Insurance
Insurance is the business of providing protection against financial aspects of risk, such as those to property, life, health and legal liability. It is one method of a greater concept known as risk management.
In insurance, the insured makes payments called "premiums" to an insurer, and in return is able to claim a payment from the insurer if the insured suffers some kind of loss. This relationship is almost always formally drawn up in a legal contract.
A classical example of insurance is where a shipowner could insure a ship, and receive payment if the ship is damaged or destroyed. This example comes from some of the earliest uses and developments of concepts like insurance. Interestingly, ships are now more often insured through risk pooling and spreading organizations such as Lloyds of London, because the loss of a large ship going down is too great for one insurer to accept.
In the case of a pension the terms 'risk' and 'loss' are somewhat inappropriate, they concern the chances of living beyond retirement from gainful employment and the need for income during the period between retirement and death.
Insurance spreads risk by pooling together a large number of risks. For example, many individual people purchase health insurance policies. They each pay a small monthly or yearly premium to the insurance company, and then when a policy holder gets ill, the insurance company will provide money to cover medical treatment. For some individuals receiving insurance benefits this may total far more money than they have ever paid into the insurance policy themselves. Others may never make a claim. When averaged out over all of the people buying policies it evens out. Insurance companies set their premiums based on their calculated payouts, aiming to take in more money than they pay out in the long run to cover expenses and, in the case of for-profit insurance companies, to make a profit.
Insurance companies also earn investment profits, because they have the use of the premium money from the time they receive it until the time they need it to pay claims. This money is referred to as "float". When the investments of float are successful, they may earn large profits, even if every penny received as premiums is eventually paid out in claims. As a matter of fact, most insurance companies pay out more money than they take in. The excess amount that they pay to policy holders is referred to as the 'cost of float'. An insurance company will profit if they invest the money at a greater return than their cost of float.
An insurance contract or "policy" will set out in detail the exact circumstances in which a benefit payment will be made and the amount of the premiums.
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2 Types of insurance 3 Types of insurance companies 4 Life insurance and saving 5 Criticisms of the Insurance Industry |
Insurance has been an institution of human society for thousands of years, having been practiced by Babylonian traders as long ago as the 2nd millennium BCE. Eventually it was given legal mention in the Code of Hammurabi, and practiced by early Mediterranean sailing merchants. The Greeks and Romans had "benevolent societies" which acted to care for the families and funeral expenses of members upon death. Guilds in the middle ages served a similar purpose, and were also precursor to trade unions. Insurance became much more sophisticated in post-Renaissance Europe, and specialized varieties developed. In America Benjamin Franklin helped to popularize and make standard the practice of insurance, particularly against fire. The 19th century saw a rise in the government regulation of insurance, and the 20th century saw further specialization and, in the United States, a bit of deregulation which allowed other financial institutions, such as banks, to offer insurance. The ever-increasing ability of science to predict catastrophes of any measure or variety continues to affect the way insurance is conducted.
There are a number of different types of insurance:
Potential sources of risk that may give rise to claims are known as perils. Examples or perils might be fire, theft, earthquake, hurricane and many other potential risks. An insurance policy will set out in detail which perils are covered by the policy and which are not.
Insurance companies may be classified as
Companies may sell both life and non life insurance, in which case they are sometimes known as composite insurance companies.
Reinsurance companies sell insurance cover to other insurance companies. This helps insurance companies to spread their risks, and protects them from very large losses. The reinsurance market is dominated by a few very large companies, with huge reserves.
As well as paying out a sum of money on death, many life insurance contracts also pay out a sum of money after a given time (in which case it is known as an endowment policy), and may also pay out a cash value if the policy is cancelled early. In many countries, such as the US and the UK, tax law provides that the interest on this cash value is not taxable.
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. Wealthy individuals buy life insurance policies as a means for avoiding income taxes and estate taxes.
If the tax benefit exceeds the fees charged by the insurance company for maintaining the policy, then the policy serves as a life insurance tax shelter. There is much controversy surrounding this practice, and the financial industry is deeply divided about whether or not these practices work as advertised.
Insurance policies can be complex, and a lot of policyholders, especially poorer ones, do not understand all the fees included in a policy. As a result, people may buy policies at unfavorable terms. In response to these issues, governments often make detailed regulations which set down minimum standards for policies and govern how they may be advertised and sold.
Location is one of the variables used to set rates. This is considered unfair by many. Insurers are also starting to use credit "scores" to set rates.
Many countries have made the societal choice to avoid this important conflict by nationalizing the health industry so that doctors, nurses, and other medical workers become state employees, all funded by taxes; or setting up a national health insurance plan that all citizens pay into with tax payments, and which pays private doctors for health care. These national health care systems have their problems, too, however; many countries have citizen groups which protest bureaucracy and cost-cutting measures that delay medical treatment unduly.
In the United States, health insurance is made more complicated by Federal Medicare/Medicaid programs, which have had the unintended consequence of determining the price of medical procedures. Many suspect that these prices are set independent of medical necessity or actual cost. A physician who refuses to accept a Medicare/Medicaid payment will be banned from accepting any such payments for a number of years, regardless of the reason for rejecting the payment or the amount offered. In either case, this means that private insurers have little incentive to pay more than the government does.
Some common complaints about private health insurance companies include:
History of Insurance
Types of insurance
A single policy may cover risks in one or more of the above categories. For example, car insurance would typically cover both property risk (covering the risk of theft or damage to the car) and liability risk (covering legal claims from say, causing an accident). A homeowner's insurance policy in the US typically includes property insurance covering damage to the home and the owner's belongings, liability insurance covering certain legal claims against the owner, and even a small amount of health insurance for medical expenses of guests who are injured on the owner's property.Types of insurance companies
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 - cover for life assurance or a pension can cover risks over many decades. By contrast, non-life insurance cover usually covers shorter periods, such as one year.Life insurance and saving
Criticisms of the Insurance Industry
Lack of knowledge of Policyholders
Redlining
Health Insurance
Health insurance is one of the most controversial forms of insurance because of the conflict between the need for the insurance company to remain solvent versus the need of its customers to remain healthy, which many view as a basic human right. This conflict exists, in a liberal healthcare system, because of the unpredictability of how patients respond to medical treatment; hypothetically, if a large number of customers of a particular insurance company were to contract a rare disease costing 100 million dollars to fight for each patient, then the insurance company would be faced with the choice of either charging all its future customers astronomical premiums (thus losing customers and going out of business); paying all claims without complaint (thus going out of business); or fighting the customers in an attempt to deny the costly treatment (thus outraging patients and their families, and becoming a target for lawsuits and legislation).