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About Insurance


Benefits of Insurance

Peace of mind.
Insurance provides some security or peace of mind from pending loss or catastrophe and improves the efficiency of individual or business decisions by reducing anxieties.

Pays losses.
Insurance supplies the financial aid which permits a family or organization to continue despite an occurrence of a serious loss.

Provides a basis for credit.
Creditors must know that their collateral will not disappear in a fire, windstorm, or other loss, and this security is accomplished by having the borrower purchase proper amounts of insurance for their homes or automobiles.

Stimulates savings.
An insurance premium is basically a prepayment in advance of a potential loss. Insurance encourages all to save so that unfortunate ones who do incur losses can be repaid for their losses. In addition, life insurance builds substantial cash, emergency, or retirement values.

Advantages of specialization.
At most times it is more efficient to let a company that specializes in risk bearing to provide this service, than to do it yourself.

Loss prevention.
Insurance fosters considerable effort to prevent losses. More lives are saved and property values preserved. Examples are fire prevention campaigns and motor vehicle safety research.

Fields of Insurance
The total field of insurance basically emphasizes the difference between social or compulsory government insurance and voluntary or private insurance.

Social insurance is designed to provide a minimum of economic security for large groups of persons and usually administered by federal or state governments. It is concerned primarily with providing basic needs in the event of unfavorable losses resulting from accidental injury, sickness, old age, unemployment, and premature death of the family wage earners.

Social insurance plans include:

• Federal Old-Age Survivors, Disability, and Health Insurance (OASDHI)
• State workers' compensation systems
• Federal-state systems of unemployment compensation
• Medicare programs for the elderly

Voluntary insurance is sought by the insured to meet a recognized need for protection and consists of commercial insurance, cooperative insurance, and voluntary government insurance.

Commercial insurance is the most highly developed of all the forms of available insurance protections. Its motivating force is profit. Two major classifications of commercial insurance are personal insurance and property insurance.

• Personal insurance protects the loss of earning power of persons that result from their death, injury, illness, old age, or loss of employment. Life and health insurance provides these types of protection.
• Property insurance protects the loss arising from the ownership or use of property. This includes damages or destruction of the owners property as well as paying for damages for which the insured is legally liable for injuries to another person and/or damage to their property. Fire, marine, casualty, and surety insurance provides these types of protection.

Cooperative insurance is usually applied to associations operating under hospital, medical, fraternal, employee, or trade-union auspices. Profit is not a motive. Associations are not incorporated or licensed as insurance companies and some of the usual state taxes and regulations do not apply to them. Blue Cross, Blue Shield is the most significant of cooperative insurance.

Voluntary government insurance are designed to benefit the entire community but are used only by those persons who wish to use the available benefits. Examples are insurance of mortgage loans by the Federal Housing Administration and government life insurance administered by the Veterans Administration for members of the armed forces.

History 101
A history of insurance is important in obtaining a proper perspective in understanding the present and to appraise the future of insurance.

Ancient Ideas
Insurance was a part of many ancient civilizations. The Babylonians and Hindus used contracts known as "bottomry" to shift the burden or risk from the owners of ships and cargos to the moneylenders of this venture who agreed to cancel the loan if the ship or cargo was lost during the voyage. If the venture was successful, the owners agreed to pay a high interest on the loan as well as a high charge for the moneylending risk.

The idea of pooling risks were also used. Chinese merchants divided their cargos among several ships for perilous voyages for the purpose of not having any one merchant suffer a total loss of cargo because of one disaster.

The Middle Ages
In the 15th century, Venetians regulated marine insurance contracts. Trade between the Mediterranean civilizations with Europe and the Near East expanded the need to guarantee financial solvency in the event of navigational disasters.

"Underwriters" appeared as a new financial specialist who fixed their names to insurance contracts to accept maritime risks. Lloyd's of London became the best-known center of marine insurance.

The 18th Century
The idea of corporate insurance emerged in 1720 during a period in which speculators and insurers alike failed in a financial panic of widespread repercussions. The result broughtforth restricted charters from the English Parliament to two insurance companies.

Colonial America took ideas from England to form the first of many insurance companies in the United States. Benjamin Franklin organized the first fire insurance company in 1752. The oldest joint stock company was formed in 1794 to do a fire and marine business.

The expanding 1800s
Growth in life insurance companies reflected the beginnings of scientific actuarial mortality tables. As city construction grew fire insurance businesses prospered and the first agency system developed. Disastrous city fires also pointed towards a crucial need for improved building codes and fire-fighting equipment.

State regulation of insurance began about 1850. Solvency and tax revenues were the prime objectives of the new laws through deposit, investment, reserve, and premium tax requirements. Abuses were corrected and mathematical standards improved in many phases of the insurance business.

The 20thCentury
Economic growth affected the rise of insurance as a major business of the 20th century. The expansion of railroads, the advent of the automobile, the mass production techniques, and the changing social consciousness of an affluent society were major factors.

Transportation risks changed as the railroads encountered competition from motortruck and the airline industries. Major developments in casualty insurance were due in part to the rise of workers' compensation insurance, the growth of automobile insurance, and the increase of negligence laws. An affluent society and property value expanded crime insurance needs.

The 21st Century and Beyond
The Internet will play a major roll in they way that insurance is transacted.

How Insurance Works
How does an insurance company assume a large risk for a comparatively small premium payment and then make a payment for a large loss? For example, a life insurance company pays for death claims on policies in which premiums were collected for less than a year. Or a building fire may result in payments of tens of thousands of dollars for premiums paid of a few dollars.

Four concepts help to explain how premium rates are set and how insurance companies manage their cash inflows and outflows to make appropriate payments when losses occur.

1. The insurance equation
   Income that comes in should equal dollars that are paid out is termed as the insurance equation.
   
   Income consists of payments of premium from policyholders, interest, and investment income. Dollars that are paid out consist of losses, expenses, and profits.
   
   Losses are benefit payments made to policyholders based on the insurance contract. In the case of life insurance, insurers are not concerned when a person dies but with how many will die out of a large group each year so that enough premiums can be collected to pay for all losses. In the case of fire losses, insurers are not interested in whether a specific building will burn but in what the ratio of fire losses to the total premium payments will be when a large group of buildings is insured. A part of the premium or the cost of the policy is set based upon the average amount of losses anticipated to be paid including abnormal such as hurricanes, windstorms, and earthquakes.
   
   Expenses are the costs of the insurer of doing business. These costs include salaries, rentals, computer systems and software, supplies, taxes, commissions, etc.
   
   Profits are the leftovers after all of the losses and expenses are paid from income. Profits are either retained by the insurance company to increase surplus and maintain solvency or are distributed to stockholders as compensation for their investment in the company, or both.
   
   Total income must in the long run equal total payments.
   
   
   
2. Probability and Uncertainty
   Insurance shifts the burden of risk or uncertainty from individuals to the insurance company. An insurer is able to reduce the total uncertainty to a reasonable degree of certainty by foreseeing normal losses and estimating the abnormal losses within calculable limits. This is based on probability that measures the chance that a particular event (loss) will occur.
   
   Premiums to be paid by policyholders can then be computed to pay for all losses, expenses, and profits. Some insurers are more successful than others in reducing this uncertainty.
   
   
   
3. Principle of large numbers
   This principle states that on a relative basis, actual results (losses) tend to equal expected or probable results (losses) as the number of independent events increase. Insurers are concerned with the number of times a loss may be expected to occur over a period of time. Certain events (losses) occur with surprising regularity when a large number of instances are observed. Insurers can then utilize past experience to predict future events (losses).
   
   As number of similar risks that are assumed by an insurance company increases, the more accurately losses can be predicted. This in turn helps the insurance company to set appropriate premium rates to cover their losses, expenses, and profits.
   
   
   
4. Adequate statistical data
   In using the mathematical laws of probability, uncertainty, and large numbers, it is apparent that there is a need for adequate statistical data. Unless accurate statistical information is available, predictions will be defective. As a result, carefully compiled statistics are assembled in each field of insurance to accumulate loss occurances as a basis for setting premium rates. For example, mortality tables are used in life insurance to estimate the number of deaths for a given age each year. In automobile insurance, data for many classifications of type and use of cars, territory, and other factors are collected. Proper classifications and use of trends to anticipate losses contribute to the setting of fair and equitable premium rates.
   
   In essence, insurance works by applying mathematical tools in using statistical data on groups to achieve better predictions than can be made by individuals themselves.