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Insurance
In the year 1347, a single contract in Genoa marked the birth of modern insurance, yet the concept of sharing risk had been practiced for millennia before that ink dried. Chinese merchants traveling treacherous river rapids as early as the third millennium BC redistributed their wares across many vessels to limit the loss from any single vessel capsizing, a primitive form of risk pooling that would eventually evolve into complex financial instruments. The Code of Hammurabi, dating back to approximately 1755 BC, already stipulated that a sea captain who saved a ship from total loss was only required to pay one-half the value of the ship to the owner, establishing an early legal framework for marine risk. By the time the Roman jurist Paulus wrote his legal opinion in 235 AD, the Lex Rhodia had established the general average principle, a fundamental rule of marine insurance that required all parties to share the loss if cargo was jettisoned to save a ship. This ancient wisdom was preserved in the Digesta, a codification of laws ordered by Emperor Justinian I between 527 and 565 AD, which included a life table compiled by the Roman jurist Ulpian around 220 AD. Even the Roman Empire had its own version of social insurance, with a burial society collegium established in Lanuvium, Italy, around 133 AD during the reign of Emperor Hadrian, which prescribed rules and membership dues for its members. The Greeks took this further with marine loans, where money was advanced on a ship or cargo to be repaid with large interest if the voyage prospered, but the money was not repaid at all if the ship were lost, effectively making the interest rate high enough to cover the risk of total loss.
The Coffee House Revolution
The transformation of insurance from a merchant's convenience into a societal necessity began in the aftermath of the Great Fire of London in 1666, which devoured more than 13,000 houses and converted the development of insurance from a matter of convenience into one of urgency. Sir Christopher Wren included a site for an Insurance Office in his new plan for London in 1667, reflecting the urgent need for financial protection in the wake of the disaster. In 1681, economist Nicholas Barbon and eleven associates established the first fire insurance company, the Insurance Office for Houses, at the back of the Royal Exchange to insure brick and frame homes, initially covering 5,000 homes. The true engine of modern insurance, however, was found in the coffee houses of London, where Edward Lloyd opened his establishment in the late 1680s. Lloyd's coffee house became the meeting place for parties in the shipping industry wishing to insure cargoes and ships, including those willing to underwrite such ventures. These informal beginnings led to the establishment of the insurance market known as Lloyd's of London and several related shipping and insurance businesses. The first known policy of life insurance was made in the Royal Exchange, London, on the 18th of June 1583, for £383, 6s. 8d. for twelve months on the life of William Gibbons, predating the formal companies that would follow. The Amicable Society for a Perpetual Assurance Office, founded in London in 1706 by William Talbot and Sir Thomas Allen, collected annual premiums from policyholders and paid the nominees of deceased members from a common fund, marking the first company to offer life insurance. Edward Rowe Mores established the Society for Equitable Assurances on Lives and Survivorship in 1762, which was the world's first mutual insurer and pioneered age-based premiums based on mortality rate, laying the framework for scientific insurance practice and development.
Common questions
When was the first modern insurance contract created in Genoa?
The first modern insurance contract was created in Genoa in the year 1347. This single contract marked the birth of modern insurance even though the concept of sharing risk had been practiced for millennia before that ink dried.
Who established the first fire insurance company in London in 1681?
Economist Nicholas Barbon and eleven associates established the first fire insurance company in 1681. They named the organization the Insurance Office for Houses and located it at the back of the Royal Exchange to insure brick and frame homes.
What was the first known life insurance policy and when was it issued?
The first known policy of life insurance was made on the 18th of June 1583 in the Royal Exchange in London. This policy cost £383, 6s. 8d. for twelve months on the life of William Gibbons.
When did Chancellor Otto von Bismarck introduce old age pensions and accident insurance in Germany?
Chancellor Otto von Bismarck introduced old age pensions, accident insurance, and medical care in the 1880s. These measures formed the basis for Germany's welfare state and extended insurance beyond private contracts to national welfare systems.
What is the combined ratio in the insurance industry and what does it measure?
The combined ratio is the ratio of expenses and losses to premiums. It measures underwriting performance with a ratio of less than 100% indicating an underwriting profit.
When was the Global Federation of Insurance Associations formally founded?
The Global Federation of Insurance Associations was formally founded in 2012. It succeeded the International Network of Insurance Associations which became active in 2008 and aims to increase insurance industry effectiveness in providing input to international regulatory bodies.
The science of insurance relies on the precise calculation of risk, a discipline that evolved from ancient life tables to the complex actuarial science used today. In 1851, future U.S. Supreme Court Associate Justice Joseph P. Bradley, once employed as an actuary for the Mutual Benefit Life Insurance Company, submitted an article to the Journal of the Institute of Actuaries detailing an historical account of a Severan dynasty-era life table compiled by the Roman jurist Ulpian. The modern insurance industry operates on the law of large numbers, where a large number of similar exposure units allow insurers to predict losses with accuracy. The premium charged to the policyholder is determined by the expected value of claims, underwriting expenses, operating expenses, and profit, minus the return on investment. Insurers make money in two ways: through underwriting, the process by which insurers select the risks to insure and decide how much in insurance premiums to charge, and by investing the insurance premiums they collect from insured parties. The float, or available reserve, is the amount of money on hand at any given moment that an insurer has collected in insurance premiums but has not paid out in claims. In 2007, U.S. industry profits from float totaled $58 billion, and in a 2009 letter to investors, Warren Buffett wrote, we were paid $2.8 billion to hold our float in 2008. The combined ratio, which is the ratio of expenses and losses to premiums, measures underwriting performance, with a ratio of less than 100% indicating an underwriting profit. The insurance cycle, or underwriting cycle, describes the tendency of the industry to swing between profitable and unprofitable periods over time, often causing insurers to shift away from investments and to toughen up their underwriting standards during economically depressed periods.
The Welfare State
The evolution of insurance extended beyond private contracts to become a cornerstone of national welfare systems, beginning in the 1840s with traditions of welfare programs in Prussia and Saxony. In the 1880s, Chancellor Otto von Bismarck introduced old age pensions, accident insurance, and medical care that formed the basis for Germany's welfare state. In Britain, more extensive legislation was introduced by the Liberal government in the National Insurance Act 1911, which gave the British working classes the first contributory system of insurance against illness and unemployment. This system was greatly expanded after the Second World War under the influence of the Beveridge Report, to form the first modern welfare state. The first company to offer accident insurance was the Railway Passengers Assurance Company, formed in 1848 in England to insure against the rising number of fatalities on the nascent railway system. The first international insurance rule was the York Antwerp Rules for the distribution of costs between ship and cargo in the event of general average, published in 1890 by the Association for the Reform and Codification of the Law of Nations, the forerunner of the International Law Association. In 2008, the International Network of Insurance Associations became active and it has been succeeded by the Global Federation of Insurance Associations, which was formally founded in 2012 to aim to increase insurance industry effectiveness in providing input to international regulatory bodies. The Global Federation of Insurance Associations consists of its 40 member associations and 1 observer association in 67 countries, which companies account for around 89% of total insurance premiums worldwide.
The Claims Process
The true utility of insurance is realized in the claims process, where the actual product is paid for by the policyholder. Claims may be filed by insureds directly with the insurer or through brokers or agents, and the insurer may require that the claim be filed on its own proprietary forms or may accept claims on a standard industry form, such as those produced by ACORD. Insurance company claims departments employ a large number of claims adjusters, supported by a staff of records management and data entry clerks. An adjuster undertakes an investigation of each claim, usually in close cooperation with the insured, determines if coverage is available under the terms of the insurance contract, and authorizes payment. Policyholders may hire their own public adjusters to negotiate settlements with the insurance company on their behalf. Adjusting liability insurance claims is particularly difficult because they involve a third party, the plaintiff, who is under no contractual obligation to cooperate with the insurer and may in fact regard the insurer as a deep pocket. The adjuster must obtain legal counsel for the insured, either inside house counsel or outside panel counsel, monitor litigation that may take years to complete, and appear in person or over the telephone with settlement authority at a mandatory settlement conference when requested by a judge. If a claims adjuster suspects underinsurance, the condition of average may come into play to limit the insurance company's exposure. In managing the claims-handling function, insurers seek to balance the elements of customer satisfaction, administrative handling expenses, and claims overpayment leakages, while also managing the major business risk of fraudulent insurance practices.
The Business of Risk
Insurance companies operate on a subscription business model, collecting premium payments periodically in return for ongoing and/or compounding benefits offered to policyholders. Insurers may use the subscription business model, collecting premium payments periodically in return for ongoing and/or compounding benefits offered to policyholders. The insurance premium is calculated as the expected value of claims plus underwriting expenses plus operating expense plus profit minus return on investment. Insurers make money in two ways: through underwriting, the process by which insurers select the risks to insure and decide how much in insurance premiums to charge for accepting those risks, and by investing the insurance premiums they collect from insured parties. A company with a combined ratio over 100% may nevertheless remain profitable due to investment earnings. The float, or available reserve, is the amount of money on hand at any given moment that an insurer has collected in insurance premiums but has not paid out in claims. Insurers start investing insurance premiums as soon as they are collected and continue to earn interest or other income on them until claims are paid out. The Association of British Insurers, grouping together 400 insurance companies and 94% of UK insurance services, has almost 20% of the investments in the London Stock Exchange. In the United States, the underwriting loss of property and casualty insurance companies was $142.3 billion in the five years ending 2003, but overall profit for the same period was $68.4 billion, as the result of float. Some insurance-industry insiders, most notably Hank Greenberg, do not believe that it is possible to sustain a profit from float forever without an underwriting profit as well, but this opinion is not universally held.
The Many Faces of Coverage
The scope of insurance has expanded to cover virtually every quantifiable risk, from the death of a person to the destruction of a building. Vehicle insurance protects the policyholder against financial loss in the event of an incident involving a vehicle they own, such as in a traffic collision, covering property damage, liability, and medical expenses. Health insurance policies cover the cost of medical treatments, and in most developed countries, all citizens receive some health coverage from their governments, paid through taxation. Disability insurance policies provide financial support in the event of the policyholder becoming unable to work because of disabling illness or injury, providing monthly support to help pay such obligations as mortgage loans and credit cards. Workers' compensation insurance replaces all or part of a worker's wages lost and accompanying medical expenses incurred because of a job-related injury. Life insurance provides a monetary benefit to a decedent's family or other designated beneficiary, and may specifically provide for income to an insured person's family, burial, funeral, and other final expenses. Property insurance provides protection against risks to property, such as fire, theft, or weather damage, including specialized forms such as flood insurance, earthquake insurance, and boiler insurance. Marine insurance and marine cargo insurance cover the loss or damage of vessels at sea or on inland waterways, and of cargo in transit, regardless of the method of transit. Liability insurance is a broad superset that covers legal claims against the insured, including public liability, directors and officers liability, and environmental liability. Cyber-insurance is a business lines insurance product intended to provide coverage to corporations from Internet-based risks, and more generally from risks relating to information technology infrastructure, information privacy, and information governance liability.
The Future of Protection
The insurance industry continues to evolve, adapting to new risks and changing societal needs through innovations in reinsurance, self-insurance, and government programs. Reinsurance companies are insurance companies that provide policies to other insurance companies, allowing them to reduce their risks and protect themselves from substantial losses. The reinsurance market is dominated by a few large companies with huge reserves, and a reinsurer may also be a direct writer of insurance risks as well. Captive insurance companies are limited-purpose insurance companies established with the specific objective of financing risks emanating from their parent group or groups, serving as an in-house self-insurance vehicle. In the United States, the most prevalent form of self-insurance is governmental risk management pools, which are self-funded cooperatives operating as carriers of coverage for the majority of governmental entities today, such as county governments, municipalities, and school districts. Of approximately 91,000 distinct governmental entities operating in the United States, 75,000 are members of self-insured pools in various lines of coverage, forming approximately 500 pools. Although a relatively small corner of the insurance market, the annual contributions to such pools have been estimated up to 17 billion dollars annually. The industry also faces challenges from moral hazard, where the existence of insurance may encourage riskier behavior, and from the need to balance the cost of premiums with the value of protection. Insurers attempt to address carelessness through inspections, policy provisions requiring certain types of maintenance, and possible discounts for loss mitigation efforts. Since about 1996, insurers have begun to take a more active role in loss mitigation, such as through building codes, to prevent disaster losses such as hurricanes. The future of insurance lies in its ability to adapt to new risks, from cyber attacks to climate change, while maintaining the core principle of pooling funds from many insured entities to pay for the losses that some may incur.