Insurance Introduction

Insurance, legal contract that protects people from the financial costs that result from loss of life, loss of health, lawsuits, or property damage. Insurance provides a means for individuals and societies to cope with some of the risks faced in everyday life. People purchase contracts of insurance, called policies, from a variety of insurance organizations.
Almost everyone living in modern, industrialized countries buys insurance. For instance, laws in most states require people who own a car to buy insurance before driving it on public roads. Lenders require anyone who finances the purchase of a home or car with borrowed money to insure that property. Business partners take out life insurance on each other to make sure the business will succeed even if one of the partners dies.
Insurance makes up part of the broader financial services industry (see Finance). In the United States in the late-1990s, more than 5500 insurance companies offered a wide range of policies and services. Some large companies sell virtually every type of insurance available in the marketplace. Smaller companies may specialize in a specific geographic region or type of insurance. In 1997 more than 300 Canadian companies sold some form of insurance.

In life, losses are sometimes unavoidable. People may become ill and lose income or savings to pay off medical bills. Individuals or their relatives may die of illness or accidents. People’s homes or other property may suffer damage or theft. People also may accidentally cause injury to others or damage to the property of others.
No one knows in advance when a loss will occur or how serious that loss will be. The uncertainty surrounding potential losses is known as risk. Insurance offers a way for people to replace risk with known costs—the costs of buying and maintaining insurance policies.
Assume a person buys a new car for $25,000. Its owner faces the possibility that, at some point, the car will suffer damage in an accident. But how could the owner budget in advance for a loss of unknown cost? The cost to repair or replace the car in the event of an accident could range from the price of a bottle of touch-up paint to as much as $25,000. If the accident injures someone, the costs of medical care could be much higher. Through the mechanism of insurance, however, the car owner can share the risk of an accident with others who face the same risk.
Insurance pools (combines) risks shared by many people, thereby reducing the risks faced by a group. People pay to buy insurance coverage (protection from risk). In exchange, all policyholders (people who own insurance policies) receive a promise that the group of policyholders—as represented by the insurance organization—will pay when any policyholder experiences a covered loss.
The reduction in risk brought by insurance relies on a mathematical concept called the law of large numbers. That law states that the ability to predict losses improves with larger groups. Using calculations based on statistics, experts known as actuaries can accurately predict the losses of a large population, even without knowing when or how any one individual will experience loss.
Insurers distinguish between two types of risk: speculative risk and pure risk. Speculative risk offers both the potential for gain and the potential for loss. People who invest in the stock of companies, for example, take speculative risk. An increase in stock prices produces a gain, while a decline in stock prices produces a loss. Pure risk, by contrast, creates the potential only for loss. Although pure risks do not necessarily result in losses, they never result in gains.
Historically, insurance dealt only with pure risks, and most people still buy insurance to cover pure risks. No one, for instance, experiences a gain when they go a full year without an auto accident. However, some insurance companies now help businesses finance large losses including those incurred on speculative risks, such as the international exchange of currency. Also, in the 1990s financial markets and some professions outside insurance, such as the field of environmental impact and damage assessment, began to expand into risk management for the first time.

Insurance benefits society by allowing individuals to share the risks faced by many people. But it also serves many other important economic and societal functions. Because insurance is available and affordable, banks can make loans with the assurance that the loan’s collateral (property that can be taken as payment if a loan goes unpaid) is covered against damage. This increased availability of credit helps people buy homes and cars. Insurance also provides the capital that communities need to quickly rebuild and recover economically from natural disasters, such as tornadoes or hurricanes.
Insurance itself has become a significant economic force in most industrialized countries. Employers buy insurance to cover their employees against work-related injuries and health problems. Businesses also insure their property, including technology used in production, against damage and theft. Because it makes business operations safer, insurance encourages businesses to make economic transactions, which benefits the economies of countries. In addition, millions of people work for insurance companies and related businesses. In 1996 more than 2.4 million people worked in the insurance industry in the United States and Canada.
Insurance companies perform a type of monetary redistribution—they collect premiums and eventually redistribute that money as payments. Depending on the type of insurance, redistribution can take anywhere from a few months to many decades. Because of this delay between collecting and paying out funds, insurance companies invest their funds to bring in extra revenues. Such investments help businesses and governments finance their operations, and profits from those investments support the operations of insurance companies. With these investment earnings, insurance companies can keep rates much lower than would otherwise be possible.
Not all effects of insurance are positive ones. The possibility of earning insurance payments motivates some people to attempt to cause damage or losses. Without the possibility of collecting insurance benefits, for instance, no one would think of arson, the willful destruction of property by fire, as a potential source of money.

To help individuals and businesses manage risk, providers of insurance must have ways of determining what kinds and degrees of risk different people and businesses face. To do this, insurers rely on the basic principle of grouping together similar risks. By examining the risks faced by a variety of individuals and businesses, insurers can establish common risk profiles (patterns of characteristics). With this information, an insurer can quickly determine what kind of insurance to offer someone applying for a policy, and how much it will cost to insure that person’s risks.
Every insurer employs underwriters to assess the insurance risk posed by applicants for insurance, and to group applicants into classes based on similar risk profiles. For example, companies that insure cars and their drivers categorize teenage drivers as a class separate from older drivers. Studies have shown that teenagers have many times more crashes than other age groups.
Individuals or businesses whose profiles indicate a statistically average class of risk or lower can usually easily qualify for insurance at reasonable prices. Those whose profiles indicate higher than average risk must pay higher prices for insurance, or they may have a difficult time getting insured at all. When applicants present too much risk, all insurance companies may decline to insure them.

An insurance policy covers the insured party (known also as the insured or the policyholder) for a specified period of time, called a term. When choosing an insurance policy, a person must decide what type of coverage to buy. This means deciding at what dollar amount of loss the coverage will begin (known as the deductible) and at what amount coverage ends (known as the policy limit). Both influence the cost of a policy, which is expressed as the price of a regular, repeated payment (known as the premium).
Different types of insurance policies provide different amounts of coverage. They also provide coverage in different ways. Some policies, such as life insurance, determine an amount of coverage in advance. An insurance company pays the full amount of such a policy, called its face value, whenever a covered loss occurs. Most other types of insurance policies determine how much to pay according to what kinds of losses policyholders experience. Such policies specify a maximum amount they will pay. For example, a policy covering a home against fire for $100,000 would pay for damages up to $100,000, but no more.

Policy Term
Policy terms commonly range from six months to many years. At the end of that term, the seller and buyer may agree to renew the contract if they wish. Only permanent life insurance does not specify a finite term. These policies, also called ordinary life insurance or whole life insurance, commit the insurance company to provide coverage for the lifetime of the person insured.

Policy Limit
Insurance policies also specify an amount at which coverage ends, known as the policy limit. Most types of insurance specify the limit as a dollar amount written in the contract. For example, an automobile insurance policy with $10,000 of collision coverage pays up to $10,000 for damage caused by an accident. For property insurance, the policy limit may not exceed the value of the property, which may either be a fixed amount or an amount based on figures such as the costs of replacing property.

Insurance policies generally include an initial amount of expense that an insured person must pay when a loss occurs. This expense is known as the policy’s deductible. The deductible is the amount of loss a policyholder agrees to pay without protection from an insurance company.
Selecting a $500 deductible on auto insurance, for instance, equals an agreement to pay up to $500 for damage to a car in the event of an accident. Under such an agreement, the insurance company will pay for losses exceeding $500. Therefore, if someone holding such a policy has an accident costing $1000 to repair, the insurance company will pay $500 toward that repair.
The premium for an insurance policy varies according to the level of its deductible. For example, a policy with a $500 deductible costs less than one with a $250 deductible, because the lower the deductible, the more the insurance company has to pay for a loss.

An insurance company sets a policy’s premium by multiplying a rate for each unit of insurance coverage by the total amount of coverage being purchased. Assume, for example, that term life insurance for 35-year-old men has a rate of $1.10 for $1000 of coverage for one year. Based on this rate, a 35-year-old father who wants $500,000 of coverage to protect his family in the case of his death will pay a premium of $1.10 times 500, or $550 for one year of coverage. Most people pay insurance premiums once or twice a year. Other people choose to make automatic monthly payments to their insurance company from a bank account.
Actuaries, experts in determining insurance rates, compute insurance rates using information not available to consumers. To compute rates, they first estimate expected losses in the coming year, based on statistics from previous years. Next they figure how much money will be needed to pay for those losses. They then divide that amount by the number of people needing insurance protection.
Consider, for example, the risks faced by 1000 people, each of whom just purchased a $25,000 car. Using statistics from past losses, an insurance company predicts that 10 of the 1000 cars will be destroyed in accidents during the next year, and 65 will be damaged. The company estimates that payments to cover the damage and destruction to these 75 cars will cost a total of $450,000. If the company collects $450 that year from each of the 1000 car owners, it should have almost exactly the funds it needs to cover those 75 out of 1000 car owners who experience losses.
In this example, each car owner would actually have to pay more than $450 to support part of the costs of the insurance company’s operations, leave some profit for the company, and leave some room for error in the company’s estimates. Also, 925 of the people who buy the insurance will have no accidents and will make no claims. Their payments will go to cover the losses of the 75 people who have accidents. But since none of the 1000 car owners knows whether or not they will have an accident, they each agree to pay the premium, even though it may go toward paying for a portion of someone else’s losses.
Although this example of computing premiums appears fairly simple, real life examples prove far more complicated. For instance, different cars have different repair costs. Car owners drive different distances and have different driving habits. Each accident can result in a different kind and degree of damage. In addition, car insurance policies typically cover much more than just damage to the driver’s automobile. By U.S. state laws, for instance, drivers generally must have some coverage for damage they cause to other cars and for medical care for other drivers and passengers injured in an accident. Taking all of these factors into consideration, the task of determining insurance rates becomes quite complex. Actuaries use statistical calculations and computer programs to make these computations.

Although policies often set coverage as a fixed amount, the value of most items or services covered by insurance changes. When someone acquires a new car, for instance, it depreciates (loses part of its value) over time. Other items, such as houses and jewelry, may appreciate (increase in value). Insurance policies can include inflation protection for very valuable items, such as houses, to allow coverage to match such increases in value.
The value of damaged property can be difficult to determine. Insurance policies often contain a promise to pay the value of an item at the time of its damage or loss, also known as its actual cash value. Publicly available resources, such as used automobile price guides, track the average market value of some used items. Insurance policies may also allow the replacement of used items with comparable used items, such as used cars purchased from classified advertisements or used car dealers.
For most types of destroyed property insurance usually covers the actual cash value of the damaged item toward the price of a new replacement. The policyholder must pay the difference. Assume, for example, that a refrigerator lasts 15 years on average. If a house fire destroys a five-year-old refrigerator, its owner loses two-thirds of the appliance’s use—that is, two-thirds of its total value. An insurance policy covering the actual cash value of the property will pay two-thirds of the cost of a new refrigerator.
Replacing used property with new items, especially in larger losses such as house fires, can create considerable financial burdens. To relieve property owners of the risks posed by large unexpected expenditures, many policies offer an option to purchase replacement cost coverage. This option, which increases a policy’s premium, pays the full cost to replace used property with new items in the event of a loss.

Insured individuals who have suffered losses and want to receive payments must notify their insurance company through a process called a claim. Insurance contracts always contain a condition that the insured must provide a proof of loss in order to be paid.
A claim begins when someone who suffers a loss completes and signs a statement describing exactly what happened that led to the loss. Most insurance claims require additional supporting evidence as well. For example, a person filing a life insurance claim must provide a copy of the policyholder’s death certificate. For a health or disability claim, the insured typically must provide a doctor’s report. Someone claiming damage to an automobile usually has to provide a repair estimate to the insurance company.
Once someone files a claim and provides necessary evidence, the insurance company’s claims representative, known commonly as a claims adjuster or claims service representative, reviews it. A claims representative verifies that a claimant (person filing a claim) is entitled to the payment requested.
First, the claims representative verifies that the claimant actually purchased an insurance policy from the company and paid a premium that covered the time period when the loss occurred. For example, if a policyholder misses payments, allowing a policy to expire, the insurer would make no payments on claims made after the policy’s expiration.
The claims representative also verifies that the terms agreed upon in the policy cover the specific claim, including the particular events that caused a loss. For example, standard policies to insure people’s homes generally cover damage from such natural events as lightning and storms. However, they do not cover damage from floods or earthquakes (those kinds of coverage are sold separately). Ultimately, careful claims processing assures that other members of a claimant’s insurance group pay out as little as possible in premiums to adequately cover valid claims.

People face many choices when buying insurance policies. They commonly choose an insurance provider based on several criteria. Some of the most important of these include: (1) the financial stability of the insurance company, (2) the price of policies, and (3) details of coverage and service.
Only a financially sound company can fulfill its promise to pay in all circumstances. Companies with proven records of stability can provide insurance security. Choice of a provider based solely on price, on the other hand, may result in poor service and coverage, even if the provider advertises comprehensive coverage and high quality service.
Policy prices vary significantly among companies, but competition usually forces most companies’ prices into a narrow range. The greater cost of some policies may pay off in the long run through better protection. Thus, a detailed examination of coverage in policies provided by different, well-regarded companies can help consumers make the best choice based on the risks they face, their needs, and their finances.
People seeking to buy insurance often use the services of an insurance agent or broker to assist in their purchase. Precisely what services these intermediaries provide, and what they can charge, varies somewhat from state to state in the United States and among provinces in Canada. But insurance agents and brokers typically help people choose among the hundreds of policies available and among the hundreds of companies that provide insurance. Some people, however, choose to buy insurance from direct providers, who sell policies without intermediaries. Direct-provider insurance may be purchased through the mail, by telephone, or via computer on the Internet.

Providers of insurance may organize themselves in several different ways. In some societies, people informally group together and pool their funds to help each other in times of need. Some much larger, formal insurance organizations work in much the same way. Others operate for profit.

Stock Insurance Companies
Some insurance providers, such as Allstate Insurance Company, operate as corporations, the form of organization common to many large businesses that operate for profit. These kinds of insurance organizations, called stock insurance companies, sell stock to shareholders whose investment provides the capital for company operations. Stock insurance companies represent the largest number of insurance companies in operation, and nearly all newly formed insurance companies.

Mutual Insurance Companies
Historically, individuals seeking to share risk joined together without the motivation of earning profits. This principle carries on today in mutual insurance companies. Everyone who purchases insurance from a mutual company owns a small piece of that company. In contrast to the first small mutual insurance associations, however, today’s large mutual companies, such as State Farm insurance companies and Northwestern Mutual Life, compete against stock companies for business and generally operate much like those companies. Mutuals have boards of directors elected by policyholders, and excess income goes back to policyholders as dividends.

Reciprocals, Lloyd’s Associations, and Cooperatives
Other forms of insurance organizations include reciprocals, Lloyd’s associations, and cooperatives. These organizations serve an important role in making insurance available to specialized businesses. Most reciprocals and Lloyd’s associations do not sell insurance to individuals.
In reciprocal insurance organizations, also known as reciprocal exchanges or interinsurance exchanges, each policyholder is directly insured by all the others. Attorneys-in-fact (contractually bound agents) manage the affairs of reciprocals for the members, and members commonly know how much liability each member of the group assumes.
Lloyd’s associations, modeled after the longstanding British insurance association Lloyd's of London, are groups of businesses and individuals who come together to underwrite (assume a portion of risk for) specific types of insurance risks. Lloyd’s associations employ independent underwriters—agents who establish insurance rules, assess the qualifications of customers to purchase insurance, and set policy rates—to make insurance contracts on their behalf. Lloyd’s associations insure a wide variety of risks faced by international businesses and, in some cases, individuals.
Cooperative organizations are nonprofit membership groups maintained and operated for the benefit of their members and subscribers. Cooperatives are prohibited by law from paying dividends or distributing profits and are exempt from most forms of taxation. Many fraternal orders also provide insurance in the same manner as cooperatives.

Most insurance falls into four main categories, according to what it covers: (1) property and casualty, (2) life, (3) health and disability, and (4) old-age and unemployment. Insurers commonly refer to insurance purchased by individuals as personal lines coverage and to insurance purchased by businesses as commercial coverage.

Property and Casualty Insurance
Property and casualty insurance policies protect things. Property insurance protects people against losses of and damage to things they have acquired, including houses and valuable items such as appliances or jewelry. Casualty insurance protects people against having their property taken to compensate others in settlements of legal disputes. Property and casualty insurance commonly go together because many policies include provisions to cover both casualty and property damage or loss. Common types of property and casualty insurance include (1) homeowner’s, (2) tenant’s, (3) automobile, (4) marine, and (5) commercial.
Casualty insurance resembles a more restrictive but similar form of coverage known as liability insurance. In general, liability refers to the legal and financial responsibility someone has to another person. A person can be found to be liable for causing loss or harm to another person or for having an unpaid debt. Some types of liability are covered under property and casualty policies. Liability claims require determination of fault for loss or damage, whereas other types of casualty claims may not.
When someone sustains injuries in, on, or caused by another person’s property, the property owner may be found legally liable for those injuries. For example, if someone is injured as a passenger in another person’s car, the car’s owner and driver are held legally responsible. If a person sustains injuries by slipping on a patch of wet ground at a private golf club, the club may be liable for damages. If someone is injured directly by someone else’s property, such as when the occupants of a car are hurt by the impact of someone else’s speeding car in an accident, the owner of that property may often be found legally liable.

Homeowner’s Insurance
Homeowner’s insurance covers a wide range of losses or damages to people’s houses and home property, as well as many types of liabilities for which homeowners might be responsible. It protects homeowners against losses from such causes as theft, storms, and fires.
Also, homeowner’s insurance typically pays for additional expenses related to home damage, such as fees for temporary lodging while damage is fixed. It also protects against most lawsuits that could arise from ownership of the property. It usually includes a type of coverage called medical payments. Such coverage would pay, for instance, for damages to a guest who slipped on the steps to the door of a house and suffered an injury. Homeowners insurance normally does not cover the risks associated with operating a home-based business, such as if a customer is injured on the premises.

Tenant’s Insurance
Tenant’s insurance, also known as renter’s insurance, provides much the same coverage as does homeowner’s insurance, but it does not cover damage to houses or apartments themselves. A fairly inexpensive form of insurance, it protects against loss of or damage to personal property and most lawsuits that could arise from occupying rented property. For example, tenant’s insurance would pay for damages caused by a fire that started in a policyholder’s apartment and spread to the rest of the building.

Automobile Insurance
Automobile insurance protects against damage to a policyholder’s car and most liabilities that could arise from operating that car. Most U.S. states allow drivers to satisfy their financial responsibility for the costs of auto accidents by obtaining insurance in three categories of liability coverage: (1) for injury to any one person, (2) for injury to two or more people, and (3) for damage to another person’s property. An increasing number of states are requiring drivers to obtain auto insurance by law.
Most U.S. states require that drivers who purchase auto insurance buy no less than a specified minimum of coverage, such as $25,000 toward the injury of another individual, $50,000 toward the injury of multiple persons, and $10,000 toward the damage of another person’s property. This minimum requirement is generally listed on policies as 25/50/10. Most Canadian provinces require $200,000 of liability coverage for covering the combined costs of bodily injury and property damage claims. In some provinces, such as British Columbia and Saskatchewan, the government operates compulsory programs of auto insurance in which all drivers must participate.
Most drivers also purchase medical payments coverage, which pays for treatment of injuries they or their passengers may sustain in an accident, and collision protection, which pays for damages to their own cars. Another optional form of auto insurance, called comprehensive, covers a person’s car against theft or many types of nonaccident damage, such as windshield cracks caused by rocks.
In addition, drivers may purchase insurance against injuries to themselves or their passengers from accidents with drivers who have little or no insurance. With underinsured motorist and uninsured motorist coverage, a person’s own insurance policy provides damage and injury compensation that would normally come from another person’s auto liability insurance. Another type of coverage, called personal injury protection or no-fault, is required in some states in addition to or instead of liability insurance. This coverage compensates drivers from their own policies for damages from accidents without determining responsibility for the accident.

Marine and Other Forms of Transportation Insurance
Boats and their cargo and passengers face many risks on unpredictable and powerful waterways. Marine insurance, one of the oldest forms of insurance, covers damage to and losses of boats, ships, marine workers, cargo, and passengers. Both businesses and individuals may purchase various forms of marine insurance.
Insurance for commercial ships or boats at sea, docked in a port, or on some inland waterways—as well as their cargo or passengers—is known as ocean marine insurance. There are four main types of ocean marine insurance: (1) hull insurance, (2) cargo insurance, (3) freight insurance, and (4) marine liability.
Hull insurance covers damage to a ship itself. Cargo insurance covers losses to a ship’s physical cargo. Freight insurance covers shippers against a loss of freight (payment for the transportation of cargo). Marine liability covers damages to people and property from collisions and other incidents.
Businesses involved in transporting cargo or passengers by land or by air can purchase coverage similar to that of marine insurance. Insurance policies for commercial transport of cargo by land or air are commonly known as inland marine insurance. However, because of the increasing importance of the passenger airline industry, specialized property and casualty coverage, known as aviation insurance or aircraft insurance, has developed to cover aircraft and their cargo or passengers.

Commercial Property and Casualty Insurance
Commercial property and casualty insurance cover businesses against a wide variety of liabilities and property damages or losses. Commercial property policies cover the building occupied by a business; such items as the furniture, fixtures, machinery, and inventory (unsold, warehoused goods) of a business; income lost by a business due to fire, theft, or other damage; and most liabilities that may arise from owning property and operating a business. A special kind of casualty insurance, called workers’ compensation, pays for employee injuries or illnesses that occur on the job.

Life Insurance
Life insurance provides compensation to specified individuals or groups—such as to family members or charities—when the policyholder dies. Some policies also provide funds for people to use during periods of their life when they will no longer be able to earn income through work, such as in the final stages of a terminal illness.
In industrialized countries such as the United States and Canada, most people must earn a living to provide for themselves and their families. When a wage-earning family member dies, remaining family members may not be able to meet financial obligations and goals. Life insurance allows people to use some of their earnings to assure that money will be available in the case of death. Individuals can purchase life insurance coverage individually from insurance companies. Others purchase coverage as part of a group, such as through their place of employment.
Some life insurance policies, known as term life, cover policyholders for set periods of time, or terms. Other policies, known as permanent life, cover policyholders for their entire lives.

Term Life Insurance
Term life insurance pays out its face value (the value specified on the policy) if the policyholder dies during the period specified in the policy. People may purchase term life coverage for 1, 5, 10, or 20 years. It works best for covering defined costs in the case of death, such as to pay off short-term loans. Younger people also buy term life insurance because of its affordability, perhaps its biggest advantage. Young families, in particular, often need more coverage than they could afford through permanent insurance. Term life can provide fairly large amounts of coverage with relatively low premiums.
However, some people need longer-term coverage to provide for such expenses as a 30-year home mortgage loan or estate taxes imposed after the insured person’s death. Term insurance can play a part in covering certain long-term expenses, if the insurer can design policy options to match the need.
Using term insurance policies to deal with long-term risks poses two serious problems: (1) An insured person’s health may decline to the point that the insurance company will no longer wish to extend a policy for another term. To protect against this problem, a policyholder can consider adding an option to make a policy guaranteed renewable, an agreement in which an insurance company must continue to provide coverage if the policyholder wants it. (2) The premiums of guaranteed renewable term life policies, or any term policy, commonly increase with each renewal. Often the increasing premiums become so high that policyholders decide to drop their coverage, sometimes before the need for the coverage disappears.
Policyholders using term life insurance to protect against long-term risks should consider buying convertible term insurance, which can be changed to permanent coverage. Convertible term life policyholders can switch their coverage as soon as they can afford additional premium costs. Once this switch is made, costs usually remain stable.

Permanent Life Insurance
Permanent life insurance pays its face value whenever policyholders die, as long as they have complied with policy requirements. Most types of permanent life insurance policies also provide a cash surrender value, which returns some money to people who cancel their policies. This practice helps maintain fairness within large groups of policyholders.
If the risk that caused some people to buy their insurance, such as an outstanding debt, should disappear, those people would probably decide to discontinue their coverage, often called “surrendering the policy.” But they would also have overpaid for the amount of risk protection delivered by the time they ended coverage. Cash surrender rules allow individuals who surrender their policies to take some or most of their overpayments out of the group without hurting those who retain their policies.
Insurance companies commonly sell three different categories of permanent life insurance: (1) whole life, (2) universal life, and (3) variable life. Although some insurance companies may use different names to market their policies, most fall into one of these three categories.
Whole life insurance spreads the cost of insurance coverage over a person’s entire life through a payment plan of regular, equal installments. People’s early payments into a whole life plan actually exceed what they would have had to pay for similar amounts of term insurance coverage. But these overpayments accumulate in whole life policies to a cash-surrender-value fund. The fund returns money to those who end their coverage and also keeps premiums from going up for people who do not end their coverage. Whole life policyholders may take out loans using their insurance as collateral, which they can either repay with interest or deduct from their death benefit (face-value benefit at death).
Another type of policy, known as endowment life insurance, resembles whole life but runs for less than the full life of the policyholder. Endowment policies pay out their face value at the contract’s end, even if the insured is still living. Because endowments have short terms, they also have higher premiums than do whole life policies, which in turn force the policyholder to save more.
Universal life insurance policies are permanent plans that incorporate some features of term life plans. Although more flexible than whole life, universal life policies transfer less of policyholders’ total risk to the insurance company. Typically, a universal life policy has a flexible target premium, which the insurance company calculates will keep the plan in force for life for a particular group of policyholders. Policyholders may pay somewhat more or less than the target premium, depending on their current financial circumstances.
When an insurance company collects universal life premiums for a particular policy period, it allocates a portion of that premium to pay claims if policyholders die during the policy period. This is called the policy’s mortality charge, which is the equivalent of a term life insurance premium. The company then deposits the remainder of the universal premium in an investment account that earns interest. The amount that results is called the policy’s accumulation value. The accumulation value minus any charge for surrendering the policy equals its cash surrender value. The company repeats the same calculation each month, deducting the mortality charge from the accumulation value in months when no premium is paid.
Variable life insurance works much like whole life except that the insurance company invests overpayments from all policyholders in the stock market instead of in accounts that earn a regular rate of interest. The performance of stock investments varies. Therefore, the insurer and policyholders cannot know the exact cash surrender values of policies in advance. Instead, their value depends on the performance of the stocks bought with money from premiums.
Some variable life policies also allow the death benefit to vary with stock market performance. Variable universal life, a variety of policy introduced in the 1980s, combines the stock market investment feature of variable life insurance with the flexible premium feature of universal life.

Health and Disability Insurance
Illnesses and disabilities can lead to enormous medical care expenses and also can prevent people from being able to earn income, so insurance can provide important economic relief. Health insurance protects people against the costs and consequences of illness and injury. Disability income insurance, or disability insurance, provides money for ordinary living expenses if an accident or illness prevents a policyholder from working. Employer-sponsored workers’ compensation plans provide limited coverage that applies only to job-caused or -related disabilities.
In many countries, government programs provide both health care services and insurance support for health care. The provincial governments of Canada, for instance, provide a fairly wide range of medical services to all of the country’s residents. Many governments also provide limited forms of disability insurance. People should understand what kinds of coverage government programs provide in order to determine what protection they need from private policies.
About 20 percent of people in the United States purchase individual health insurance to cover medical costs. Policies that cover all expenses for what is defined as medically necessary treatment provide better protection than do ones that limit benefits to accidents, cancer, or other specific causes for treatment.
Most people buy health insurance as part of a group. Group health plans generally have lower premiums than do individual plans. In 1995 in the United States, employee benefit plans, group plans sponsored by many employers, provided medical coverage for about 60 percent of nonelderly individuals and families. More employers offer insurance to cover medical expenses than coverage for income loss due to disability.
Independent insurance companies and health care providers manage most employee health insurance plans, and most insurers work with a number of businesses. Similar plans exist in Canada, but they provide more limited coverage because they build upon the substantial base provided by government-funded health plans. In addition to employers, many professional associations, unions, and other organizations offer benefit plans to their members.
Some very large businesses may provide their own group insurance plans, known as self-insured health plans. Many government regulations that apply to standard insured plans do not apply to self-insured health plans. Therefore, people covered under self-insured plans have limited recourse in the event of a dispute over medical service or insurance coverage.
Many health insurance plans offer separate policies for very specific kinds of insurance, in addition to general medical care. For instance, dental coverage, if purchased, pays for routine care and often a portion of the costs of more complex dental procedures. Vision care insurance pays for visits to eye doctors as well as a portion of the price of prescription corrective eyewear. Another type of policy provides long-term care for critically ill or terminally ill patients. These coverages, when added to general health insurance, lead to higher premium costs.

Government Programs
The governments of many countries provide a basic level of health and disability insurance and services for their citizens. In the United States, the Medicare program, operated by the Social Security Administration, helps assure that people with disabilities and senior citizens have access to health services. Medicaid programs, funded by both state and federal revenues, also operate in all 50 states to provide medical care for the poor (see Medicare and Medicaid).
Medicare medical insurance, which helps pay for routine medical care, is funded by contributions from the elderly and by general federal revenues. The U.S. government takes a tax out of people’s paychecks to fund Medicare hospital insurance, which helps pay for hospital care.
Canada also has provincially administered health insurance programs called Medicare (in most provinces) that are very different from the U.S. program of the same name. Under the Canadian Medicare program, each province and territory provides a wide range of health coverage to all residents. See also National Health Insurance.
The U.S. Social Security program provides some disability protection for workers through its Old-Age, Survivor’s, and Disability Insurance program, or OASDI. The federal government takes a portion of people’s incomes in taxes earmarked specifically to pay for OASDI. The disability portion of OASDI provides fairly minimal coverage, and it does not cover short-term disabilities. Thus, people who want adequate compensation in the event of disability usually try to have a combination of government-provided and employer-provided or individual plans. Similarly in Canada, the Canada Pension Plan and the Quebec Pension Plan provide limited disability benefits to workers who have contributed to the system.

Private Health and Disability Insurance
The health insurance sold by private U.S. insurance companies promises to indemnify (reimburse) the insured for covered medical expenses. A contract of indemnification puts the ultimate responsibility for the entire bill with the policyholder. Doctors and hospitals often submit their bills directly to insurers as an administrative courtesy designed to speed up their payments. Any portion of a bill not paid by an insurer becomes the policyholder’s own responsibility to pay.
Health insurance plans that offer only indemnity coverage are known as fee-for-service plans. Today, however, many people cover the costs of health care through managed care plans, which promise to actually manage or provide, not simply insure, medical services covered by their policies. People who use managed care rarely or never go through a process of indemnification, because their contracts guarantee the provision of health care services instead of repayment for the cost of those services. In some cases, a managed care plan may use a process of indemnification to pay for services given by health care providers who are not part of the plan. The common types of managed care include (1) health maintenance organizations, (2) preferred provider organizations, and (3) point-of-service plans.
A health maintenance organization (HMO) agrees to provide patients with whatever medical services they need usually given by health care providers who are part of the HMO in exchange for their monthly premium payment. HMOs tend to provide good coverage of routine health care services, but limit the choices of which doctors and hospitals patients can use.
Preferred provider organizations (PPOs) have contracts with health care providers who will charge favorable rates for services to insured members. PPO members choose a primary care physician who is responsible for referring patients to specialists. Policyholders must pay higher amounts for services received from health care providers not in the PPO network.
Point-of-service (POS) plans provide a combination of PPO network benefits with the option of receiving indemnity coverage for care outside the network. Health care service within a POS network works the same as in a PPO.
In most U.S. states and in parts of Canada, a system of independent insurance providers known as Blue Cross and Blue Shield member plans offer many types of health insurance coverage. Blue Cross and Blue Shield plans were the first to offer a form of prepaid health care coverage, beginning in the 1930s. Today they offer HMO, PPO, POS, and fee-for-service coverage. Collectively, Blue Cross and Blue Shield member plans are the largest provider of managed care services in the United States.
The individual disability insurance offered by private insurance companies often has fairly strict coverage qualifications. Plans commonly offer to provide between 50 percent and 60 percent of a person’s income should he or she suffer a disability. Many people purchase individual disability insurance to augment the coverage provided by group plans and government disability-income insurance.

Old-Age and Unemployment Insurance
Old-age insurance policies pay out funds after a person retires. Most people’s insurance protection for loss of income in their old age comes from annuities, policies that pay out regular monthly amounts for many years. In Canada and Australia, annuities are sometimes called superannuation policies.
Unlike annuities, life insurance protects policyholders and their families against the loss of income that can result if the insured person dies before retirement. Annuities, on the other hand, protect policyholders against outliving their financial resources, of which income is a big part.
The U.S. Social Security program, through OASDI, provides old-age insurance along with its disability coverage. Americans usually augment their social security retirement benefits with employment-based old-age pension plans and other retirement investments such as individual retirement accounts (IRAs). Canadians similarly augment their benefits from the Canada Pension Plan (or the Quebec Pension Plan) with employment-based pension plans and retirement investments such as Registered Retirement Savings Plans (RRSPs).
Unemployment insurance provides income to people experiencing periods without paid work. Free-market economies, common to almost all countries today, depend on having a slight surplus of workers—that is, having some level of unemployment. This allows businesses to keep wages from going up too quickly, because unemployed people may be willing to work for fairly low wages. In the strongest economies, unemployment rates may be about 2 to 3 percent, while weaker economies in industrialized countries may have rates well above 20 percent. But even the lowest rates of unemployment indicate that hundreds of thousands of people are out of work.
Because unemployment results from government free-market economic policies, affects so many people at any given time, and is so predictably persistent, private insurers do not cover it. Instead, most governments support unemployment insurance programs. In the United States, employers must pay for unemployment insurance. Canadian workers and their employers contribute to a similar government-run system of Employment Insurance (EI). In both countries people can collect unemployment benefits on a regular basis for specified periods of time if they lose their jobs for reasons out of their control, provided that they continue to actively look for work.

The insurance business in many countries comes under some degree of government regulation. Insurance is complex, takes in money for something not delivered at the time of sale, and is poorly understood by many consumers. Regulation assures that insurers deal fairly with clients and can actually pay out on all valid claims.
Insurance is one of the largest U.S. industries, in terms of revenues, to come under regulation by individual states. Each state has an insurance commissioner who issues licenses to sellers of insurance, oversees the financial stability of the state’s insurance companies, and assists in resolving consumer complaints. The National Association of Insurance Commissioners, which coordinates insurance laws and regulations among all U.S. states and territories, makes it easier for insurers and clients to conduct business across the country.
In Canada, an insurance company chooses to be regulated either by the federal government or by one of the provincial governments. The Canadian federal government oversees the operations of most of the country’s large insurance companies.
The U.S. insurance industry also works with government regulators to protect purchasers of insurance. Together they have established a system of safeguards to assure that policyholders receive most of their benefits for valid claims, even if their insurance provider becomes unable to pay.
Most state governments have two insurance protection systems, known as guaranty funds, one for life insurance and health insurance and one for property insurance and casualty insurance. State governments finance guaranty funds primarily with taxes on solvent private insurers. Canada also has separate systems protecting customers using these two sides of the insurance industry: the Canadian Life and Health Insurance Compensation Corporation and the Property and Casualty Insurance Compensation Corporation.



Early Development
Historians believe insurance first developed in Sumer and Babylonia (both in what is now Iraq) beginning in about 3000 bc. The merchants and traders of these societies transferred and pooled their money to protect themselves from losses of cargo to thieves and pirates.
In the 18th century bc, Babylonian king Hammurabi developed a code of law, known as the Code of Hammurabi, which codified many specific rules governing the practices of early risk-sharing activities. For instance, the code dictated that traders had to repay merchants who financed trading voyages unless thieves stole goods in transit, in which case debts would be cancelled.
Seagoing merchants from Phoenicia (in and around present-day Lebanon) began using a system of insurance known as bottomry about 1200 bc. In this system, backers loaned money to merchants to finance voyages. Merchants offered their ships (the hull was known as the ship’s ‘bottom’) as collateral for such loans. When a trip succeeded, the merchant would pay the trip’s backer the original loan plus interest, the equivalent of a premium. If a ship went down on its voyage, the trip’s backer would cancel the merchant’s loan. Forms of insurance resembling bottomry had spread to other parts of Asia and the Mediterranean by 400 bc.
In the last several centuries bc the societies of Greece and Rome developed some of the earliest systems of life insurance. Greek and Roman citizens formed benevolent societies, organizations in which members paid dues that went toward paying for the burial of members who died. Sometimes these societies also paid for the living expenses of deceased members’ families. During the Middle Ages (5th to 15th centuries ad), workers joined together in craft. Many guilds, particularly in England and Italy, provided benefits to workers and their families in the event of illness or death.

Growth of Modern Insurance in Europe
Many modern forms of insurance developed in England between the 16th to 18th centuries. The first known life insurance policy was written in London during the late 1500s. In England, groups called friendly societies gradually assumed many of the functions of guilds, including providing insurance to society members. Workers contributed to a society’s pool of funds. If workers fell ill or died, the society would distribute money to them or their families. However, many friendly societies went bankrupt due to poor management. In response, the English government enacted the Friendly Society Act of 1793, which placed regulations on the societies’ practices.
Also in England in the early 1700s, seagoing merchants and traders began pooling their risks against damage to the goods they transported by ship. Seafarers and people wishing to back their expeditions met informally to make insurance arrangements, sometimes at a pub called Lloyd’s in London. Lloyd’s pub later developed into the formal association of insurance brokers known as Lloyd’s of London. Insurance arrangements such as those negotiated at Lloyd’s were the forerunners of modern marine insurance.
As growing commerce fueled the development of new urban centers, primarily in Europe and North America, new risks also emerged. New forms of insurance developed to manage these risks. In 1666 a fire raged through London for five days and destroyed about 85 percent of the city. The following year, a real estate developer began promising to rebuild any house he sold if it burned down. The idea became so popular that it developed into England’s first fire insurance business. Soon, many more companies formed to offer fire insurance, which became one of the most widely offered forms of property insurance.
The Industrial Revolution, which began in Great Britain in the late 1700s and spread around the world during the following century, brought even more people into cities. These increases in urban population density concentrated the risks of fire and other types of property damage. Between 1640 and 1827, major fires occurred in a number of growing cities, including London; Hamburg, Germany; Paris, France; Saint Petersburg, Russia; and Philadelphia, Pennsylvania, in the United States.

In the United States


Beginnings and Growth
Insurance also developed during the 1700s in the North American colonies. In 1730 Benjamin Franklin helped form the Philadelphia Contributionship for the Insurance of Houses from Loss by Fire. The company collected contributions from citizens of Philadelphia, and this money went into an investment fund. Interest on this fund went toward paying for claims on losses from fires and for dividends to those who contributed money.
The Presbyterian Ministers’ Fund of Philadelphia, a church organization incorporated in 1759 and still in existence today, was the first American organization to offer life insurance benefits. It offered coverage only to its members not to the general public.
As the insurance business grew in the American colonies, many insurance companies began selling marine coverage. But British underwriters kept much of the marine insurance business during the 1700s by offering greater coverage and lower rates.
In 1792 a group of American insurers came up with $600,000 to sell competitive marine coverage as the Insurance Company of North America. This company also sold the first publicly offered life insurance policies in the United States. But low demand for life insurance at the beginning of the 19th century kept that business marginal. Marine insurance in the United States, along with maritime trade, remained dominated by Britain through the 1800s and into the 1900s.
The Industrial Revolution in the United States, in the early and mid-1800s, prompted dramatic growth in the insurance industry. During this time, many companies were established to sell life insurance and annuities. Several mutual insurance companies, which shared profits among policyholders, also developed. In addition, some life insurance companies began for the first time to vary premiums according to people’s age and health.

Early Regulatory Measures
New regulations on the U.S. insurance industry came into force in the mid-1800s. Until that time, people who became unable to pay their life insurance premiums would lose all of their previous contributions. Many people in financial distress auctioned their policies at low prices. People who bought these forfeited policies would take over paying the premiums in order to collect benefits when the original policyholders died.
Mathematician and abolitionist Elizur Wright disliked the practices of auctioning and collecting on other people’s insurance. Wright lobbied the Massachusetts legislature to introduce a nonforfeiture policy to end such practices, which the legislature adopted in 1861. Wright also developed mathematical formulas for insurance companies to calculate how much money they would need in reserves to meet their obligations on claims. Based on these formulas, the new Massachusetts law required insurance companies to maintain adequate reserves.
In 1869 the Supreme Court of the United States ruled in favor of the constitutionality of state insurance regulation. Most state governments soon had insurance departments that oversaw the operation of insurance companies.
After the Civil War (1861-1865), both the number of people buying life insurance and the premiums that life insurance companies charged rose dramatically. In 1900 U.S. insurance companies held almost $9 billion in policies, compared with only about $5 million in 1840. These changes led to widespread fraudulent practices in the insurance industry. In 1906 the New York state legislature created an insurance code regulating the practices of the industry. This code became a model for life insurance regulation in all states.
Fire insurance companies also began to regulate their business practices. In the early 1800s, fire insurance companies would lose business between major fires, so they would cut their rates to win customers. When fires hit, however, many insurers could not pay on claims. By the mid-1800s, many fire insurance companies began to group together to set standard fire insurance rates, thus preventing defaults on coverage. After the great Chicago fire of 1871, companies further adjusted their operations to be able to cope with large disasters. Most fire insurance companies managed to pay claims on fire damage that resulted from a massive earthquake in San Francisco, California, in 1906.

Expansion and Diversification
Developments in the late 19th and early 20th century led to the rise of new types of insurance in the United States, as well as in many other industrialized countries. Advances in medicine, combined with the decline of family-provided care due to the scattering of family members to distant locations for work, prompted the development of health insurance. In addition, the growth in work-related injuries prompted many governments to pass their first workers’ compensation laws in the early 1900s. The U.S. government initiated workers’ compensation in 1908. Also, many countries enacted social welfare legislation, thus creating unemployment insurance and forms of national health insurance. The Congress of the United States passed social security legislation in 1935.
Trends in transportation also created need for new forms of insurance. The first U.S. automobile insurance was issued in 1897, and by the 1920s the mass production of the automobile had created a greater need for automotive coverage. Over the following decades, new types of cargo and passenger transportation—including electric railroads, interstate trucking, and airplanes—prompted the development of new forms of accident, theft, and shipping insurance.
In 1944 the Supreme Court of the United States ruled that, because many kinds of insurance were forms of interstate commerce, the federal government should be given the power to regulate insurance. But one year later the U.S. Congress declined to grant this power, and passed laws reasserting the rights of states to regulate insurance. Because the federal government does not regulate insurance, states must work with each other to develop and enforce insurance laws. If the states fail to adequately control the practices of the insurance industry, the federal government could assume that responsibility.
The federal government does control the insurance of the country’s banking system. In 1933 Congress passed the Federal Reserve Act, which required that banks keep a certain portion of their deposits in cash to cover emergency withdrawals. The act also established the Federal Deposit Insurance Corporation (FDIC), a government agency that promises to cover any person’s deposits against potential bank failures. At its creation, the FDIC guaranteed to protect deposits of up to $100,000. Banks can become federally insured by meeting reserve requirements and certain other qualifications. Today, the FDIC includes two branches, one that insures commercial banks and one that insures savings institutions.
After the end of World War II (1939-1945), the United States experienced great economic growth and people began investing much more than they had previously invested in insurance. Many more families began to buy property such as houses and cars and to believe in the possibility of having lifetime economic security. Insurance law evolved and the insurance industry responded by offering new forms of coverage.
Before the 1950s, insurance laws had required insurers to restrict themselves to providing one type of coverage, such as property or liability insurance. Beginning in the 1950s, insurers could offer package policies that combined different types of coverage, such as homeowner’s insurance that covers property and liability. In 1965 Congress added Medicare health insurance to the social security system.

The Insurance Business Today
Since the 1970s, the insurance business has grown dramatically and undergone tremendous changes. As a result of the deregulation of financial services businesses—including insurance, banking, and securities trading—the roles, products, and services of these formerly distinct businesses have become blurred. For instance, citizens in the U.S. state of California voted in 1988 to allow banks to sell insurance in that state. In Canada, banks may also soon be allowed to sell insurance.
Advances in communications technology have also allowed traditionally distinct financial businesses to keep instantaneous track of developments in other businesses and compete for some of the same customers. Some insurance companies now offer deposit accounts and mortgages. In the United States, life insurance companies now sell more pension plans and other asset management services than they do conventional life insurance.
Developments in computer technology that have given insurance providers the ability to quickly access and process information have allowed them to custom-design policies to fit the needs of individual customers. But the increasing complexity of policies has also made some aspects of buying and selling insurance more difficult.
For example, though the Internet offers tremendous access to information about prices, it has done little to simplify the process of comparing the offerings of different insurance policies and services. Therefore, consumers have increasingly come to view insurance as a commodity, differing only in price from provider to provider. This attitude may lead people to buy insurance that does not give them the kind of coverage they need.
Other types of technology and scientific developments may also have great effect on insurance. By providing a broad scope of new information about people’s medical predispositions, genetic testing has the potential to redefine how providers of life and health insurance determine risk. Genetic engineering in medical treatments may provide new ways to extend people’s lives, changing traditional assessments of life expectancy.
In addition, improvements in geological and meteorological technology have the potential to change the way property insurers calculate risks of damage. For example, as scientists improve their abilities to predict severe weather patterns, such as hurricanes, and geological disturbances, such as earthquakes, insurers may change how they provide protection against losses from such events.
Contributed By:Norma L. Nielson

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