Insurance
Insurance, in
law and
economics, is a form of
risk management primarily used to
hedge against the
risk of potential
financial 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 and duty of care.
Losses must be uncertain.
The rate and distribution of losses must be predictable: To set premiums (prices) insurers must be able to estimate them accurately. This is done using the
Law of Large Numbers which states that: The larger the number of
homogenous exposures considered, the more closely the losses reported will equal the underlying probability of loss. If the coverage is unique, the insured will pay a correspondingly higher premium.
Lloyd's of London often accepts unique coverages. (e.g., the insuring of
Tina Turner's legs and
Jennifer Lopez's buttocks)
The loss must be significant: The legal principle of
De minimis dictates that trivial matters are not covered. Furthermore, rational insurance uses existing insurance when the
transaction costs dictate that filing a claim is not rational.
The loss must not be catastrophic: If the insurer is
insolvent, it will be unable to pay the insured. In the United States, there is a system of Guarantee Funds that run at the state level to reimburse insured people whose insurance companies have become insolvent. [
1] This program is run by the National Association of Insurance Commissioners (NAIC). [
2] To avoid catastrophic depletion of their own capital, insurers almost universally purchase
reinsurance to protect them against excessively large accumulations of risk in a single area, and to protect them against large-scale catastrophes.
Additionally, "speculative risks" like those incurred through
gambling or through the purchase of company
stocks are uninsurable.
A property or liability insurance policy is a "personal contract," a "conditional contract," a "unilateral contract," a "contract of adhesion," a "contract of indemnity," and a contract which requires that the person insured have an insurable interest at the time of the insured-against contingency.
Further: An Insurance Contract is one of Uberrima fides. This is a Latin phrase meaning "utmost good faith" (or translated literally, "most abundant faith"). It is the name of a legal doctrine which governs insurance contracts. This means that all parties to an insurance contract must deal in good faith, making a full declaration of all material facts in the insurance proposal. This contrasts with the legal doctrine of caveat emptor (let the buyer beware).
Personal Contract
Property and liability insurance policies cover persons and not property or operations. Although the terms "insured my house" or "insured my motorcycle" are used commonly, they are not technically correct. The contract between the insurer and the insured is a personal contract between an insuring entity and a person(s) based upon their financial, "insurable interest", in the object or liability being insured. In other words, the question of whether payment is due upon the occurrence of a contingency, and how such payment will be measured, depends upon economic loss suffered by the person(s).
Conditional Contract
Property and liability insurance policies are said to be "conditional contracts" because the obligation of the insurer to perform may be conditioned upon the insured satisfying certain conditions.
Unilateral Contract
Only one party is legally bound to contractual obligations after the premium is paid to the insurer. Only the insurer has made a promise of future performance, and only the insurer can be charged with breach of contract.
Contract of Adhesion
Property and liability insurance policies are said to be "contracts of adhesion" because the insurer and insured parties are of unequal bargaining power where the insured party cannot negotiate the terms of the contract and must take the offer of the insurer as made. Importantly, the rule of law regarding "contracts of adhesion" is that any ambiguities resolve in favor of the insured.
Contract of Indemnity
Property and liability insurance policies are said to be "contracts of indemnity" because the purpose of insurance is to indemnify the insuredâ€"that is, to make good a loss that the insured has suffered. The principle of indemnification is that the insured should not profit from the policy. This does not preclude that the insured will suffer some loss. In fact, many policies include a deductible which guarantees that the insured will pay part of each loss himself.
Insurable Interest
Insurable interest is one wherein economic loss would be suffered from an adverse occurrence to the person(s) insured.
A contract of insurance is valid in law only if the insured has an insurable interestâ€"that is, if he has a legally recognized financial relationship with the subject matter of the insurance and stands to lose out if that subject is damaged.
An entity seeking to transfer risk (an individual, corporation, or association of any type) becomes the 'insured' party once risk is assumed by an 'insurer', the insuring party, by means of a
contract, defined as an insurance 'policy'. This
legal contract sets out terms and conditions specifying the amount of coverage (compensation) to be rendered to the insured, by the insurer upon assumption of risk, in the event of a loss, and all the specific perils covered against (
indemnified), for the term of the contract.
When insured parties experience a loss for a specified peril, the coverage entitles the policyholder to make a 'claim' against the insurer for the amount of loss as specified by the policy contract. The
fee paid by the insured to the insurer for assuming the risk is called the 'premium'. Insurance premiums from many clients are used to fund accounts set aside for later payment of claimsâ€"in theory for a relatively few claimantsâ€"and for
overhead costs. So long as an insurer maintains adequate funds set aside for anticipated losses, the remaining margin becomes their
profit.
Profit = Earned Premium + Investment Income - Incurred Loss - Underwriting Expenses.
Insurers make money in two ways. Through
underwriting, the process through which insurers select what risks to insure and decide how much premium to charge for accepting those risks and by investing the premiums they have collected from insureds.
The most difficult aspect of the insurance business is the
underwriting of policies. Based on a wide assortment of data, insurers predict the likelihood that a claim will be made against their policies and price products accordingly. To this end, the industry uses
actuarial science to quantify the risk they are willing to assume. Data is analyzed fairly accurately to project the rate of future claims based on a given risk. Actuarial science uses
statistics and
probability to analyze the risks associated with the range of perils covered, and these scientific principles are used to determine the insurers overall expose. At the end of a given policy, the amount of premium collected minus the amount paid out in claims is the insurer's
underwriting profit.
An insurer's underwriting performance is measured in their combined ratio. The loss ratio (incurred losses and loss-adjustment expenses divided by net earned premium) is added to the expense ratio (underwriting expenses divided by net premium written) to determine the company's combined ratio. The combined ratio is a reflection of the company's overall
underwriting profitability. A combined ratio of less than 100 percent indicates profitability, while anything over 100 indicates a loss.
Insurance companies also earn
investment profits on "float". "Float" or available reserve is the amount of money, at-hand at any given moment, that an insurer has collected in insurance premium but has not been paid out in claims. Insurers start investing insurance premium as soon as it is collected and keeps earning interest on it until claims are paid out.
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, at 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.
Insurers currently make the most money from their auto insurance line of business. Generally better statistics are available on auto losses and underwriting on this line of business has benefited greatly from advances in computing. Additionally, property losses in the US, due to natural catastrophes, have perpetuated this trend.
Some people consider insurance a type of
wager (particularly as associated with
moral hazard) that executes over the policy period. The insurance company bets that you or your property will not suffer a loss while you put money on the opposite outcome. The difference in the fees paid to the insurance company versus the amount for which they can be held liable if an
accident happens is roughly analogous to the odds one might expect when betting on a
racehorse (for example, 10 to 1). For this reason, a number of
religious groups, including the
Amish and some Muslim groups, avoid insurance and instead depend on support provided by their
communities when
disasters strike. This can be thought of as "social insurance," as the risk of any given person is assumed collectively by the community who will all bear the cost of rebuilding. In closed, supportive communities where others can be trusted to step in to rebuild lost property, this arrangement can work.
However, most
societies could not effectively support this type of system, and the system will not work for large risks. For very large risks, Western insurance can also run into difficulties. This is the reason why most U.S.
homeowner's insurance does not cover
floods. A company that sells homeowner's insurance in a given city can accurately estimate the number of claims it would have to pay due to fires,
tornadoes, and other smaller-scale disasters. However, a flood may impact a large percentage of the city and the company might be unable to deal with this. A prime example of this is the flooding in
New Orleans as a result of
Hurricane Katrina. For the same reason, losses due to
war and
earthquakes are generally excluded. In the case of floods and earthquakes (which are smaller-scale than war) homeowners can purchase separate insurance from national companies with larger resources, which are able to distribute the risk across regions rather than individual buildings.
In gaming or gambling, the game is fixed at the start so that the odds are not affected by the players. However, to obtain certain types of insurance, such as fire insurance, policyholders are often required to conduct risk mitigation practices, such as installing
sprinklers and using fireproof building materials to reduce the odds of loss to fire. In addition, after a proven loss, insurers specialize in providing rehabilitation to minimize the total loss.
While insurance is analogous to gambling in terms of risk and reward, the main difference is in the motivation behind the process (risk seeking vs. risk avoidance). When gambling, you are assuming risk that you would not otherwise be exposed to that has the possibility of either a loss or a gain (speculative risk). (Perhaps put differently, in a gambling transaction the relationship between the bettor and the subject is created through the bet itself; for an insurance transaction, there is an exogenous relationship, usual economic or familial, that is connected to the insuranceâ€"which is a way of restating the
insurance interest requirement.) With insurance, you are managing risk that you could not otherwise avoid, and which does not present the possibility of gain (pure risk).
Risk management, the practice of appraising and controlling risk, has evolved as a discrete field of study and practice. Avoiding, mitigating and transferring certain risk creates greater predictability for consumers and business, and allows people and organizations to use risk intelligently to maximize their opportunities.
Historically, gambling has been considered an uninsurable risk. Recent developments, however, have led to the invention and patenting of new types of insurance to protect against gambling losses. An example is United States Patent 6,869,362,
"Method and apparatus for providing insurance policies for gambling losses"Early methods of transferring or distributing risk were practiced by
Chinese and
Babylonian traders as long ago as the
3rd and
2nd millennia BCE respectively. Chinese merchants traveling treacherous river rapids would redistribute their wares across many vessels to limit the loss due to any single capsizing. The Babylonians developed a system which was recorded in the famous
Code of Hammurabi, c. 1750 BC, and practiced 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.
Achaemenian monarchs 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 and when a gift was worth more than 10,000 Derrik (Achaemenian gold coin weighing 8.35-8.42) the issue was registered in a special office. This was advantageous to those 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 aim of registering was that whenever the one who presented the gift registered by the court was in trouble, the monarch and the court would help him or her. Jahez, a historian and writer, writes in one of his books on ancient Iran: "... and whenever 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 jettisoned during storm or sinkage.
The
Greeks and
Romans introduced the origins of health and life insurance c. 600 AD when they organized guilds called "benevolent societies" which acted to care for the
families and
funeral expenses of members upon
death.
Guilds in the
Middle Ages served a similar purpose. The
Talmud deals with several aspects of insuring
goods. Before insurance was established in the late 17th century, "friendly societies" existed in England, in which people donated amounts of money to a general sum that could be used in case of emergency.
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.
Toward the end of the seventeenth century, the growing importance of London as a center for trade led to rising demand for marine insurance. In the late 1680s, Mr. Edward Lloyd opened a coffee house which 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 for marine and other specialist types of insurance, but it works rather differently than the more familiar kinds of insurance.
Insurance as we know it today can be traced to the
Great Fire of London, which in 1666 devoured 13,200 houses. In the aftermath of this disaster
Nicholas Barbon opened an office to insure buildings. In 1680 he established England's first fire insurance company, "The Fire Office," to insure brick and frame homes.
The first insurance company in the
United States provided 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
commissioner's organization. In recent years, some have called for a federal regulatory system for insurance similar to that of the banking industry.
In the State of
New York, which has unique laws in keeping with its stature as a global business center, Attorney General
Eliot Spitzer has been in a unique position to grapple with major national insurance brokerages. Spitzer alleged that
Marsh & McLennan steered business to insurance carriers based on the amount of contingent commissions that could be extracted from carriers, rather than basing decisions on whether carriers had the best deals for clients. Several of the largest commercial insurance brokerages have since stopped accepting contingent commissions and have adopted new business models.
Any risk that can be quantified probably has a type of insurance to protect it. Among the different types of insurance are:
*
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. Over most of the
United States purchasing an auto insurance policy is required to legally operate a motor vehicle on public roads. Recommendations for which policy limits should be used are specified in a number of books. In some jurisdictions, bodily injury compensation for automobile accident victims has been changed to
No Fault systems, which reduce or eliminate the ability to sue for compensation but provide automatic eligibility for benefits.
*
Boiler insurance (also known as Boiler and Machinery insurance or Equipment Breakdown Insurance)
*
Casualty insurance insures against accidents, not necessarily tied to any specific property.
*
Credit insurance pays some or all of a
loan back when certain things happen to the borrower such as
unemployment,
disability, or
death.
*
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.
*
Health insurance covers
medical bills incurred because of
sickness or accidents.
*
Liability insurance covers legal claims against the insured. For example, a homeowner's insurance policy provides the insured with protection in the event of a claim brought by someone who slips and falls on the property, and brings a lawsuit for her injuries. Similarly, a
doctor may purchase liability insurance to cover any legal claims against him if his negligence (carelessness) in treating a patient caused the patient injury and/or monetary harm. The protection offered by a liability insurance policy is two-fold: a legal defense in the event of a lawsuit commenced against the policyholder, plus indemnification (payment on behalf of the insured) with respect to a settlement or court verdict.
*
Life insurance provides a cash benefit to a decedent's family or other designated beneficiary, and may specifically provide for
burial,
funeral and other final expenses.
**
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 complement of life insurance.
*
Total permanent disability insurance 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.
*
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 unauthorised parties. In special cases, a government may authorise its use in protecting semi-private funds which are liable to tamper. Terms of this type of insurance are usually very strict. As such it is only used in extreme cases where maximum security of funds is required.
*
Marine Insurance covers the loss or damage of goods at sea. Marine insurance typically compensates the owner of merchandise for losses sustained from fire, shipwreck, etc., but excludes losses that can be recovered from the carrier.
* Nuclear incident insurance â€" damages resulting from an incident involving radioactivive materials is generally arranged at the national level. (For the United States, see
Price-Anderson Nuclear Industries Indemnity Act.)
*
Environmental Liability Insurance protects the insured from bodily injury, property damage and cleanup costs as a result of the dispersal, release or escape of a pollutant.
*
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.
*
Professional Indemnity Insurance is normally a mandatory requirement for professional practitioners such as Architects, Lawyers, Doctors and Accountants to provide insurance cover against potential negligence claims. Non licensed professionals may also purchase malpractice insurance, it is commonly called Errors and Omissions Insurance and covers a service provider for claims made against them that arise out of the performance of specified professional services. For instance, a web site designer can obtain E&O insurance to cover them for certain claims made by third parties that arise out of negligent performance of web site development services.
*
Property insurance provides protection against risks to property, such as fire,
theft or
weather damage. This includes specialized forms of insurance such as
fire insurance,
flood insurance,
earthquake insurance,
home insurance, inland marine insurance or
boiler insurance.
*
Terrorism insurance*
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 done 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, lost of personal belongings, travel delay, personal liabilities.. etc.
*
Workers' compensation insurance replaces all or part of a worker's
wages lost and accompanying medical expense incurred due to a job-related injury.
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 U.S. typically includes property insurance covering damage to the home and the owner's belongings, liability insurance covering certain legal claims against the owner, and even a small amount of 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.
Insurance companies may be classified as
*
Life insurance companies, who sell life insurance, annuities and pensions products.
*
Non-life or
general insurance companies, who sell other types of insurance.
In most countries, life and non-life insurers are subject to different regulations,
tax and
accounting rules. The main reason for the distinction between the two types of company is that life 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.
Insurance companies are generally classified as either
mutual or
stock companies. This is more of a traditional distinction as true mutual companies are becoming rare. Mutual companies are owned by the policyholders, while stockholders, (who may or may not own policies) own stock insurance companies.
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.
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 terms, 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 industry members); 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 due to the reductions on costs they help create, the ease for insurance risk management and the flexibility for cash flows they generate. Additionally, they may provide coverage of risks which are neither available nor offered in the traditional insurance market at reasonable prices.
The types of risk that a captive can underwrite for the parent include property damage, public and products 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.
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.
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. See
life insurance.
In many countries, such as the U.S. and the UK,
tax law provides that the interest on this cash value is not taxable under certain circumstances. This leads to widespread use of life insurance as a tax-efficient method of
saving as well as protection in the event of early death.
In U.S., interest income of life insurance policy (or annuity) is income tax deferred in general. However, its tax deferred benefit may be offset by a low return in some cases. This depends upon the insuring company, type of policy and other variables (mortality, market return, etc.). In 2000 and 2001 permanent life insurance had the second greatest investment return besides real estate. Also, other income tax saving vehicles (i.e. IRA, 401K or Roth IRA) appear to be better alternatives for value accumulation. Combination of low-cost term life insurance and higher return tax-efficient retirement account can achieve better performance.
Global insurance premiums grew by 9.7% in 2004 to reach $3.3 trillion. This follows 11.7% growth in the previous year. Life insurance premiums grew by 9.8% during the year due to rising demand for annuity and pension products. Non-life insurance premiums grew by 9.4% as premium rates increased. Over the past decade, global insurance premiums rose by more than a half as annual growth fluctuated between 2% and 10%.
Advanced economies account for the bulk of global insurance. With premium income of $1,217bn in 2004, North America was the most important region, followed by the EU ($1,198bn) and Japan ($492bn). The top four countries accounted for nearly two-thirds of premiums in 2004. The United States and Japan alone accounted for a half 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 10% of premiums. The volume of UK insurance business totalled $295bn in 2004 or 9.1% of global premiums. [
3]
Financial stability and strength of the insurance company should be a major consideration when purchasing 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 with less attractive payouts for losses). A number of independent rating agencies, such as Best's, provide information and rate the financial viability of insurance companies.
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 should be (since the insured assumes the risk belongs to the insurer). This problem is known to the insurance industry 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 some kind of behavior that grossly magnifies their risk of loss or liability.
For example, life insurance providers may require higher premiums or deny coverage to people who work hazardous occupations or engage in dangerous sports. Liability insurance providers do not provide coverage for liability arising from
intentional torts committed by the insured. Even if a provider was irrational enough to try 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.
Complexity of insurance policy contracts
Insurance policies can be complex and some policyholders may not understand all the fees, regulation and coverages included in a policy. As a result, people could buy policies at unfavorable terms. In response to these issues, governments often make detailed regulations that set down minimum standards for policies and govern how they may be
advertised and sold.
Many individuals purchase policies through an insurance broker. The broker can counsel the policyholder on which coverage to purchase and limitations of the policy. A broker generally holds contracts with many insurers which allows the broker to "shop" the
market for the best rates and coverage possible.
People may also purchase policies through a "producer" (a seller of insurance). Unlike a broker, who represents the policyholder, a producer represents the insurance company from whom the policyholder buys. A producer can represent more than one company. In the United States, these people are known as "resident producers" in the states where they are licensed. In some states (such as Michigan), insurance brokers are not allowed to operate because the cheapest rates may not be in the best interest of the policyholder.
Redlining
Redlining is the practice of some insurance companies to deny the issuance of coverage in specific geographic areas, with the purported reason of an increased likelihood of risk; the validity of the assessment is often attributed to discrimination.
Evaluation of risk, when an insurer determines a premium or premium rate structure, considers quantifiable factors, including location,
credit scores,
gender,
occupation,
marital status, and
education level. However, the use of these essential factors, whether inappropriately or not, are often considered to be unfair or
discriminatory by some consumers and their advocates, sometimes leading to political disputes about insurers' determination of premiums and possible
government intervention to limit the factors used.
A refutation to this is that the job of an insurance underwriter is to properly categorize a given risk as to the likelihood that the loss will occur. Any factor that causes a greater likelihood of loss should in theory, be charged a higher rate. This is a basic principle of insurance and must be followed for insurance companies or groups to operate properly, even for
non-profit organizations. Thus, discrimination of potential insureds by legitimate factors is central to insurance. Therefore the only thing that can be considered legitimately unfair are practices that
discriminate against a given group without actual factors that show that the group is a higher risk. So, eliminating real factors discriminates against other insureds by forcing them to bear part of the cost of the disallowed perceived factors.
Health insurance
Health insurance, which is coverage for individuals to protect them against medical costs, is a highly charged and political issue in the United States, which does not have socialized health coverage. In theory, the market for health insurance provision should function in a manner similar to other insurance coverages, but the skyrocketing cost of health coverage has disrupted markets around the globe, but perhaps most glaringly in the U.S. Please see
health insurance for a discussion of this category.
Dental insurance
Dental insurance, like health insurance, is coverage for individuals to protect them against dental costs. Dental insurance usually goes hand-in-hand with health insurance, with most people in the United States receiving it included in their health insurance plan from their employer. Along with receiving dental insurance from your employer, there are ways to receive dental insurance through resellers and companies for individuals and families; although this way tends to be too expensive for most people.
Insurance Patents
New insurance products can now be protected from copying with a
business method patent. This may lead to the more rapid introduction of new insurance products as insurance companies will invest more heavily in new product development if they can be reasonably assured that their patents will keep those products from being copied.
A recent example of a new insurance product that is patented is telematic
auto insurance. It was independently invented and patented by a major U.S. auto insurance company,
Progressive Auto Insurance (
U.S. patent 5,797,134) and a Spanish independent inventor, Salvador Minguijon Perez (
European Patent EP0700009B1).
The basic idea of telematic auto insurance is that a driver's behavior is monitored directly while the person drives and this information is transmitted to an insurance company. The insurance company then assesses the risk of that driver having an accident and charges insurance premiums accordingly. A driver that drives a lot of distance at high speed, for example, will be charged a higher rate than a driver that drives small distances at low speed.
A British auto insurance company,
Norwich Union, has taken a license to both the Progressive patent and Perez patent. They have made additional investments in infrastructure and developed a commercial offering called "Pay As You Drive" or PAYD.
Many independent inventors are in favor of patenting new insurance products since it gives them protection from big companies when they bring their new insurance products to market. Independent inventors account for 70% of the new U.S. patent applications in this area.
Many insurance executives are opposed to patenting insurance products because it creates a new risk for them.
The Hartford insurance company, for example, had to recently pay
US$80 million to an independent inventor, Bancorp Services, in order to settle a patent infringement and theft of trade secret lawsuit for a new 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.
(Source: Insurance IP Bulletin, December 15, 2005). Only about 20–30 patents per year, however, are actually issued.
The insurance industry and rent seeking
Certain insurance products and practices have been described as
rent seeking by critics. That is, insurance companies have been alleged to have certain products or practices that are only useful due to certain government laws (especially tax laws), and that the insurance industry in these cases generally adds no economic value but instead supports politicians who will continue the legal regime which gives the insurance company these benefits. For example, in the United States the current tax rules generally allow owners of variable annuities (see
annuity (US financial products) and variable life insurance (see
variable universal life insurance) to invest in the stock market and defer or eliminate paying any taxes until withdrawals are made. Sometimes this tax deferral is the only reason some individuals use these products instead of a mutual fund. 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 itself are immune from the estate tax.
* 'Combined Ratio' = loss ratio + expense ratio. Loss Ratio is calculated by dividing the amount of losses by the amount of earned premium. Expense ratio is calculated by dividing the amount of operational expenses by the amount of earned premium. A lower number indicates a better return on the amount of capital placed at risk by an insurer.
*
Hank Greenberg told his board of directors, "you can't even spell 'insurance'"[
4] (hearsay, April 2005)
*
Cindy Ossias*
False insurance claims*
Financial services (broader industry to which insurance belongs)
*
Intergovernmental Risk Pool*
Uberrima fides*
Insurance hall of fame*
Blackjack for how the term 'insurance' is used in that
casino game
*
Life Insurance - India*
Insurance Services OfficeLists
*
List of insurance topics*
List of finance topics*
List of U.S. insurance companies*
Insurance industry statistics in the world.*
Insurance industry statistics in the U.S.*
Life Insurance in the United States through World War I*
Columbia Encyclopedia: The History of Insurance*
Congressional Research Service (CRS) Reports regarding the U.S. Insurance industry*
The British Library - finding information on the insurance industry (UK bias)*
Insurance in Ancient Iran
