Premium. If the likelihood of an
insured event is so high, or the cost of the event so large,
that the resulting premium is large relative to the amount
of protection offered, it is not likely that anyone will buy
insurance, even if on offer. Further, as the accounting
profession formally recognizes in financial accounting
standards, the premium cannot be so large that there is not
a reasonable chance of a significant loss to the insurer. If
there is no such chance of loss, the transaction may have
the form of insurance, but not the substance. (See the U.S.
Financial Accounting Standards Board
standard number 113)
- Calculable Loss. There are two elements that must
be at least estimable, if not formally calculable: the
probability of loss, and the attendant cost. Probability of
loss is generally an empirical exercise, while cost has more
to do with the ability of a reasonable person in possession
of a copy of the insurance policy and a proof of loss
associated with a claim presented under that policy to make
a reasonably definite and objective evaluation of the amount
of the loss recoverable as a result of the claim.
- Limited risk of catastrophically large losses.
The essential risk is often aggregation. If the same event
can cause losses to numerous policyholders of the same
insurer, the ability of that insurer to issue policies
becomes constrained, not by factors surrounding the
individual characteristics of a given policyholder, but by
the factors surrounding the sum of all policyholders so
exposed. Typically, insurers prefer to limit their exposure
to a loss from a single event to some small portion of their
capital base, on the order of 5
percent. Where the loss can be aggregated, or an
individual policy could produce exceptionally large claims,
the capital constraint will restrict an insurer's appetite
for additional policyholders. The classic example is
earthquake insurance, where the ability of an underwriter to
issue a new policy depends on the number and size of the
policies that it has already underwritten. Wind insurance in
hurricane zones, particularly along coast lines, is another
example of this phenomenon. In extreme cases, the
aggregation can affect the entire industry, since the
combined capital of insurers and reinsurers can be small
compared to the needs of potential policyholders in areas
exposed to aggregation risk. In commercial fire insurance it
is possible to find single properties whose total exposed
value is well in excess of any individual insurer¡¯s capital
constraint. Such properties are generally shared among
several insurers, or are insured by a single insurer who
syndicates the risk into the
reinsurance market.
Indemnification
The technical definition of "indemnity" means to make whole
again. There are two types of insurance contracts;
- an "indemnity" policy and
- a "pay on behalf" or "on behalf of"[3]
policy.
The difference is significant on paper, but rarely material
in practice.
An "indemnity" policy will never pay claims until the insured
has paid out of pocket to some third party; for example, a
visitor to your home slips on a floor that you left wet and sues
you for $10,000 and wins. Under an "indemnity" policy the
homeowner would have to come up with the $10,000 to pay for the
visitor's fall and then would be "indemnified" by the insurance
carrier for the out of pocket costs (the $10,000)[4].
Under the same situation, a "pay on behalf" policy, the
insurance carrier would pay the claim and the insured (the
homeowner) would not be out of pocket for anything. Most modern
liability insurance is written on the basis of "pay on behalf"
language[5].
An entity seeking to transfer risk (an individual,
corporation, or association of any type, etc.) becomes the
'insured' party once risk is assumed by an 'insurer', the
insuring party, by means of a
contract, called an insurance 'policy'. Generally, an
insurance contract includes, at a minimum, the following
elements: the parties (the insurer, the insured, the
beneficiaries), the premium, the period of coverage, the
particular loss event covered, the amount of coverage (i.e., the
amount to be paid to the insured or beneficiary in the event of
a loss), and exclusions (events not covered). An insured is thus
said to be "indemnified"
against the loss covered in the policy.
When insured parties experience a loss for a specified peril,
the coverage entitles the policyholder to make a 'claim' against
the insurer for the covered amount of loss as specified by the
policy. The fee paid by the insured to the insurer for assuming
the risk is called the 'premium'. Insurance premiums from many
insureds are used to fund accounts reserved for later payment of
claims¡ªin theory for a relatively few claimants¡ªand for
overhead costs. So long as an insurer maintains adequate
funds set aside for anticipated losses (i.e., reserves), the
remaining margin is an insurer's
profit.
Insurers' business model
Underwriting and investing
The business model can be reduced to a simple equation:
Profit =
earned premium + investment income - incurred loss -
underwriting expenses.
Insurers make money in two ways:
- Through
underwriting, the process by which insurers select the
risks to insure and decide how much in premiums to charge
for accepting those risks;
- By
investing the premiums they collect from insured
parties.
The most complicated aspect of the insurance business is the
underwriting of policies. Using a wide assortment of data,
insurers predict the likelihood that a claim will be made
against their policies and price products accordingly. To this
end, insurers use
actuarial science to quantify the risks they are willing to
assume and the premium they will charge to assume them. Data is
analyzed to fairly accurately project the rate of future claims
based on a given risk. Actuarial science uses
statistics and
probability to analyze the risks associated with the range
of perils covered, and these scientific principles are used to
determine an insurer's overall exposure. Upon termination of a
given policy, the amount of premium collected and the investment
gains thereon minus the amount paid out in claims is the
insurer's
underwriting profit on that policy. Of course, from the
insurer's perspective, some policies are "winners" (i.e., the
insurer pays out less in claims and expenses than it receives in
premiums and investment income) and some are "losers" (i.e., the
insurer pays out more in claims and expenses than it receives in
premiums and investment income); insurance companies essentially
use actuarial science to attempt to underwrite enough "winning"
policies to pay out on the "losers" while still maintaining
profitability.
An insurer's underwriting performance is measured in its
combined ratio. The loss ratio (incurred losses and
loss-adjustment expenses divided by net earned premium) is added
to the expense ratio (underwriting expenses divided by net
premium written) to determine the company's combined ratio. The
combined ratio is a reflection of the company's overall
underwriting profitability. A combined ratio of less than
100 percent indicates underwriting profitability, while anything
over 100 indicates an underwriting loss.
Insurance companies also earn
investment profits on ¡°float¡±. ¡°Float¡± or available reserve
is the amount of money, at hand at any given moment, that an
insurer has collected in insurance premiums but has not been
paid out in claims. Insurers start investing insurance premiums
as soon as they are collected and continue to earn interest on
them until claims are paid out. The Association of British
Insurers (gathering 400 insurance companies and 94% of UK
insurance services) has almost 20% of the investments in the
London Stock Exchange.[6]
In the
United States, the underwriting loss of
property and
casualty insurance companies was $142.3 billion in the five
years ending 2003. But overall profit for the same period was
$68.4 billion, as the result of float. Some insurance industry
insiders, most notably
Hank Greenberg, do not believe that it is forever possible
to sustain a profit from float without an underwriting profit as
well, but this opinion is not universally held. Naturally, the
¡°float¡± method is difficult to carry out in an economically
depressed period. Bear markets do cause insurers to shift away
from investments and to toughen up their underwriting standards.
So a poor economy generally means high insurance premiums. This
tendency to swing between profitable and unprofitable periods
over time is commonly known as the "underwriting" or
insurance cycle.
[7]
Property and casualty insurers currently make the most money
from their auto insurance line of business. Generally better
statistics are available on auto losses and underwriting on this
line of business has benefited greatly from advances in
computing. Additionally, property losses in the
United States, due to unpredictable natural catastrophes,
have exacerbated this trend.
Claims
Claims and loss handling is the materialized utility of
insurance; it is the actual "product" paid for, though one hopes
it will never need to be used. Claims may be filed by insureds
directly with the insurer or through brokers or agents. The
insurer may require that the claim be filed on its own
proprietary forms, or may accept claims on a standard industry
form such as those produced by
ACORD.
Insurance company claim departments employ a large number of
claims adjusters supported by a staff of
records management and
data entry clerks. Incoming claims are classified based on
severity and are assigned to adjusters whose settlement
authority varies with their knowledge and experience. The
adjuster undertakes a thorough investigation of each claim,
usually in close cooperation with the insured, determines if
coverage is available under the policy terms, what its
reasonable monetary value is, and authorizes payment. Adjusting
liability insurance claims is particularly difficult because
there is a third party involved the claimant(in the event the
claim is escalated to a court setting they are refered to as the
plaintiff) is under no contractual obligation to cooperate with
the insurer and in fact may regard the insurer as a
deep pocket. The adjuster must obtain legal counsel for the
insured (either inside "house" counsel or outside "panel"
counsel), monitor litigation that may take years to complete,
and appear in person or over the telephone with settlement
authority at a mandatory settlement conference when requested by
the judge.
In managing the claims handling function, insurers seek to
balance the elements of customer satisfaction, administrative
handling expenses, and claims overpayment leakages. As part of
this balancing act,
fraudulent insurance practices are a major business risk
that must be managed and overcome. Disputes between insurers and
insureds over the validity of claims or claims handling
practices occasionally escalate into litigation; see
insurance bad faith.
History of
insurance
In some sense we can say that insurance appears
simultaneously with the appearance of human society. We know of
two types of economies in human societies: money economies (with
markets, money, financial instruments and so on) and non-money
or natural economies (without money, markets, financial
instruments and so on). The second type is a more ancient form
than the first. In such an economy and community, we can see
insurance in the form of people helping each other. For example,
if a house burns down, the members of the community help build a
new one. Should the same thing happen to one's neighbour, the
other neighbours must help. Otherwise, neighbours will not
receive help in the future. This type of insurance has survived
to the present day in some countries where modern money economy
with its financial instruments is not widespread.
Turning to insurance in the modern sense (i.e., insurance in
a modern money economy, in which insurance is part of the
financial sphere), early methods of transferring or distributing
risk were practised by
Chinese and
Babylonian traders as long ago as the
3rd and
2nd
millennia BC, respectively.[8]
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 practised by early
Mediterranean sailing
merchants. If a merchant received a loan to fund his
shipment, he would pay the lender an additional sum in exchange
for the lender's guarantee to cancel the loan should the
shipment be stolen or lost at sea.
Achaemenian monarchs of Ancient Persia were the first to
insure their people and made it official by registering the
insuring process in governmental notary offices. The insurance
tradition was performed each year in Norouz (beginning of the
Iranian New Year); the heads of different ethnic groups as well
as others willing to take part, presented gifts to the monarch.
The most important gift was presented during a special ceremony.
When a gift was worth more than 10,000 Derrik (Achaemenian gold
coin) the issue was registered in a special office. This was
advantageous to those who presented such special gifts. For
others, the presents were fairly assessed by the confidants of
the court. Then the assessment was registered in special
offices.
The purpose of registering was that whenever the person who
presented the gift registered by the court was in trouble, the
monarch and the court would help him. Jahez, a historian and
writer, writes in one of his books on
ancient Iran: "[W]henever the owner of the present is in
trouble or wants to construct a building, set up a feast, have
his children married, etc. the one in charge of this in the
court would check the registration. If the registered amount
exceeded 10,000 Derrik, he or she would receive an amount of
twice as much."[1]
A thousand years later, the inhabitants of
Rhodes invented the concept of the 'general
average'. Merchants whose goods were being shipped together
would pay a proportionally divided premium which would be used
to reimburse any merchant whose goods were jettisoned during
storm or sinkage.
The
Greeks and
Romans introduced the origins of health and life insurance
c. 600 AD when they organized guilds called "benevolent
societies" which cared for the
families and paid
funeral expenses of members upon
death.
Guilds in the
Middle Ages served a similar purpose. The
Talmud deals with several aspects of insuring
goods. Before insurance was established in the late 17th
century, "friendly societies" existed in England, in which
people donated amounts of money to a general sum that could be
used for emergencies.
Separate insurance contracts (i.e., insurance policies not
bundled with loans or other kinds of contracts) were invented in
Genoa
in the 14th century, as were insurance pools backed by pledges
of landed estates. These new insurance contracts allowed
insurance to be separated from investment, a separation of roles
that first proved useful in marine insurance. Insurance became
far more sophisticated in post-Renaissance
Europe, and specialized varieties developed.
Some forms of insurance had developed in London by the early
decades of the seventeenth century. For example, the will of the
English colonist
Robert Hayman mentions two "policies of insurance" taken out
with the diocesan Chancellor of London, Arthur Duck. Of the
value of £100 each, one relates to the safe arrival of Hayman's
ship in Guyana and the other is in regard to "one hundred pounds
assured by the said Doctor Arthur Ducke on my life". Hayman's
will was signed and sealed on 17 November 1628 but not proved
until 1633.[9]
Toward the end of the seventeenth century, London's growing
importance as a centre for trade increased demand for marine
insurance. In the late 1680s,
Edward Lloyd opened a coffee house that became a popular
haunt of ship owners, merchants, and ships¡¯ captains, and
thereby a reliable source of the latest shipping news. It became
the meeting place for parties wishing to insure cargoes and
ships, and those willing to underwrite such ventures. Today,
Lloyd's of London remains the leading market (note that it
is not an insurance company) for marine and other specialist
types of insurance, but it works rather differently than the
more familiar kinds of insurance.
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 Insurance Office' in his new
plan for London in 1667."[10]
A number of attempted fire insurance schemes came to nothing,
but in 1681
Nicholas Barbon, and eleven associates, established
England's first fire insurance company, the 'Insurance Office
for Houses', at the back of the Royal Exchange. Initially, 5,000
homes were insured by Barbon's Insurance Office.[11]
The first insurance company in the
United States underwrote fire insurance and was formed in
Charles Town (modern-day
Charleston),
South Carolina, in 1732.
Benjamin Franklin helped to popularize and make standard the
practice of insurance, particularly against
fire
in the form of
perpetual insurance. In 1752, he founded the
Philadelphia Contributionship for the Insurance of Houses from
Loss by Fire. Franklin's company was the first to make
contributions toward fire prevention. Not only did his company
warn against certain
fire hazards, it refused to insure certain buildings where
the risk of fire was too great, such as all wooden houses. In
the United States,
regulation of the insurance industry is highly
Balkanized, with primary responsibility assumed by
individual
state insurance departments. Whereas insurance markets have
become centralized nationally and internationally, state
insurance commissioners operate individually, though at times in
concert through a
national insurance commissioners' organization. In recent
years, some have called for a dual state and federal regulatory
system (commonly referred to as the
Optional federal charter (OFC)) for insurance similar to
that which oversees state banks and national banks.
Types of
insurance
Any risk that can be quantified can potentially be insured.
Specific kinds of risk that may give rise to claims are known as
"perils". An insurance policy will set out in detail which
perils are covered by the policy and which are not. Below are
(non-exhaustive) lists of the many different types of insurance
that exist. A single policy may cover risks in one or more of
the categories set out below. For example, auto insurance would
typically cover both property risk (covering the risk of theft
or damage to the car) and liability risk (covering legal claims
from causing an accident). A
homeowner's insurance policy in the U.S. 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 coverage for
medical expenses of guests who are injured on the owner's
property.
Business insurance can be any kind of insurance that
protects businesses against risks. Some principal subtypes of
business insurance are (a) the various kinds of professional
liability insurance, also called professional indemnity
insurance, which are discussed below under that name; and
(b) the business owner's policy (BOP), which bundles into one
policy many of the kinds of coverage that a business owner
needs, in a way analogous to how homeowners insurance bundles
the coverages that a homeowner needs.[12]
Auto insurance
Auto insurance protects you against financial loss if you
have an accident. It is a contract between you and the insurance
company. You agree to pay the premium and the insurance company
agrees to pay your losses as defined in your policy. Auto
insurance provides property, liability and medical coverage:
- Property coverage pays for damage to or theft of your
car.
- Liability coverage pays for your legal responsibility to
others for bodily injury or property damage.
- Medical coverage pays for the cost of treating injuries,
rehabilitation and sometimes lost wages and funeral
expenses.
An auto insurance policy comprises six kinds of coverage.
Most countries require you to buy some, but not all, of these
coverages. If you're financing a car, your lender may also have
requirements. Most auto policies are for six months to a year.
In the
United States, your insurance company should notify you by
mail when it¡¯s time to renew the policy and to pay your premium.
[13]
Home insurance
Main article:
Home insuranceHome insurance provides compensation for damage or
destruction of a home from disasters. In some geographical
areas, the standard insurances exclude certain types of
disasters, such as flood and earthquakes, that require
additional coverage. Maintenance-related problems are the
homeowners' responsibility. The policy may include inventory, or
this can be bought as a separate policy, especially for people
who rent housing. In some countries, insurers offer a package
which may include liability and legal responsibility for
injuries and property damage caused by members of the household,
including pets.[14]
Health
Health insurance policies by the
National Health Service in the
United Kingdom (NHS) or other publicly-funded health
programs will cover the cost of medical treatments. Dental
insurance, like medical insurance, is coverage for individuals
to protect them against dental costs. In the U.S., dental
insurance is often part of an employer's benefits package, along
with health insurance.
Accident, Sickness and Unemployment Insurance
-
Disability insurance policies provide financial support
in the event the policyholder is unable to work because of
disabling illness or injury. It provides monthly support to
help pay such obligations as
mortgages and
credit cards.
-
Disability overhead insurance allows business owners to
cover the overhead expenses of their business while they are
unable to work.
-
Total permanent disability insurance provides benefits
when a person is permanently disabled and can no longer work
in their profession, often taken as an adjunct to life
insurance.
-
Workers' compensation insurance replaces all or part of
a worker's
wages lost and accompanying medical expenses incurred
because of a job-related injury.
Casualty
Casualty insurance insures against accidents, not necessarily
tied to any specific property.
Life
Main article:
Life insuranceLife insurance provides a monetary benefit to a decedent's
family or other designated beneficiary, and may specifically
provide for income to an insured person's family,
burial,
funeral and other final expenses. Life insurance policies
often allow the option of having the proceeds paid to the
beneficiary either in a lump sum cash payment or an annuity.
Annuities provide a stream of payments and are generally
classified as insurance because they are issued by insurance
companies and regulated as insurance and require the same kinds
of actuarial and investment management expertise that life
insurance requires. 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 complement of life insurance and, from an
underwriting perspective, are the mirror image of life
insurance.
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 annuities and
endowment policies, are financial instruments to accumulate
or
liquidate
wealth when it is needed.
In many countries, such as the U.S. and the UK, the
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.
In U.S., the tax on interest income on life insurance
policies and annuities is generally deferred. However, in some
cases the benefit derived from tax deferral may be offset by a
low return. This depends upon the insuring company, the type of
policy and other variables (mortality, market return, etc.).
Moreover, other income tax saving vehicles (e.g., IRAs, 401(k)
plans, Roth IRAs) may be better alternatives for value
accumulation.
Property
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, inland marine insurance or
boiler insurance.
-
Automobile insurance, known 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 insured's
vehicle itself. Throughout the
United States an auto insurance policy is required to
legally operate a motor vehicle on public roads. In some
jurisdictions, bodily injury compensation for automobile
accident victims has been changed to a
no-fault system, which reduces or eliminates the ability
to sue for compensation but provides automatic eligibility
for benefits. Credit card companies insure against
damage on rented cars.
- Driving School Insurance insurance provides cover
for any authorized driver whilst undergoing tuition,
cover also unlike other motor policies provides cover
for instructor liability where both the pupil and
driving instructor are equally liable in the event of a
claim.
-
Aviation insurance insures against hull, spares,
deductibles, hull wear and liability risks.
-
Boiler insurance (also known as boiler and machinery
insurance or equipment breakdown insurance) insures against
accidental physical damage to equipment or machinery.
-
Builder's risk insurance insures against the risk of
physical loss or damage to property during construction.
Builder's risk insurance is typically written on an "all
risk" basis covering damage due to any cause (including the
negligence of the insured) not otherwise expressly excluded.
Builder's risk insurance is coverage that protects a
person's or organization's insurable interest in materials,
fixtures and/or equipment being used in the construction or
renovation of a building or structure should those items
sustain physical loss or damage from a covered cause.[15]
-
Crop insurance "Farmers use crop insurance to reduce or
manage various risks associated with growing crops. Such
risks include crop loss or damage caused by weather, hail,
drought, frost damage, insects, or disease, for instance."[16]
-
Earthquake insurance is a form of property insurance
that pays the policyholder in the event of an
earthquake that causes damage to the property. Most
ordinary
homeowners insurance policies do not cover earthquake
damage. Most earthquake insurance policies feature a high
deductible. Rates depend on location and the probability
of an earthquake, as well as the
construction of the home.
- A
fidelity bond is a form of casualty insurance that
covers policyholders for losses that they incur as a result
of fraudulent acts by specified individuals. It usually
insures a business for losses caused by the dishonest acts
of its employees.
-
Flood insurance protects against property loss due to
flooding. Many insurers in the U.S. do not provide flood
insurance in some portions of the country. In response to
this, the federal government created the
National Flood Insurance Program which serves as the
insurer of last resort.
- Home insurance or homeowners' insurance: See "Property
insurance".
-
Landlord insurance is specifically designed for people
who own properties which they rent out. Most house insurance
cover in the UK will not be valid if the property is rented
out therefore landlords must take out this specialist form
of home insurance.
-
Marine insurance and marine cargo insurance cover the
loss or damage of ships at sea or on inland waterways, and
of the cargo that may be on them. When the owner of the
cargo and the carrier are separate corporations, marine
cargo insurance typically compensates the owner of cargo for
losses sustained from fire, shipwreck, etc., but excludes
losses that can be recovered from the carrier or the
carrier's insurance. Many marine insurance underwriters will
include "time element" coverage in such policies, which
extends the indemnity to cover loss of profit and other
business expenses attributable to the delay caused by a
covered loss.
-
Surety bond insurance is a three party insurance
guaranteeing the performance of the principal.
-
Terrorism insurance provides protection against any loss
or damage caused by
terrorist activities.
- Volcano insurance is an insurance that covers volcano
damage in Hawaii.
- Windstorm insurance is an insurance covering the damage
that can be caused by hurricanes and tropical cyclones.
Liability
Liability insurance is a very broad superset that covers
legal claims against the insured. Many types of insurance
include an aspect of liability coverage. For example, a
homeowner's insurance policy will normally include liability
coverage which protects the insured in the event of a claim
brought by someone who slips and falls on the property;
automobile insurance also includes an aspect of liability
insurance that indemnifies against the harm that a crashing car
can cause to others' lives, health, or property. The protection
offered by a liability insurance policy is twofold: a legal
defense in the event of a lawsuit commenced against the
policyholder and indemnification (payment on behalf of the
insured) with respect to a settlement or court verdict.
Liability policies typically cover only the negligence of the
insured, and will not apply to results of wilful or intentional
acts by the insured.
- Public
liability insurance covers a business against claims
should its operations injure a member of the public or
damage their property in some way.
-
Directors and officers liability insurance protects an
organization (usually a corporation) from costs associated
with litigation resulting from mistakes made by directors
and officers for which they are liable. In the industry, it
is usually called "D&O" for short.
- Environmental liability insurance protects the insured
from bodily injury, property damage and cleanup costs as a
result of the dispersal, release or escape of pollutants.
- Errors and omissions insurance: See "Professional
liability insurance" under "Liability insurance".
-
Prize indemnity insurance protects the insured from
giving away a large prize at a specific event. Examples
would include offering prizes to contestants who can make a
half-court shot at a basketball game, or a hole-in-one at a
golf tournament.
-
Professional liability insurance, also called
professional indemnity insurance, protects insured
professionals such as architectural corporation and medical
practice against potential negligence claims made by their
patients/clients. Professional liability insurance may take
on different names depending on the profession. For example,
professional liability insurance in reference to the medical
profession may be called malpractice insurance.
Notaries public may take out errors and omissions
insurance (E&O). Other potential E&O policyholders
include, for example, real estate brokers, Insurance agents,
home inspectors, appraisers, and website developers.
Credit
Credit insurance repays some or all of a
loan
when certain things happen to the borrower such as
unemployment,
disability, or
death.
-
Mortgage insurance insures the lender against default by
the borrower. Mortgage insurance is a form of credit
insurance, although the name credit insurance more
often is used to refer to policies that cover other kinds of
debt.
- Many credit cards offer payment protection plans which
are a form of credit insurance.
Other types
-
Collateral protection insurance or CPI, insures property
(primarily vehicles) held as collateral for loans made by
lending institutions.
- Defense Base Act Workers' compensation or DBA Insurance
provides coverage for civilian workers hired by the
government to perform contracts outside the U.S. and Canada.
DBA is required for all U.S. citizens, U.S. residents, U.S.
Green Card holders, and all employees or subcontractors
hired on overseas government contracts. Depending on the
country, Foreign Nationals must also be covered under DBA.
This coverage typically includes expenses related to medical
treatment and loss of wages, as well as disability and death
benefits.
-
Expatriate insurance provides individuals and
organizations operating outside of their home country with
protection for automobiles, property, health, liability and
business pursuits.
- Financial loss insurance or Business Interruption
Insurance protects individuals and companies against various
financial risks. For example, a
business might purchase coverage 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 the failure of a
creditor to pay
money it owes to the insured. This type of insurance is
frequently referred to as "business interruption insurance."
Fidelity bonds and
surety bonds are included in this category, although
these products provide a benefit to a third party (the
"obligee") in the event the insured party (usually referred
to as the "obligor") fails to perform its obligations under
a contract with the obligee.
-
Kidnap and ransom insurance
-
Legal Expenses Insurance covers policyholders against
the potential costs of legal action against an institution
or an individual.
-
Locked funds insurance is a little-known hybrid
insurance policy jointly issued by governments and banks. It
is used to protect public funds from tamper by unauthorized
parties. In special cases, a government may authorize its
use in protecting semi-private funds which are liable to
tamper. The terms of this type of insurance are usually very
strict. Therefore it is used only in extreme cases where
maximum security of funds is required.
- Media Insurance is designed to cover professionals that
engage in film, video and TV production.
- Nuclear incident insurance covers damages resulting from
an
incident involving radioactive materials and is
generally arranged at the national level. See the
Nuclear exclusion clause and for the United States the
Price-Anderson Nuclear Industries Indemnity Act)
-
Pet insurance insures pets against accidents and
illnesses - some companies cover routine/wellness care and
burial, as well.
- Pollution Insurance which consists of first-party
coverage for contamination of insured property either by
external or on-site sources. Coverage for liability to third
parties arising from contamination of air, water, or land
due to the sudden and accidental release of hazardous
materials from the insured site. The policy usually covers
the costs of cleanup and may include coverage for releases
from underground storage tanks. Intentional acts are
specifically excluded.
- Purchase insurance is aimed at providing protection on
the products people purchase. Purchase insurance can cover
individual purchase protection, warranties, guarantees, care
plans and even mobile
phone insurance. Such insurance is normally very limited
in the scope of problems that are covered by the policy.
-
Title insurance provides a guarantee that title to
real property is vested in the purchaser and/or
mortgagee, free and clear of
liens or encumbrances. It is usually issued in
conjunction with a search of the public records performed at
the time of a
real estate transaction.
-
Travel insurance is an insurance cover taken by those
who travel abroad, which covers certain losses such as
medical expenses, loss of personal belongings, travel delay,
personal liabilities, etc.
Insurance financing vehicles
- Fraternal insurance is provided on a cooperative basis
by
fraternal benefit societies or other social
organizations.[17]
-
No-fault insurance is a type of insurance policy
(typically automobile insurance) where insureds are
indemnified by their own insurer regardless of fault in the
incident.
- Protected Self-Insurance is an alternative risk
financing mechanism in which an organization retains the
mathematically calculated cost of risk within the
organization and transfers the catastrophic risk with
specific and aggregate limits to an insurer so the maximum
total cost of the program is known. A properly designed and
underwritten Protected Self-Insurance Program reduces and
stabilizes the cost of insurance and provides valuable risk
management information.
-
Retrospectively Rated Insurance is a method of
establishing a premium on large commercial accounts. The
final premium is based on the insured's actual loss
experience during the policy term, sometimes subject to a
minimum and maximum premium, with the final premium
determined by a formula. Under this plan, the current year's
premium is based partially (or wholly) on the current year's
losses, although the premium adjustments may take months or
years beyond the current year's expiration date. The rating
formula is guaranteed in the insurance contract. Formula:
retrospective premium = converted loss + basic premium ¡Á tax
multiplier. Numerous variations of this formula have been
developed and are in use.
- Formal
self insurance is the deliberate decision to pay for
otherwise insurable losses out of one's own money. This can
be done on a formal basis by establishing a separate fund
into which funds are deposited on a periodic basis, or by
simply forgoing the purchase of available insurance and
paying out-of-pocket. Self insurance is usually used to pay
for high-frequency, low-severity losses. Such losses, if
covered by conventional insurance, mean having to pay a
premium that includes loadings for the company's general
expenses, cost of putting the policy on the books,
acquisition expenses, premium taxes, and contingencies.
While this is true for all insurance, for small, frequent
losses the transaction costs may exceed the benefit of
volatility reduction that insurance otherwise affords.
-
Reinsurance is a type of insurance purchased by
insurance companies or self-insured employers to protect
against unexpected losses.
Financial reinsurance is a form of reinsurance that is
primarily used for capital management rather than to
transfer insurance risk.
-
Social insurance can be many things to many people in
many countries. But a summary of its essence is that it is a
collection of insurance coverages (including components of
life insurance, disability income insurance, unemployment
insurance, health insurance, and others), plus retirement
savings, that requires participation by all citizens. By
forcing everyone in society to be a policyholder and pay
premiums, it ensures that everyone can become a claimant
when or if he/she needs to. Along the way this inevitably
becomes related to other concepts such as the justice system
and the
welfare state. This is a large, complicated topic that
engenders tremendous debate, which can be further studied in
the following articles (and others):
- Stop-loss insurance provides protection against
catastrophic or unpredictable losses. It is purchased by
organizations who do not want to assume 100% of the
liability for losses arising from the plans. Under a
stop-loss policy, the insurance company becomes liable for
losses that exceed certain limits called deductibles.
Some communities prefer to create virtual insurance amongst
themselves by other means than contractual risk transfer, which
assigns explicit numerical values to risk. A number of
religious groups, including the
Amish
and some
Muslim groups, depend on support provided by their
communities when
disasters strike. The risk presented by any given person is
assumed collectively by the community who all bear the cost of
rebuilding lost property and supporting people whose needs are
suddenly greater after a loss of some kind. In supportive
communities where others can be trusted to follow community
leaders, this tacit form of insurance can work. In this manner
the community can even out the extreme differences in
insurability that exist among its members. Some further
justification is also provided by invoking the
moral hazard of explicit insurance contracts.
In the
United Kingdom,
The Crown (which, for practical purposes, meant the
Civil service) did not insure property such as government
buildings. If a government building was damaged, the cost of
repair would be met from public funds because, in the long run,
this was cheaper than paying insurance premiums. Since many UK
government buildings have been sold to property companies, and
rented back, this arrangement is now less common and may have
disappeared altogether.
Insurance
companies
Insurance companies may be classified into two groups:
- Life insurance companies, which sell life
insurance, annuities and pensions products.
- Non-life, General, or Property/Casualty
insurance companies, which sell other types of insurance.
General insurance companies can be further divided into these
sub categories.
- Standard Lines
- Excess Lines
In most countries, life and non-life insurers are subject to
different regulatory regimes and different
tax
and
accounting rules. The main reason for the distinction
between the two types of company is that life, annuity, and
pension business is very long-term in nature ¡ª coverage for life
assurance or a pension can cover risks over many
decades. By contrast, non-life insurance cover usually
covers a shorter period, such as one year.
In the United States, standard line insurance companies are
"mainstream" insurers. These are the companies that typically
insure autos, homes or businesses. They use pattern or
"cookie-cutter" policies without variation from one person to
the next. They usually have lower premiums than excess lines and
can sell directly to individuals. They are regulated by state
laws that can restrict the amount they can charge for insurance
policies.
Excess line insurance companies (also known as Excess and
Surplus) typically insure risks not covered by the standard
lines market. They are broadly referred as being all insurance
placed with non-admitted insurers. Non-admitted insurers are not
licensed in the states where the risks are located. These
companies have more flexibility and can react faster than
standard insurance companies because they are not required to
file rates and forms as the "admitted" carriers do. However,
they still have substantial regulatory requirements placed upon
them. State laws generally require insurance placed with surplus
line agents and brokers not to be available through standard
licensed insurers.
Insurance companies are generally classified as either
mutual or stock companies. Mutual companies are
owned by the policyholders, while stockholders (who may or may
not own policies) own stock insurance companies.
Demutualization of mutual insurers to form stock companies,
as well as the formation of a hybrid known as a mutual holding
company, became common in some countries, such as the United
States, in the late 20th century.
Other possible forms for an insurance company include
reciprocals, in which policyholders 'reciprocate' in
sharing risks, and Lloyd's organizations.
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.
Reinsurance companies are insurance companies that sell
policies to other insurance companies, allowing them to reduce
their risks and protect themselves from very large losses. The
reinsurance market is dominated by a few very large companies,
with huge reserves. A reinsurer may also be a direct writer of
insurance risks as well.
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 a 100%
subsidiary of the self-insured parent 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.
The types of risk that a captive can underwrite for their
parents include property damage, public and product liability,
professional indemnity, employee benefits, employers' liability,
motor and medical aid expenses. The captive's exposure to such
risks may be limited by the use of reinsurance.
Captives are becoming an increasingly important component of
the risk management and risk financing strategy of their parent.
This can be understood against the following background:
- heavy and increasing premium costs in almost every line
of coverage;
- difficulties in insuring certain types of fortuitous
risk;
- differential coverage standards in various parts of the
world;
- rating structures which reflect market trends rather
than individual loss experience;
- insufficient credit for deductibles and/or loss control
efforts.
There are also companies known as 'insurance consultants'.
Like a mortgage broker, these companies are paid a fee by the
customer to shop around for the best insurance policy amongst
many companies. Similar to an insurance consultant, an
'insurance broker' also shops around for the best insurance
policy amongst many companies. However, with insurance brokers,
the fee is usually paid in the form of commission from the
insurer that is selected rather than directly from the client.
Neither insurance consultants nor insurance brokers are
insurance companies and no risks are transferred to them in
insurance transactions. Third party administrators are companies
that perform underwriting and sometimes claims handling services
for insurance companies. These companies often have special
expertise that the insurance companies do not have.
The financial stability and strength of an insurance company
should be a major consideration when buying an insurance
contract. An insurance premium paid currently provides coverage
for losses that might arise many years in the future. For that
reason, the viability of the insurance carrier is very
important. In recent years, a number of insurance companies have
become insolvent, leaving their policyholders with no coverage
(or coverage only from a government-backed insurance pool or
other arrangement with less attractive payouts for losses). A
number of independent rating agencies provide information and
rate the financial viability of insurance companies.
Global
insurance industry
Global insurance premiums grew by 3.4% in 2008 to reach $4.3
trillion. For the first time in the past three decades, premium
income declined in inflation-adjusted terms, with non-life
premiums falling by 0.8% and life premiums falling by 3.5%. The
insurance industry is exposed to the global economic downturn on
the assets side by the decline in returns on investments and on
the liabilities side by a rise in claims. So far the extent of
losses on both sides has been limited although investment
returns fell sharply following the bankruptcy of Lehman Brothers
and bailout of AIG in September 2008. The financial crisis has
shown that the insurance sector is sufficiently capitalised. The
vast majority of insurance companies had enough capital to
absorb losses and only a small number turned to government for
support.
Advanced economies account for the bulk of global insurance.
With premium income of $1,753bn, Europe was the most important
region in 2008, followed by North America $1,346bn and Asia
$933bn. The top four countries generated more than a half of
premiums. The US and Japan alone accounted for 40% of world
insurance, much higher than their 7% share of the global
population. Emerging markets accounted for over 85% of the
world¡¯s population but generated only around 10% of premiums.
Their markets are however growing at a quicker pace.
[18]
Controversies
Religious
concerns
Muslim scholars have varying opinions about insurance.
Insurance policies that earn interest are generally considered
to be a form of
riba[19]
(usury) and some consider even policies that do not earn
interest to be a form of gharar (speculation). Some argue
that gharar is not present due to the actuarial science
behind the underwriting.[20]
Jewish rabbinical scholars also have expressed reservations
regarding insurance as an avoidance of God's will but most find
it acceptable in moderation.[21]
Some Christians believe insurance represents a lack of faith[22]
and there is a long history of resistance to commercial
insurance in
Anabaptist communities (Mennonites,
Amish,
Hutterites,
Brethren in Christ) but many participate in community-based
self-insurance programs that spread risk within their
communities.[23][24][25]
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 might otherwise be (since, by
definition, the insured has transferred the risk to the
insurer), a concept known as
moral hazard. To reduce their own financial exposure,
insurance companies have contractual clauses that mitigate their
obligation to provide coverage if the insured engages in
behavior that grossly magnifies their risk of loss or liability.[citation
needed]
For example, life insurance companies may require higher
premiums or deny coverage altogether to people who work in
hazardous occupations or engage in dangerous sports. Liability
insurance providers do not provide coverage for liability
arising from
intentional torts committed by or at the direction of the
insured. Even if a provider were so irrational as to want 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.[citation
needed]
Complexity of insurance policy contracts
Insurance policies can be complex and some policyholders may
not understand all the fees and coverages included in a policy.
As a result, people may buy policies on unfavorable terms. In
response to these issues, many countries have enacted detailed
statutory and regulatory regimes governing every aspect of the
insurance business, including minimum standards for policies and
the ways in which they may be
advertised and sold.
For example, most insurance policies in the English language
today have been carefully drafted in
plain English; the industry learned the hard way that many
courts will not enforce policies against insureds when the
judges themselves cannot understand what the policies are
saying.
Many institutional insurance purchasers buy insurance through
an insurance broker. While on the surface it appears the broker
represents the buyer (not the insurance company), and typically
counsels the buyer on appropriate coverage and policy
limitations, it should be noted that in the vast majority of
cases a broker's compensation comes in the form of a commission
as a percentage of the insurance premium, creating a conflict of
interest in that the broker's financial interest is tilted
towards encouraging an insured to purchase more insurance than
might be necessary at a higher price. A broker generally holds
contracts with many insurers, thereby allowing the broker to
"shop" the
market for the best rates and coverage possible.
Insurance may also be purchased through an agent. Unlike a
broker, who represents the policyholder, an agent represents the
insurance company from whom the policyholder buys. An agent can
represent more than one company.
An independent insurance consultant advises insureds on a
fee-for-service retainer, similar to an attorney, and thus
offers completely independent advice, free of the financial
conflict of interest of brokers and/or agents. However, such a
consultant must still work through brokers and/or agents in
order to secure coverage for their clients.
Redlining
Redlining is the practice of denying insurance coverage in
specific geographic areas, supposedly because of a high
likelihood of loss, while the alleged motivation is unlawful
discrimination.
Racial profiling or
redlining has a long history in the property insurance
industry in the United States. From a review of industry
underwriting and marketing materials, court documents, and
research by government agencies, industry and community groups,
and academics, it is clear that race has long affected and
continues to affect the policies and practices of the insurance
industry.[26]
In July, 2007, The Federal Trade Commission released a report
presenting the results of a study concerning credit-based
insurance scores and automobile insurance. The study found that
these scores are effective predictors of the claims that
consumers will file.
[2]
All states have provisions in their rate regulation laws or
in their fair trade practice acts that prohibit unfair
discrimination, often called redlining, in setting rates and
making insurance available.[27]
In determining premiums and premium rate structures, insurers
consider quantifiable factors, including location,
credit scores,
gender,
occupation,
marital status, and
education level. However, the use of such factors is often
considered to be unfair or unlawfully
discriminatory, and the reaction against this practice has
in some instances led to political disputes about the ways in
which insurers determine premiums and regulatory intervention to
limit the factors used.
An insurance underwriter's job is to evaluate a given risk as
to the likelihood that a loss will occur. Any factor that causes
a greater likelihood of loss should theoretically be charged a
higher rate. This basic principle of insurance must be followed
if insurance companies are to remain solvent.[citation
needed] Thus, "discrimination" against (i.e.,
negative differential treatment of) potential insureds in the
risk evaluation and premium-setting process is a necessary
by-product of the fundamentals of insurance underwriting. For
instance, insurers charge older people significantly higher
premiums than they charge younger people for term life
insurance. Older people are thus treated differently than
younger people (i.e., a distinction is made, discrimination
occurs). The rationale for the differential treatment goes to
the heart of the risk a life insurer takes: Old people are
likely to die sooner than young people, so the risk of loss (the
insured's death) is greater in any given period of time and
therefore the risk premium must be higher to cover the greater
risk. However, treating insureds differently when there is no
actuarially sound reason for doing so is unlawful
discrimination.
What is often missing from the debate is that prohibiting the
use of legitimate, actuarially sound factors means that an
insufficient amount is being charged for a given risk, and there
is thus a deficit in the system.[citation
needed] The failure to address the deficit may
mean insolvency and hardship for all of a company's insureds.[citation
needed] The options for addressing the deficit
seem to be the following: Charge the deficit to the other
policyholders or charge it to the government (i.e., externalize
outside of the company to society at large).[citation
needed]
Insurance
patents
New assurance products can now be protected from copying with
a
business method patent in the
United States.
A recent example of a new insurance product that is patented
is
Usage Based
auto insurance. Early versions were independently invented
and patented by a major U.S. auto insurance company,
Progressive Auto Insurance (U.S.
Patent 5,797,134) and a Spanish independent inventor,
Salvador Minguijon Perez (EP patent 0700009).
Many independent inventors are in favor of patenting new
insurance products since it gives them protection from big
companies when they bring their new insurance products to
market. Independent inventors account for 70% of the new U.S.
patent applications in this area.
Many insurance executives are opposed to patenting insurance
products because it creates a new risk for them.
The Hartford insurance company, for example, recently had to
pay $80 million to an independent inventor, Bancorp Services, in
order to settle a patent infringement and theft of trade secret
lawsuit for a type of corporate owned life insurance product
invented and patented by Bancorp.
There are currently about 150 new patent applications on
insurance inventions filed per year in the United States. The
rate at which patents have issued has steadily risen from 15 in
2002 to 44 in 2006.
[28]
Inventors can now have their insurance U.S. patent
applications reviewed by the public in the
Peer to Patent program.[29]
The first insurance patent application to be posted was
US2009005522 ¡°Risk assessment company¡±. It was posted on
March 6, 2009. This patent application describes a method for
increasing the ease of changing insurance companies.[30]
The insurance industry and rent seeking
Certain insurance products and practices have been described
as
rent seeking by critics.[citation
needed] That is, some insurance products or
practices are useful primarily because of legal benefits, such
as reducing taxes, as opposed to providing protection against
risks of adverse events. Under United States tax law, for
example, most owners of
variable annuities and
variable life insurance can invest their premium payments in
the stock market and defer or eliminate paying any taxes on
their investments until withdrawals are made. Sometimes this tax
deferral is the only reason people use these products.[citation
needed] Another example is the legal
infrastructure which allows life insurance to be held in an
irrevocable trust which is used to pay an
estate tax while the proceeds themselves are immune from the
estate tax.
