Principles of insuranceFrom the point of view of the insurance company there are four general criteria for deciding whether to insure events or not.
1. There must be a larger number of similar objects so the financial outcome of insuring the pool of exposures is predictable. Therefore they can calculate a "fair" premium.
2. The losses have to be accidental and unintentional (i.e., on the insured's part).
3. The losses must be measurable, identifiable in location and time, and definite. An insurer also requires that losses cause economic hardship. This so that the insured has an incentive to protect and preserve the property to minimize the probability that the losses occur.
4. The loss potential to the insurer must be non-catastrophic, i.e., it cannot put the insurance company in financial jeopardy.
Losses must be uncertain of occurrence.The rate and distribution of losses must be predictable: To set premiums insurers must be able to predict losses 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, for instance, 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. Actually, de minimis does not come into play here. The reality is that it costs too much to insure frequent and/or small losses. It is much more cost-effective not to transfer a small loss potential to insurance companies by taking the largest deductible that one can stand (given adequate price reduction). As for filing small claims, if the insurance company is contractually obligated to cover a claim, no matter its size, the customer should file it. This is the difference between deciding before the contract the parameters and after following through.
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 operate at the state level to reimburse insureds whose insurance companies have become insolvent.[1] This program is run by the National Association of Insurance Commissioners (NAIC).[2] In the United Kingdom, the Financial Services Authority (FSA), which regulates all insurance companies, has its own standards of solvency which are legally required to be adhered to.
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 stock are uninsurable. Insurable risks should have accidental and not intentional losses, and they should have economically feasible premiums, meaning that chance of loss must not be too high.
IndemnificationAn 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: the 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 events 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 (i.e., reserves), the remaining margin is an insurer's profit.
Insurer’s business modelProfit = 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 and (2) by investing the premiums they collect from insureds.
The most difficult aspect of the insurance business is the underwriting of policies. Using 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, insurers use actuarial science to quantify the risks they are willing to assume and the premium they will charge to assume them. Data are 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 an insurer's overall exposure. 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. Of course, from the insurer's perspective, some policies are winners (i.e., the insurer pays out less in claims and expenses than it receives in premiums and investment income) and some are losers (i.e., the insurer pays out more in claims and expenses than it receives in premiums and investment income).
An insurer's underwriting performance is measured in its 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, 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 time periods alternating over time cycles is commonly known as the "underwriting" or "insurance" cycle.
Property and casualty 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 exacerbated this trend.
Finally, claims and loss handling is the materialized utility of insurance. 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, insurance fraud is a major business risk that must be managed and overcome.
Gambling analogySome people consider insurance a type of wager (particularly as associated with moral hazard) that is played out over the policy period. The insurance company bets that an insured or its property will not suffer a loss while the insured puts money on the opposite outcome. The difference in the fees paid to the insurance company and the amount for which it 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 because of fires, tornadoes, and other smaller-scale disasters. However, a flood may impact a large percentage of a city and the company might be unable to pay such a large number of claims and become insolvent. For the same reason, losses due to war and earthquakes are generally excluded. In the case of floods and earthquakes (which occur on a smaller scale than war does), homeowners can purchase separate insurance from national companies with larger resources and a greater ability 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: gamblers are risk seekers; insurance buyers are risk avoiders. Gamblers assume a risk that they would not otherwise be exposed to that has the possibility of either a loss or a gain (i.e., a speculative risk). (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, usually economic or familial, that is connected to the insurance—which is a way of restating the insurable interest requirement.) With insurance, an insured is managing risk that it could not otherwise avoid and that 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."
History of insuranceIn some sense we can say that insurance appears simultaneously with appearance of human society. We know of two types of economies in human societies: money economies (with markets, money, financial instruments and so on) and non-money or natural economies (without money, markets, financial instruments and so on). The second type is a more ancient form than the first. In such an economy and community, we can see insurance in the form of people helping each other. For example, if a house burns down, the members of the community help build a new one. Should the same thing happen to one's neighbour, the other neighbours must help. Otherwise, neighbours will not receive help in the future. This type of insurance has survived to the present day in some countries where modern money economy with its financial instruments is not widespread (for example countries in the territory of the former Soviet Union).
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 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 vessel's capsizing. The Babylonians developed a system which was recorded in the famous Code of Hammurabi, c. 1750 BCE, 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. 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 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 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 cared for the families and paidfuneral 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 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.
Toward the end of the seventeenth century, London's growing importance as a center for trade increased demand for marine insurance. In the late 1680s, Mr. 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 not an insurance company) 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 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 for insurance similar to that which oversees state banks and national banks.
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.
Types of insuranceAny risk that can be quantified can potentially be insured. Among the different types of commercially available insurance are:
Automobile insurance, known 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 insured's vehicle itself. Throughout most of the United States an auto insurance policy is required to legally operate a motor vehicle on public roads. In some jurisdictions, bodily injury compensation for automobile accident victims has been changed to a no fault system, which reduces or eliminates the ability to sue for compensation but provides automatic eligibility for benefits. Aviation insurance insures against hull, spares, deductible, hull war and liability risks. Boiler insurance (also known as boiler and machinery insurance or equipment breakdown insurance) insures against accidental physical damage to 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 due to any cause (including the negligence of the insured) not otherwise expressly excluded. Casualty insurance insures against accidents, not necessarily tied to any specific property. Credit insurance repays some or all of a loan back when certain things happen to the borrower such as unemployment, disability, or death. Crime insurance insures 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. Directors and officers liability insurance protects an organization (usually a corporation) from costs associated with litigation resulting from mistakes incurred by directors and officers for which they are liable. In the industry, it is usually called "D&O" for short. 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 the failure of a creditor to pay money it owes to the insured. This type of insurance is frequently referred to as "business interruption insurance." Fidelity bonds and surety bonds are included in this category, although these products provide a benefit to a third party (the "obligee") in the event the insured party (usually referred to as the "obligor") fails to perform its obligations under a contract with the obligee. Health insurance policies will often cover the cost of private medical treatments if the National Health Service in the UK (NHS) or other publicly-funded health programs do not pay for them. It will often result in quicker health care where better facilities are available. Disability insurance policies provide financial support in the event the policyholder is unable to work because of disabling illness or injury. It provides monthly support to help pay such obligations as mortgages and credit cards. Liability insurance covers legal claims against the insured. For example, a homeowner's insurance policy will normally include liability coverage which will protect the insured 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 monetary harm. 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 willful or intentional acts by the insured. Marine cargo insurance covers physical loss or damage to property while in transit via sea or inland waterways. Marine insurance typically refers to coverage of physical damage to the transporting vessel. 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. 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. Life insurance provides a monetary benefit to a decedent's family or other designated beneficiary, and may specifically provide for 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 and 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. 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. 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. 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 covers damages resulting from an incident involving radioactivive materials and is generally arranged at the national level. (For the United States, see the 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 pollutants. Pet insurance insures pets against accidents and illnesses - some companies cover routine/wellness care and burial, as well. 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, in which case it is commonly called errors and omissions insurance and covers a service provider for claims made against him that arise out of the performance of specified professional services. For instance, a web site designer can obtain E&O insurance to cover her 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 provides protection against.
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, 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 because of a job-related injury. A single policy may cover risks in one or more of the categories set forth above. For example, auto insurance would typically cover both property risk (covering the risk of theft or damage to the car) and liability risk (covering legal claims from 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,and hurricane, among many others. An insurance policy will set out in detail which perils are covered by the policy and which are not.
Types of insurance companiesInsurance companies may be classified as
Life insurance companies, which sell life insurance, annuities and pensions products. Non-life or general insurance companies, which sell other types of insurance. 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.
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. 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 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.
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.
Life insurance and savingCertain 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, 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 U.S., 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. A combination of low-cost term life insurance and a higher-return tax-efficient retirement account may achieve better investment return.
Size of global insurance industryGlobal 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, thanks 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%. [citation needed]
Advanced economies account for the bulk of global insurance. With premium income of $1,217 billion in 2004, North America was the most important region, followed by the EU (at $1,198 billion) and Japan (at $492 billion). 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 premiums, 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 $295 billion in 2004 or 9.1% of global premiums. [3]
Financial viability of insurance companiesFinancial stability and strength of an 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 or other arrangement with less attractive payouts for losses). A number of independent rating agencies, such as Best's, Fitch, Standard & Poor's, and Moody's Investors Service, provide information and rate the financial viability of insurance companies.
ControversiesInsurance insulates too muchBy 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). 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 behavior that grossly magnifies their risk of loss or liability.
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 the insured. Even if a provider were so irrational as to desire 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 contractsInsurance 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.
Many institutional insurance purchasers buy insurance through an insurance broker. Brokers represent the buyer (not the insurance company), and typically counsel the buyer on appropriate coverages, policy limitations. 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. An agent can represent more than one company.
RedliningRedlining is the practice of denying insurance coverage in specific geographic areas, purportedly because of a high likelihood of loss, while the alleged motivation is unlawful discrimination.
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. Thus, "discrimination" against (i.e., 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. The failure to address the deficit may mean insolvency and hardship for all of a company's insureds. 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).
Health insuranceHealth 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 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. See health insurance.
Dental insuranceDental insurance, like health insurance, is coverage for individuals to protect them against dental costs. In the U.S., dental insurance is often part of an employer's benefits package, along with health insurance.
Insurance patentsNew insurance 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 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 (EP patent 0700009).
The basic idea of telematic auto insurance is that a driver's behavior is monitored directly while he or she drives and the information is transmitted to the insurance company. The insurance company uses the information to assess the likelihood that a drive will have an accident and adjusts premiums accordingly. A driver who drives great distances at high speeds, for example, will be charged a higher rate than a driver who drives small distances at low speeds.
A British auto insurance company, Norwich Union, has obtained a license to both the Progressive patent and Perez patent. They have made 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, 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.
The insurance industry and rent seekingCertain 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 useful only because of certain 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 people 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 themselves are immune from the estate tax.
Glossary'Combined ratio' = loss ratio + expense ratio. Loss ratio is calculated by dividing the amount of losses (sometimes including loss adjustment expenses) 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.
[Courtesy Wiki]
