All About Insurance

Insurance, in law and economics, is a form of risk management primarily used to hedge against the risk of a contingent loss. Insurance is defined as the equitable transfer of the risk of a potential loss, from one entity to another, in exchange for a premium. Insurer, in economics, is the company that sells the insurance. Insurance rate is a factor used to determine the amount, called the premium, to be charged for a certain amount of insurance coverage. Risk management, the practice of appraising and controlling risk, has evolved as a discrete field of study and practice.

I. Principles of insurance

Commercially insurable risks typically share seven common characteristics. 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. 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, the actual results are increasingly likely to become close to expected results. There are exceptions to this criterion. Lloyds 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 insurance should, 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 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 (See FAS 113 for example), 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. Calculable Loss. There are two elements that must be at least estimateable, 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%. Where the loss can be aggregated, or an individual policy could produce exceptionally large claims, the capital constraint will restrict an insurers 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

II. Types of insurance

- Assets & revenue insurance

To protect your assets and revenue-generating capacity, here are some of the types of insurance available : Building and contentsCovers the building, contents and stock of your business against fire and other perils such as earthquake, lightning, storms, impact, malicious damage and explosion. BurglaryInsures your business assets against burglary, and is most important for retailers or a business which maintains an unattended premises. Business interruption or loss of profitsCovers you if your business is interrupted through damage to property by fire or other insured perils. Ensures your ongoing expenses are met and anticipated net profit is maintained through a provision of cash flow. Fidelity guaranteeCovers losses resulting from misappropriation by employees who embezzle or steal. Machinery breakdown Protects your business when mechanical and electrical plant and machinery at the work site break down. Motor vehicleIt is compulsory to insure all company or business vehicles for third party injury liability. Many different types of policies are available, so make sure you understand the options before making a decision. There are four basic options : Compulsory third party (injury) - covers you for claims made against you for personal injuries and legal costs arising from the use of your car. You must obtain this insurance to register your car. Third party property damage - covers your liability for damage to another person or to the property of others and your legal costs. It doesn’t include repairs to your own car if you caused an accident. Third party, fire and theft - covers you against the events covered above, as well as fire and theft. It also insures against damage caused if your car was stolen. Comprehensive - covers you for all of the above plus damage caused to your own car by you in an accident. If you're buying a car on an installment basis, financiers will usually insist on this cover.

- People insurance

Insurance cover for you and your employees : Workers CompensationYou must provide accident and sickness insurance for your employees - workers compensation - through an approved insurer. Workers compensation is covered by separate state and territory legislation. Personal accident and illnessIf you are self employed you won’t be covered by workers compensation, so you need to cover yourself for accident and sickness insurance through a private insurer. There are several types of life insurance. Some are investment-type funds where you contribute over a certain time and get back your investment plus interest earnings at the maturity date. Others are designed to cover risk - things that could happen to you. Income protection or disability insurance - covers part of your normal income if you are prevented from working through sickness or accident. Trauma insurance - provides a lump sum when you are diagnosed with one of several specified life threatening illnesses.Term life insurance or whole of life cover - provides your dependents with a lump sum if you die.Total and permanent disability insurance - provides a lump sum only if you are totally and permanently disabled before retirement

- Liability Insurance

Types of liability insurance you need to consider : Public LiabilityPublic liability insurance protects you and your business against the financial risk of being found liable to a third party for death or injury, loss or damage of property or pure economicâl loss resulting from your negligence. Professional Indemnity Professional indemnity insurance protects you from legal action taken for losses incurred as a result of your advice. It provides indemnity cover if your client suffers a loss - either material, financial or physical - directly attributed to negligent acts. Product LiabilityIf you sell, supply or deliver goods, even in the form of repair or service, you may need cover against claims of goods causing injury or damage. Product liability insurance covers damage or injury caused to another business or person by the failure of your product or the product you are selling


III. History Of Insurance

Early instances of insurance.—Forms of insurance were known to the Romans and to some extent were practiced among the Collegia. In certain respects these bodies resembled our benefit societies. For example, they provided for burial and also made some form of provision for promotion among the soldiers in their organizations. In reality, then, they were based on the insurance principle since they accepted from their members a certain stipulated sum and in return agreed to perform certain services. Demosthenes describes marine loans made to the ancient Greeks ; we also have record that insurance existed among the Chinese 2500 years ago. In none of these early instances, however, did insurance reach anything like large proportions. In fact, so far as we know, it entirely disappeared, many centuries passing before there was a revival. It is true that certain laws among the Romans governing annuities necessitated a mortality table, but it was, however, for this sole purpose and apparently not in any sense an insurance matter. Present forms of insurance.—The business of insurance is divided into four main branches : marine insurance, fire insurance, life insurance and casualty insurance. The first three state the form of disaster against which insurance is provided. The fourth—originally accident insurance—includes all forms not embraced in the other three. An idea of the variety of events against which insurance is offered. Marine insurance antedates every other form, its history dating back over seven centuries. It appears to have been practiced in the Mediterranean, and at least one old policy has come down from the thirteenth century, proving that marine insurance was an established practice among the commercial countries of that time. A broad gap exists between that period and the continuous history running back now some four hundred years, but since that time insurance has been an established business among those engaged in maritime adventures. Fire insurance, the second oldest form to become permanently established, dates from the great London fire of 1666. Life insurance followed a little later, although not until 1760 was a company founded on a modern basisCasualty insurance owes its origin to the application of steam to railway travel; its more common name of accident insurance was due to the fact that the first events to be insured against were those of accidents to the person on a railway journey. It originated in England in the first half of the nineteenth century.