What is insurance?
Insurance is a means of protection against financial loss. It is a form of risk management that is primarily used to hedge against the risk of contingent or uncertain loss.
The entity that provides insurance is known as an insurer, insurance company, carrier or underwriter. The person or entity that buys the insurance is called the policyholder, while the person or entity that is covered by the policy is called the insured. Policyholder and insured are often used interchangeably, but they are not necessarily synonymous because coverage can sometimes extend to additional policyholders who did not purchase insurance.
An insurance transaction involves the policyholder assuming a guaranteed, known and relatively small loss in the form of a payment to the insurer (premium) in exchange for the insurer’s promise to indemnify the insured in the event of a covered loss. The loss may or may not be financial, but must be reducible to financial terms. Furthermore, it is usually something in which the insured has an insurable interest based on an ownership, holding or pre-existing relationship.
The insured receives a contract called an insurance policy that details the terms and circumstances under which the insurer will indemnify the insured or his designated beneficiary or assignee. The amount of money charged by the insurer to the policyholder for the coverage specified in the insurance contract is called the premium.
If the insured suffers damage that is potentially covered by the insurance contract, the insured submits a claim to the insurer for processing by the claims adjuster. Mandatory out-of-pocket payments that are required by the policy before the insurer will pay for the insured event are called deductibles (or deductibles if required by the health insurance policy). An insurer can insure its own risk by taking out collateral, with another insurer agreeing to bear some of the risks, particularly if the primary insurer deems the risk too large to bear.
In insurance, a policy is a contract (generally a standard form contract) between the insurer and the policyholder that determines the claims that the insurer is legally obligated to pay. In exchange for an initial payment, known as the premium, the insurer promises to pay for a loss caused by a peril covered by the language of the policy.
Insurance policies are designed to meet specific needs and therefore have many features not found in many other types of policies. Because insurance policies are standard forms, they contain standard language that is similar across a number of different types of insurance policies.
The policy is generally an integrated contract, that is, it includes all the forms associated with the agreement between the insured and the insurer.
History of Insurance
Methods for transferring or spreading risk were practiced by Babylonian, Chinese, and Indian traders as early as the 3rd and 2nd millennia BC. Chinese merchants traveling through treacherous river rapids would redistribute their goods among many vessels to limit losses from one vessel capsizing.
Codex Hammurabi Law 238 (c. 1755–1750 BCE) stipulated that a sea captain, shipkeeper, or charterer who saved a ship from total loss was only required to pay the shipowner half of the ship’s value.
The law of general averages is a basic principle that underlies all insurance. In 1816, archaeological excavations at Minya, Egypt (under the Eyalet of the Ottoman Empire) produced a Nerva-Antonine-era tablet from the ruins of the Temple of Antinone in Antinoöpolis, Aegyptus, which prescribed the rules and membership contributions of a funeral. Society collegium founded in Lanuvius, Italy about 133 AD during the reign of Hadrian (117–138) of the Roman Empire. In 1851 AD, future US Supreme Court Associate Justice Joseph P. Bradley (1870–1892 AD), once employed as an actuary at the Mutual Benefit Life Insurance Company, submitted an article to the Journal of the Institute of Actuaries detailing the historical description of the table of the life of the Severan dynasty, compiled by the Roman jurist Ulpian in about AD 220 during the reign of Elagabalus (218–222), which was also included in the Digesta.
Insurance concepts were also found in 3rd century BCE Hindu scriptures such as Dharmasastra, Arthashastra and Manusmriti. The ancient Greeks had maritime loans. Money was advanced against a ship or cargo to be repaid with heavy interest if the voyage prospered.
However, the money would not be repaid at all if the ship was lost, so the interest rate would be high enough to pay not only for the use of the capital but also for the risk of its loss (fully described by Demosthenes). Loans of this nature have since been common in coastal countries under the name bottomry and respondentia bonds.
Direct marine risk insurance for premiums paid independently of loans began in Belgium around 1300 AD.
In the 14th century, independent insurance contracts (ie policies not linked to loans or other types of contracts) were invented in Genoa, as were insurance funds secured by mortgages of landed estates.
The first known insurance contract dates from Genoa in 1347. In addition, the following century saw the widespread development of marine insurance, and premiums intuitively varied according to risks. These new policies allowed the separation of insurance from investment, a separation of roles that first proved useful in marine insurance.
The earliest known life insurance policy was taken out on the Royal Exchange in London on 18 June 1583 for £383.6s. 8d. twelve months in the life of William Gibbons.
Insurance became much more sophisticated in Enlightenment Europe, where specialized varieties developed.
Property insurance as we know it today can be traced back to the Great Fire of London in 1666, which consumed more than 13,000 houses. The devastating effects of the fire transformed the development of insurance “from a matter of practicality to one of urgency, a change of heart reflected in Sir Christopher Wren’s inclusion of a place for an ‘Insurance Office’ in his new plan for London in 1667.”
A number of attempts at fire insurance schemes failed, but in 1681 the economist Nicholas Barbon and eleven associates established the first fire insurance company, the “House Insurance Office”, at the rear of the Royal Exchange to insure brick houses. Initially, 5,000 households were insured by his insurance company.
At the same time, the first insurance programs were available for underwriting business enterprises. By the end of the seventeenth century, the growth of London as a center of trade was increasing due to the demand for marine insurance. In the late 1780s, Edward Lloyd opened a coffee house that became a meeting place for parties in the shipping industry who wished to insure cargo and ships, including those willing to underwrite such businesses. These informal beginnings led to the establishment of the Lloyd’s of London insurance market and several related shipping and insurance companies.
The first life insurance policies were taken out at the beginning of the 18th century. The first company to offer life insurance was the Amicable Society for a Perpetual Assurance Office, founded in London in 1706 by William Talbot and Sir Thomas Allen. On the same principle, Edward Rowe Mores founded the Society for Equitable Guarantees of Lives and Survivals in 1762.
It was the world’s first mutual insurance company and pioneered age-based premiums based on mortality rates, which laid “the framework for scientific insurance practice and development” and “the foundation of modern life insurance on which all life insurance systems have subsequently been based”.
In the late 1800s, “emergency insurance” became available. The first company to offer accident insurance was the Railway Passengers Assurance Company, founded in 1848 in England to insure against the growing number of fatalities on the nascent railway system.
In the late 19th century, governments began to initiate national insurance programs against sickness and old age. Germany continued the tradition of social programs in Prussia and Saxony, which began as early as the 1840s.
In the 1880s, Chancellor Otto von Bismarck introduced the old-age pensions, accident insurance and medical care that formed the basis of the German welfare state. In Britain, more extensive legislation was introduced by the Liberal government in the National Insurance Act of 1911. This gave the British working classes the first contributory insurance scheme against sickness and unemployment. This system was greatly expanded after the Second World War under the influence of the Beveridge Report, creating the first modern welfare state.