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 Home > By Career > Banking and Finance > Insurance
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In law and economics, insurance is a form of risk management primarily used to hedge
against the risk of a contingent, uncertain loss. Insurance is defined as the equitable
transfer of the risk of a loss, from one entity to another, in exchange for payment.
An insurer is a company selling the insurance; an insured, or policyholder, is the
person or entity buying the insurance policy. The insurance rate is a factor used
to determine the amount to be charged for a certain amount of insurance coverage,
called the premium. Risk management, the practise of appraising and controlling
risk, has evolved as a discrete field of study and practice. The transaction involves
the insured assuming a guaranteed and known relatively small loss in the form of
payment to the insurer in exchange for the insurer's promise to compensate (indemnify)
the insured in the case of a financial (personal) loss. The insured receives a contract,
called the insurance policy, which details the conditions and circumstances under
which the insured will be financially compensated.
Principles
Insurance involves pooling funds from many insured entities (known as exposures)
to pay for the losses that some may incur.
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The insured entities are therefore protected from risk for a fee, with the fee being
dependent upon the frequency and severity of the event occurring. In order to be
insurable, the risk insured against must meet certain characteristics in order to
be an insurable risk. Insurance is a commercial enterprise and a major part of the
financial services industry, but individual entities can also self-insure through
saving money for possible future losses.
Insurability
Risk which can be insured by private companies typically share seven common characteristics:
1. Large number of similar exposure units: Since insurance operates through pooling
resources, the majority of insurance policies are provided for individual members
of large classes, allowing insurers to benefit from the law of large numbers in
which predicted losses are similar to the actual losses. Exceptions include Lloyd's
of London, which is famous for insuring the life or health of actors, sports figures
and other famous individuals. However, all exposures will have particular differences,
which may lead to different premium rates.
2. Definite loss: The loss takes 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.
3. 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 or even purchasing a lottery ticket, are generally not
considered insurable.
4. 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 hardly any point in paying such costs unless the protection
offered has real value to a buyer.
5. 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 the insurance will be purchased,
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
US Financial Accounting Standards Board standard number 113)
6. 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.
7. Limited risk of catastrophically large losses: Insurable losses are ideally independent
and non-catastrophic, meaning that the losses do not happen all at once and individual
losses are not severe enough to bankrupt the insurer; insurers may prefer to limit
their exposure to a loss from a single event to some small portion of their capital
base. Capital constrains insurers' ability to sell earthquake insurance as well
as wind insurance in hurricane zones. In the US, flood risk is insured by the federal
government. 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.
Legal
When a company insures an individual entity, there are basic legal requirements.
Several commonly cited legal principles of insurance include:
1. Indemnity – the insurance company indemnifies, or compensates, the insured in
the case of certain losses only up to the insured's interest.
2. Insurable interest – the insured typically must directly suffer from the loss.
Insurable interest must exist whether property insurance or insurance on a person
is involved. The concept requires that the insured have a "stake" in the loss or
damage to the life or property insured. What that "stake" is will be determined
by the kind of insurance involved and the nature of the property ownership or relationship
between the persons.
3. Utmost good faith – the insured and the insurer are bound by a good faith bond
of honesty and fairness. Material facts must be disclosed.
4. Contribution – insurers which have similar obligations to the insured contribute
in the indemnification, according to some method.
5. Subrogation – the insurance company acquires legal rights to pursue recoveries
on behalf of the insured; for example, the insurer may sue those liable for insured's
loss.
6. Causa proxima, or proximate cause – the cause of loss (the peril) must be covered
under the insuring agreement of the policy, and the dominant cause must not be excluded
7. Principle of loss minimization - In case of any loss or casualty, the asset owner
must attempt to keep the loss to a minimum, as if the asset was not insured.
Indemnification
To "indemnify" means to make whole again, or to be reinstated to the position that
one was in, to the extent possible, prior to the happening of a specified event
or peril. Accordingly, life insurance is generally not considered to be indemnity
insurance, but rather "contingent" insurance (i.e., a claim arises on the occurrence
of a specified event). There are generally two types of insurance contracts that
seek to indemnify an insured:
1. an "indemnity" policy, and
2. a "pay on behalf" or "on behalf of"[4] 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).
Under the same situation, a "pay on behalf" policy, the insurance carrier would
pay the claim and the insured (the homeowner in the above example) would not be
out of pocket for anything. Most modern liability insurance is written on the basis
of "pay on behalf" language.
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: identification
of participating 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 — in theory for a relatively
few claimants — and for overhead costs. So long as an insurer maintains adequate
funds set aside for anticipated losses (called reserves), the remaining margin is
an insurer's profit.
Effects
Insurance can have various effects on society through the way that it changes who
bears the cost of losses and damage. On one hand it can increase fraud, on the other
it can help societies and individuals prepare for catastrophes and mitigate the
effects of catastrophes on both households and societies.
Insurance can influence the probability of losses through moral hazard, insurance
fraud, and preventive steps by the insurance company. Insurance scholars have typically
used morale hazard to refer to the increased loss due to unintentional carelessness
and moral hazard to refer to increased risk due to intentional carelessness or indifference.Insurers
attempt to address carelessness through inspections, policy provisions requiring
certain types of maintenance, and possible discounts for loss mitigation efforts.
While in theory insurers could encourage investment in loss reduction, some commentators
have argued that in practice insurers had historically not aggressively pursued
loss control measures - particularly to prevent disaster losses such as hurricanes
- because of concerns over rate reductions and legal battles. However, since about
1996 insurers began to take a more active role in loss mitigation, such as through
building codes.
Insurers' business model
Underwriting and investing
The business model is to collect more in premium and investment income than is paid
out in losses, and to also offer a competitive price which consumers will accept.
Profit can be reduced to a simple equation: Profit = earned premium + investment
income - incurred loss - underwriting expenses.
Insurers make money in two ways: 1. Through underwriting, the process by which insurers
select the risks to insure and decide how much in premiums to charge for accepting
those risks;
2. By investing the premiums they collect from insured parties. The most complicated
aspect of the insurance business is the actuarial science of ratemaking (price-setting)
of policies, which uses statistics and probability to approximate the rate of future
claims based on a given risk. After producing rates, the insurer will use discretion
to reject or accept risks through the underwriting process.
At the most basic level, initial ratemaking involves looking at the frequency and
severity of insured perils and the expected average payout resulting from these
perils. Thereafter an insurance company will collect historical loss data, bring
the loss data to present value, and compare these prior losses to the premium collected
in order to assess rate adequacy.Loss ratios and expense loads are also used. Rating
for different risk characteristics involves at the most basic level comparing the
losses with "loss relativities" - a policy with twice as many losses would therefore
be charged twice as much. More complex multivariate analyses are sometimes used
when multiple characteristics are involved and a univariate analysis could produce
confounded results. Other statistical methods may be used in assessing the probability
of future losses.
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. Underwriting performance is measured by something called
the "combined ratio"[9] which is the ratio of expenses/losses to premiums. A combined
ratio of less than 100 percent indicates an underwriting profit, while anything
over 100 indicates an underwriting loss. A company with a combined ratio over 100%
may nevertheless remain profitable due to investment earnings.
Insurance companies earn investment profits on "float". Float, or available reserve,
is the amount of money on hand at any given moment that an insurer has collected
in insurance premiums but has not paid out in claims. Insurers start investing insurance
premiums as soon as they are collected and continue to earn interest or other income
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.
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.
Claims
Claims and loss handling is the materialized utility of insurance; it is the actual
"product" paid for. 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 claims 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 an investigation of
each claim, usually in close cooperation with the insured, determines if coverage
is available under the terms of the insurance contract, and if so, the reasonable
monetary value of the claim, and authorizes payment.
The policyholder may hire their own public adjuster to negotiate the settlement
with the insurance company on their behalf. For policies that are complicated, where
claims may be complex, the insured may take out a separate insurance policy add
on, called loss recovery insurance, which covers the cost of a public adjuster in
the case of a claim.
Adjusting liability insurance claims is particularly difficult because there is
a third party involved, the plaintiff, who is under no contractual obligation to
cooperate with the insurer and may in fact 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.
If a claims adjuster suspects under-insurance, the condition of average may come
into play to limit the insurance company's exposure. 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).
Marketing
Insurers will often use insurance agents to initially market or underwrite their
customers. Agents can be captive, meaning they write only for one company, or independent,
meaning that they can issue policies from several companies. Commissions to agents
represent a significant portion of an insurance cost and insurers that sell policies
directly via mass marketing campaigns can offer lower prices. The existence and
success of companies using insurance policy (with higher prices) is likely due to
improved and personalized service.
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: natural
or non-monetary economies (using barter and trade with no centralized nor standardized
set of financial instruments) and more modern monetary economies (with markets,
currency, financial instruments and so on). The former is more primitive and the
insurance in such economies entails agreements of mutual aid. If one family's house
is destroyed the neighbours are committed to help rebuild. Granaries housed another
primitive form of insurance to indemnify against famines. Often informal or formally
intrinsic to local religious customs, 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. 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."
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 deliberately
jettisoned in order to lighten the ship and save it from total loss.
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.
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Some forms of insurance had developed in London by the early decades of the 17th
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.[15] 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 an insurance market rather
than a company) for marine and other specialist types of insurance, but it operates
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."[16] 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.
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, vehicle insurance
would typically cover both the property risk (theft or damage to the vehicle) and
the liability risk (legal claims arising from an accident). A home insurance policy
in the US typically includes coverage for damage to the home and the owner's belongings,
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 take a number of different forms, such as the various kinds
of professional liability insurance, also called professional indemnity (PI), which
are discussed below under that name; and the business owner's policy (BOP), which
packages into one policy many of the kinds of coverage that a business owner needs,
in a way analogous to how homeowners' insurance packages the coverages that a homeowner
needs.
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Lloyd's of London, pictured in 1991,
is one of the world's leading and most
famous insurance markets
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Auto insurance
Auto insurance protects the policyholder against financial loss in the event of
an incident involving a vehicle they own, such as in a traffic collision.
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Coverage typically includes:
1. Property coverage, for damage to or theft of the car;
2. Liability coverage, for the legal responsibility to others for bodily injury
or property damage;
3. Medical coverage, for the cost of treating injuries, rehabilitation and sometimes
lost wages and funeral expenses.
Most countries, such as the United Kingdom, require drivers to buy some, but not
all, of these coverages. When a car is used as collateral for a loan the lender
usually requires specific coverage.
Home insurance
Home insurance provides coverage for damage or destruction of the policyholder's
home. In some geographical areas, the policy may exclude certain types of risks,
such as flood or earthquake, that require additional coverage. Maintenance-related
issues are typically the homeowner's 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.
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The demand for terrorism
insurance surged after 9/11
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Health insurance
Health insurance policies cover the cost of medical treatments. Dental insurance,
like medical insurance, protects policyholders for dental costs. In the US and Canada,
dental insurance is often part of an employer's benefits package, along with health
insurance.
Accident, sickness and unemployment insurance
Workers' compensation, or employers' liability insurance, is compulsory in some
countries
• Disability insurance policies provide financial support in the event of the policyholder
becoming unable to work because of disabling illness or injury. It provides monthly
support to help pay such obligations as mortgage loans and credit cards. Short-term
and long-term disability policies are available to individuals, but considering
the expense, long-term policies are generally obtained only by those with at least
six-figure incomes, such as doctors, lawyers, etc. Short-term disability insurance
covers a person for a period typically up to six months, paying a stipend each month
to cover medical bills and other necessities.
• Long-term disability insurance covers an individual's expenses for the long term,
up until such time as they are considered permanently disabled and thereafter. Insurance
companies will often try to encourage the person back into employment in preference
to and before declaring them unable to work at all and therefore totally disabled.
• 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. It is a broad spectrum of insurance that a number of other types of insurance
could be classified, such as auto, workers compensation, and some liability insurances.
• Crime insurance is a form of casualty insurance that covers the policyholder against
losses arising from the criminal acts of third parties. For example, a company can
obtain crime insurance to cover losses arising from theft or embezzlement.
• Political risk insurance is a form of casualty insurance that can be taken out
by businesses with operations in countries in which there is a risk that revolution
or other political conditions could result in a loss.
Life
Life insurance provides a monetary benefit to a descendant'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, are 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 US 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 the US, 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.
Burial insurance
Burial insurance is a very old type of life insurance which is paid out upon death
to cover final expenses, such as the cost of a funeral. The Greeks and Romans introduced
burial insurance circa 600 AD when they organized guilds called "benevolent societies"
which cared for the surviving families and paid funeral expenses of members upon
death. Guilds in the Middle Ages served a similar purpose, as did friendly societies
during Victorian times.
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Property
This tornado damage to an Illinois home would be considered an "Act of God" for
insurance purposes
Property insurance provides protection against risks to property, such as fire,
theft or weather damage. This may include specialized forms of insurance such as
fire insurance, flood insurance, earthquake insurance, home insurance, inland marine
insurance or boiler insurance. The term property insurance may, like casualty insurance,
be used as a broad category of various subtypes of insurance, some of which are
listed below:
US Airways Flight 1549 was written off after ditching into the Hudson River
• Aviation insurance protects aircraft hulls and spares, and associated liability
risks, such as passenger and third-party liability. Airports may also appear under
this subcategory, including air traffic control and refuelling operations for international
airports through to smaller domestic exposures.
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US Airways Flight 1549 was written off
after ditching into the Hudson River
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• Boiler insurance (also known as boiler and machinery insurance, or equipment breakdown
insurance) insures against accidental physical damage to boilers, 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 arising from 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 an insured peril.
• Crop insurance may be purchased by farmers 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.
• 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
home insurance policies do not cover earthquake damage. Earthquake insurance policies
generally feature a high deductible. Rates depend on location and hence the likelihood
of an earthquake, as well as the construction of the home.
• Fidelity bond is a form of casualty insurance that covers policyholders for losses
incurred as a result of fraudulent acts by specified individuals. It usually insures
a business for losses caused by the dishonest acts of its employees.
Hurricane Katrina caused over $80 billion of storm and flood damage
• Flood insurance protects against property loss due to flooding. Many insurers
in the US do not provide flood insurance in some parts 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, also commonly called hazard insurance, or homeowners insurance
(often abbreviated in the real estate industry as HOI), is the type of property
insurance that covers private homes, as outlined above.
• Landlord insurance covers residential and commercial properties which are rented
to others. Most homeowners' insurance covers only owner-occupied homes.
Fire aboard MV Hyundai Fortune
• Marine insurance and marine cargo insurance cover the loss or damage of vessels
at sea or on inland waterways, and of cargo in transit, regardless of the method
of transit. 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.
• Supplemental natural disaster insurance covers specified expenses after a natural
disaster renders the policyholder's home uninhabitable. Periodic payments are made
directly to the insured until the home is rebuilt or a specified time period has
elapsed.
• Surety bond insurance is a three-party insurance guaranteeing the performance
of the principal.
The demand for terrorism insurance surged after 9/11
• Terrorism insurance provides protection against any loss or damage caused by terrorist
activities. In the US in the wake of 9/11, the Terrorism Risk Insurance Act 2002
(TRIA) set up a federal Program providing a transparent system of shared public
and private compensation for insured losses resulting from acts of terrorism. The
program was extended until the end of 2014 by the Terrorism Risk Insurance Program
Reauthorization Act 2007 (TRIPRA).
• Volcano insurance is a specialized insurance protecting against damage arising
specifically from volcanic eruptions.
• Windstorm insurance is an insurance covering the damage that can be caused by
wind events such as hurricanes.
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 or organization against claims should
its operations injure a member of the public or damage their property in some way.
• Directors and officers liability insurance (D&O) protects an organization (usually
a corporation) from costs associated with litigation resulting from errors made
by directors and officers for which they are liable.
• 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 is business liability insurance for professionals
such as insurance agents, real estate agents and brokers, architects, third-party
administrators (TPAs) and other business professionals.
• 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
(PI), protects insured professionals such as architectural corporations and medical
practitioners 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 medical malpractice insurance.
Credit
Credit insurance repays some or all of a loan when certain circumstances arise 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.
• Accounts Receivable insurance also known as Credit or Trade Credit insurance is
business insurance over the accounts receivables of the insured. The policy pays
the policy holder for covered accounts receivable if the debtor defaults on payment.
Other types
• All-risk insurance is an insurance that covers a wide-range of incidents and perils,
except those noted in the policy. All-risk insurance is different from peril-specific
insurance that cover losses from only those perils listed in the policy In car insurance,
all-risk policy includes also the damages caused by the own driver.
• Bloodstock insurance covers individual horses or a number of horses under common
ownership. Coverage is typically for mortality as a result of accident, illness
or disease but may extend to include infertility, in-transit loss, veterinary fees,
and prospective foal.
• Business interruption insurance covers the loss of income, and the expenses incurred,
after a covered peril interrupts normal business operations.
• Collateral protection insurance (CPI) insures property (primarily vehicles) held
as collateral for loans made by lending institutions.
• Defense Base Act (DBA) insurance provides coverage for civilian workers hired
by the government to perform contracts outside the US and Canada. DBA is required
for all US citizens, US residents, US 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.
• Kidnap and ransom insurance is designed to protect individuals and corporations
operating in high-risk areas around the world against the perils of kidnap, extortion,
wrongful detention and hijacking.
• Legal expenses insurance covers policyholders for the potential costs of legal
action against an institution or an individual. When something happens which triggers
the need for legal action, it is known as "the event". There are two main types
of legal expenses insurance: before the event insurance and after the event insurance.
• 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.
• Livestock insurance is a specialist policy provided to, for example, commercial
or hobby farms, aquariums, fish farms or any other animal holding. Cover is available
for mortality or economic slaughter as a result of accident, illness or disease
but can extend to include destruction by government order.
• Media liability insurance is designed to cover professionals that engage in film
and television production and print, against risks such as defamation.
• 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 US 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 usually takes the form of first-party coverage for contamination
of insured property either by external or on-site sources. Coverage is also afforded
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, and personal liabilities.
Insurance financing vehicles
• Fraternal insurance is provided on a cooperative basis by fraternal benefit societies
or other social organizations.
• 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 × 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):
o National Insurance
o Social safety net
o Social security
o Social Security debate (United States)
o Social Security (United States)
o Social welfare provision
• 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.
Closed community self-insurance
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 — 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. Across the world
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.
Regulatory differences
In the United States, insurance is regulated by the states under the McCarran-Ferguson
Act, with "periodic proposals for federal intervention", and a nonprofit coalition
of state insurance agencies called the National Association of Insurance Commissioners
works to harmonize the country's different laws and regulations.[25] The National
Conference of Insurance Legislators (NCOIL) also works to harmonize the different
state laws.
In the European Union, the Third Non-Life Directive and the Third Life Directive,
both passed in 1992 and effective 1994, created a single insurance market in Europe
and allowed insurance companies to offer insurance anywhere in the EU (subject to
permission from authority in the head office) and allowed insurance consumers to
purchase insurance from any insurer in the EU.
The insurance industry in China was nationalized in 1949 and thereafter offered
by only a single state-owned company, the People's Insurance Company of China, which
was eventually suspended as demand declined in a communist environment. In 1978,
market reforms led to an increase in the market and by 1995 a comprehensive Insurance
Law of the People's Republic of China was passed, followed in 1998 by the formation
of China Insurance Regulatory Commission (CIRC), which has broad regulatory authority
over the insurance market of China.
Controversies
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
9/11 was a major insurance loss, but there were disputes over the World Trade Center's
insurance policy
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. Typically, courts construe ambiguities in insurance
policies against the insurance company and in favor of coverage under the policy.
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. Just as there is a potential conflict of interest with a broker, an agent
has a different type of conflict. Because agents work directly for the insurance
company, if there is a claim the agent may advise the client to the benefit of the
insurance company. It should also be noted that agents generally can not offer as
broad a range of selection compared to an insurance broker.
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.
Limited consumer benefits
Economists and consumer advocates generally consider insurance to be worthwhile
for low-probability, catastrophic losses, but not for high-probability, small losses.
Because of this, consumers are advised to select high deductibles and to not insure
losses which would not cause a disruption in their life. However, consumers have
shown a tendency to prefer low deductibles and to prefer to insure relatively high-probability,
small losses over low-probability, perhaps due to not understanding or ignoring
the low-probability risk.This is associated with reduced purchasing of insurance
against low-probability losses, and may result in increased inefficiencies from
moral hazard.
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. In July,
2007, The Federal Trade Commission (FTC) released a report presenting the results
of a study concerning credit-based insurance scores in automobile insurance. The
study found that these scores are effective predictors of risk. It also showed that
African-Americans and Hispanics are substantially overrepresented in the lowest
credit scores, and substantially underrepresented in the highest, while Caucasians
and Asians are more evenly spread across the scores. The credit scores were also
found to predict risk within each of the ethnic groups, leading the FTC to conclude
that the scoring models are not solely proxies for redlining. The FTC indicated
little data was available to evaluate benefit of insurance scores to consumers.[32]
The report was disputed by representatives of the Consumer Federation of America,
the National Fair Housing Alliance, the National Consumer Law Center, and the Center
for Economic Justice, for relying on data provided by the insurance industry. 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. 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 US auto insurance company, Progressive Auto Insurance (U.S.
Patent 5,797,134) and a Spanish independent inventor, Salvador Minguijon Perez (EP
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 US 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.
Inventors can now have their insurance US patent applications reviewed by the public
in the Peer to Patent program.[36] 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.
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.
Religious concerns
Muslim scholars have varying opinions about insurance. Insurance policies that earn
interest are generally considered to be a form ofriba (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.
Jewish rabbinical scholars also have expressed reservations regarding insurance
as an avoidance of God's will but most find it acceptable in moderation. Some Christians
believe insurance represents a lack of faith 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.
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