Introduction

In insurance, the insured makes payments called "premiums" to an insurer, and in return is able to claim a payment from the insurer if the insured suffers some kind of loss. This relationship is usually drawn up in a formal legal contract.

In one classic example of insurance, a ship-owner insures a ship and receives payment if the ship is damaged or destroyed. This example is one of the earliest uses and developments of concepts like insurance. Interestingly, ships are now more often insured through risk pooling and spreading organizations such as Lloyd's of London because the loss of a large ship going down is too great for one insurer to accept.

In the case of annuities, such as a pension, similar concepts apply, but in some sense in the reverse. When applied to annuities, the terms risk and loss are somewhat different from traditional insurance as they concern the chances of living beyond life expectancy and the need for income during the period between annuitization and death.

Insurance attempts to quantify risk by pooling together a large number of risks. This makes use of the law of large numbers. As applied to insurance, this means that the greater the number of similar risks, the greater accuracy with which insurers can estimate the overall risk.

For example, many individual people purchase health insurance policies and they each pay a small monthly or yearly premium to an insurance company. When a policyholder gets ill, the insurance company provides money to cover medical treatment. For some individuals the insurance benefits may total far more money than they have ever paid into the insurance policy. Others may never make a claim. When averaged out over all of the people buying policies, value of the claims even out. Insurance companies set their premiums based on their calculated payouts. They plan to take in more money (in premiums and in profit from the float, see below) than they pay out in the end to cover expenses. For-profit insurance companies set their rates to make a profit rather than to break even.

Insurance companies also earn investment profits, because they have the use of the premium money from the time they receive it until the time they need it to pay claims. This money is called the float. When the investments of float are successful, they may earn large profits, even if the insurance company pays out in claims every penny received as premiums. In fact, most insurance companies pay out more money than they receive in premiums. The excess amount that they pay to policyholders is the cost of float. An insurance company will profit if they invest the money at a greater return than their cost of float.

An insurance contract or policy will set out in detail the exact circumstances under which a benefit payment will be made and the amount of the premiums.

History of insurance

Insurance has been an institution of human society for thousands of years, having been practiced by Babylonian traders as long ago as the 2nd millennium BCE. Eventually it was given legal mention in the Code of Hammurabi, and practiced by early Mediterranean sailing merchants. The Greeks and Romans had "benevolent societies" which acted to care for the families and funeral expenses of members upon death. Guilds in the middle ages served a similar purpose. Insurance became much more sophisticated in post-Renaissance Europe, and specialized varieties developed. In America, Benjamin Franklin helped to popularize and make standard the practice of insurance, particularly against fire. The 19th century saw a rise in the government regulation of insurance, and the 20th century saw further specialization and, in the United States, a bit of deregulation that allowed other financial institutions, such as banks, to offer insurance. The ever-increasing ability of science to predict catastrophes of any measure or variety continues to affect the way insurance is conducted.

[ US Health Insurance]

Types of insurance

There are a number of different types of insurance:

• Automobile insurance, also known as Auto insurance, Car insurance and in the UK as Motor insurance, is probably the most common form of insurance and may cover both legal liability claims against the driver and loss of or damage to the vehicle itself.
• Property insurance provides protection against risks to property, such as fire, theft or weather damage. This includes specialized forms of insurance such as fire insurance, flood insurance, earthquake insurance, home insurance or boiler insurance.
• Casualty insurance insures against accidents, not necessarily tied to any specific piece of property.
• Liability insurance covers legal claims against the insured. For example, a doctor may purchase insurance to cover any legal claims against him if he were to make a mistake in treating a patient.
• Financial loss insurance protects individuals and companies against various financial risks. For example, a business might purchase cover to protect it from loss of sales if a fire in a factory prevented it from carrying out its business for a time. Insurance might also cover failure of a creditor to pay money it owes to the insured. Fidelity bonds and surety bonds are included in this category.
• Title insurance provides a guarantee on research done on public records affecting title to real property, usually in conjunction with a search done at the time of a real estate transaction, such as a sale, or a mortgage.
• Health insurance covers medical bills incurred because of sickness or accidents.
• Life insurance provides a benefit to a decedent's family or other designated beneficiary, usually to make up for their loss of his or her income.
• Annuities provide a stream of payments and are generally classified as insurance because they are issued by insurance companies and regulated as insurance. Annuities and pensions that pay a benefit for life are sometimes regarded as insurance against the possibility that a retiree will outlive his or her financial resources. In that sense, they are the opposite of life insurance.
• Credit insurance pays some or all of a loan back when certain things happen to the borrower like unemployment, disability, or death.
• Terrorism insurance
• Political risk insurance can be taken out by businesses with operations in countries in which there is a risk that revolution or other political conditions will result in a loss

A single policy may cover risks in one or more of the above categories. For example, car insurance would typically cover both property risk (covering the risk of theft or damage to the car) and liability risk (covering legal claims from say, causing an accident). A homeowner's insurance policy in the US typically includes property insurance covering damage to the home and the owner's belongings, liability insurance covering certain legal claims against the owner, and even a small amount of health insurance for medical expenses of guests who are injured on the owner's property.

Potential sources of risk that may give rise to claims are known as perils. Examples of perils might be fire, theft, earthquake, hurricane and many other potential risks. An insurance policy will set out in details which perils are covered by the policy and which are not.

[Standard Automobile Insurance ]

Health insurance

Health insurance is one of the most controversial forms of insurance because of the conflict between the need for the insurance company to remain solvent versus the need of its customers to remain healthy, which many view as a basic human right. This conflict exists in a liberal healthcare system because of the unpredictability of how patients respond to medical treatment. Suppose a large number of customers of a particular insurance company were to contract a rare disease costing 100 million dollars to fight for each patient. The insurance company would be faced with the choice of either charging all its future customers astronomical premiums (thus losing customers and going out of business), paying all claims without complaint (thus going out of business) or fighting the customers in an attempt to deny the costly treatment (thus outraging patients and their families, and becoming a target for lawsuits and legislation).

Many countries have made the societal choice to avoid this important conflict by nationalizing the health industry so that doctors, nurses, and other medical workers become state employees, all funded by taxes; or setting up a national health insurance plan that all citizens pay into with tax payments, and which pays private doctors for health care. These national health care systems also have their problems. Many countries have citizen groups which protest bureaucracy and cost-cutting measures that unduly delay medical treatment.

In the United States, health insurance is made more complicated by Federal Medicare/Medicaid programs, which have had the unintended consequence of determining the price of medical procedures. Many suspect that these prices are set independently of medical necessity or actual cost. A physician who refuses to accept a Medicare/Medicaid payment will be banned from accepting any such payments for a number of years, regardless of the reason for rejecting the payment or the amount offered. In either case, this means that private insurers have little incentive to pay more than the government does.

Some common complaints about private health insurance companies are discussed in the health insurance article.

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See Also