This article is about risk management. For Insurance (blackjack), see
Blackjack. For the contract between insurer and insured, see
Insurance policy.
is the equitable transfer of the risk of a loss, from one entity to another in exchange for payment. It is a form of
risk management primarily used to
hedge against the risk of a contingent, uncertain loss.
An insurer, or insurance carrier, is a company selling the insurance;
the insured, or policyholder, is the person or entity buying the
insurance policy. The amount of
money to be charged for a certain amount of insurance coverage is called the premium.
Risk management, the practice of
appraising and controlling risk, has evolved as a discrete field of study and practice.
The transaction involves the insured assuming a guaranteed and known
relatively small loss in the form of payment to the insurer in exchange
for the insurer's promise to compensate (
indemnify) the insured in the case of a financial (personal) loss. The insured receives a
contract, called the
insurance policy, which details the conditions and circumstances under which the insured will be financially compensated.
History
Early methods
Merchants have sought methods to minimize risks since early times. Pictured,
Governors of the Wine Merchant's Guild by
Ferdinand Bol, c. 1680.
Methods for transferring or distributing risk were practiced by
Chinese and
Babylonian traders as long ago as the
3rd and
2nd millennia BC, respectively.
[1]
Chinese merchants travelling 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 BC, 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 or lost at sea.
At some point in the 1st millennium BC, the inhabitants of
Rhodes created the '
general average'.
This allowed groups of merchants to pay to insure their goods being
shipped together. The collected premiums would be used to reimburse any
merchant whose goods were jettisoned during transport, whether to storm
or sinkage.
[2]
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. The first known insurance contract dates from
Genoa in 1347, and in the next century maritime insurance developed widely and premiums were intuitively varied with risks.
[3]
These new insurance contracts allowed insurance to be separated from
investment, a separation of roles that first proved useful in
marine insurance.
Modern insurance
Insurance became far more sophisticated in
Enlightenment era Europe, and specialized varieties developed.
Property insurance as we know it today can be traced to the
Great Fire of London,
which in 1666 devoured more than 13,000 houses. The devastating effects
of the fire converted the development of insurance "from a matter of
convenience into one of urgency, a change of opinion reflected in Sir
Christopher Wren's inclusion of a site for 'the Insurance Office' in his new plan for London in 1667".
[4] A number of attempted fire insurance schemes came to nothing, but 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, 5,000 homes were insured by his
Insurance Office.
[5]
At the same time, the first insurance schemes for the
underwriting of
business ventures
became available. By the end of the seventeenth century, London's
growing importance as a centre for trade was increasing demand for
marine insurance. In the late 1680s, Edward Lloyd opened
a coffee house,
which became the meeting place for parties in the shipping industry
wishing to insure cargoes and ships, and those willing to underwrite
such ventures. These informal beginnings led to the establishment of the
insurance market
Lloyd's of London and several related shipping and insurance businesses.
[6]
The first
life insurance policies were taken out in the early 18th century. The first company to offer life insurance was the
Amicable Society for a Perpetual Assurance Office, founded in London in 1706 by
William Talbot and
Sir Thomas Allen.
[7][8] Edward Rowe Mores established the
Society for Equitable Assurances on Lives and Survivorship in 1762.
It was the world's first
mutual insurer and it pioneered age based premiums based on
mortality rate laying “the framework for scientific insurance practice and development”
[9] and “the basis of modern life assurance upon which all life assurance schemes were subsequently based”.
[10]
In the late 19th century, "accident insurance" began to become available. This operated much like modern
disability insurance.
[11][12]
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.
By the late 19th century, governments began to initiate national insurance programs against sickness and old age.
Germany built on a tradition of welfare programs in Prussia and Saxony that began as early as in the 1840s. 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.
[13][14] In Britain more extensive legislation was introduced by the
Liberal government in the
1911 National Insurance Act. This gave the British working classes the first contributory system of insurance against illness and unemployment.
[15] This system was greatly expanded after the
Second World War under the influence of the
Beveridge Report, to form the first modern
welfare state.
[13][16]
Principles
Insurance involves
pooling funds from
many
insured entities (known as exposures) to pay for the losses that some
may incur. The insured entities are therefore protected from risk for a
fee, with the fee being dependent upon the frequency and severity of the
event occurring. In order to be an
insurable risk, the risk insured against must meet certain characteristics. Insurance as a
financial intermediary is a commercial enterprise and a major part of the financial services industry, but individual entities can also
self-insure through saving money for possible future losses.
[17]
Insurability
Main article:
Insurability
Risk which can be insured by private companies typically shares seven common characteristics:
[18]
- Large number of similar exposure units: Since insurance
operates through pooling resources, the majority of insurance policies
are provided for individual members of large classes, allowing insurers
to benefit from the law of large numbers in which predicted losses are similar to the actual losses. Exceptions include Lloyd's of London,
which is famous for insuring the life or health of actors, sports
figures, and other famous individuals. However, all exposures will have
particular differences, which may lead to different premium rates.
- Definite loss: The loss takes place at a known time, in a
known place, and from a known cause. The classic example is death of an
insured person on a life insurance policy. Fire, automobile accidents, and worker injuries may all easily meet this criterion. Other types of losses may only be definite in theory. Occupational disease,
for instance, may involve prolonged exposure to injurious conditions
where no specific time, place, or cause is identifiable. Ideally, the
time, place, and cause of a loss should be clear enough that a
reasonable person, with sufficient information, could objectively verify
all three elements.
- Accidental loss: The event that constitutes the trigger of a
claim should be fortuitous, or at least outside the control of the
beneficiary of the insurance. The loss should be pure, in the sense that
it results from an event for which there is only the opportunity for
cost. Events that contain speculative elements, such as ordinary
business risks or even purchasing a lottery ticket, are generally not
considered insurable.
- Large loss: The size of the loss must be meaningful from the
perspective of the insured. Insurance premiums need to cover both the
expected cost of losses, plus the cost of issuing and administering the
policy, adjusting losses, and supplying the capital needed to reasonably
assure that the insurer will be able to pay claims. For small losses,
these latter costs may be several times the size of the expected cost of
losses. There is hardly any point in paying such costs unless the
protection offered has real value to a buyer.
- Affordable premium: If the likelihood of an insured event is
so high, or the cost of the event so large, that the resulting premium
is large relative to the amount of protection offered, then it is not
likely that the insurance will be purchased, even if on offer.
Furthermore, as the accounting profession formally recognizes in
financial accounting standards, the premium cannot be so large that
there is not a reasonable chance of a significant loss to the insurer.
If there is no such chance of loss, then the transaction may have the
form of insurance, but not the substance. (See the US Financial Accounting Standards Board standard number 113)
- Calculable loss: There are two elements that must be at least
estimable, if not formally calculable: the probability of loss, and the
attendant cost. Probability of loss is generally an empirical exercise,
while cost has more to do with the ability of a reasonable person in
possession of a copy of the insurance policy and a proof of loss
associated with a claim presented under that policy to make a reasonably
definite and objective evaluation of the amount of the loss recoverable
as a result of the claim.
- Limited risk of catastrophically large losses: Insurable losses are ideally independent
and non-catastrophic, meaning that the losses do not happen all at once
and individual losses are not severe enough to bankrupt the insurer;
insurers may prefer to limit their exposure to a loss from a single
event to some small portion of their capital base. Capital constrains insurers' ability to sell earthquake insurance as well as wind insurance in hurricane zones. In the US, flood risk
is insured by the federal government. In commercial fire insurance, it
is possible to find single properties whose total exposed value is well
in excess of any individual insurer's capital constraint. Such
properties are generally shared among several insurers, or are insured
by a single insurer who syndicates the risk into the reinsurance market.
Legal
When a company insures an individual entity, there are basic legal
requirements. Several commonly cited legal principles of insurance
include:
[19]
- Indemnity
– the insurance company indemnifies, or compensates, the insured in the
case of certain losses only up to the insured's interest.
- Insurable interest
– the insured typically must directly suffer from the loss. Insurable
interest must exist whether property insurance or insurance on a person
is involved. The concept requires that the insured have a "stake" in the
loss or damage to the life or property insured. What that "stake" is
will be determined by the kind of insurance involved and the nature of
the property ownership or relationship between the persons. The
requirement of an insurable interest is what distinguishes insurance
from gambling.
- Utmost good faith – (Uberrima fides) the insured and the insurer are bound by a good faith bond of honesty and fairness. Material facts must be disclosed.
- Contribution – insurers which have similar obligations to the
insured contribute in the indemnification, according to some method.
- Subrogation – the insurance company acquires legal rights to pursue
recoveries on behalf of the insured; for example, the insurer may sue
those liable for the insured's loss.
- Causa proxima, or proximate cause – the cause of loss (the peril) must be covered under the insuring agreement of the policy, and the dominant cause must not be excluded
- Mitigation – In case of any loss or casualty, the asset owner must
attempt to keep loss to a minimum, as if the asset was not insured.
Indemnification
To "indemnify" means to make whole again, or to be reinstated to the
position that one was in, to the extent possible, prior to the happening
of a specified event or peril. Accordingly,
life insurance
is generally not considered to be indemnity insurance, but rather
"contingent" insurance (i.e., a claim arises on the occurrence of a
specified event). There are generally three types of insurance contracts
that seek to indemnify an insured:
- a "reimbursement" policy, and
- a "pay on behalf" or "on behalf of"[20] policy, and
- an "indemnification" policy.
From an insured's standpoint, the result is usually the same: the insurer pays the loss and claims expenses.
If the Insured has a "reimbursement" policy, the insured can be
required to pay for a loss and then be "reimbursed" by the insurance
carrier for the loss and out of pocket costs including, with the
permission of the insurer, claim expenses.
[20][21]
Under a "pay on behalf" policy, the insurance carrier would defend
and pay a claim on behalf of the insured who would not be out of pocket
for anything. Most modern liability insurance is written on the basis of
"pay on behalf" language which enables the insurance carrier to manage
and control the claim.
Under an "indemnification" policy, the insurance carrier can
generally either "reimburse" or "pay on behalf of", whichever is more
beneficial to it and the insured in the claim handling process.
An 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: identification of participating 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 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 (called reserves), the remaining margin is an
insurer's
profit.
Societal effects
Insurance can have various effects on society through the way that it
changes who bears the cost of losses and damage. On one hand it can
increase fraud; on the other it can help societies and individuals
prepare for catastrophes and mitigate the effects of catastrophes on
both households and societies.
Insurance can influence the probability of losses through
moral hazard,
insurance fraud, and preventive steps by the insurance company. Insurance scholars have typically used
morale hazard
to refer to the increased loss due to unintentional carelessness and
moral hazard to refer to increased risk due to intentional carelessness
or indifference.
[22]
Insurers attempt to address carelessness through inspections, policy
provisions requiring certain types of maintenance, and possible
discounts for loss mitigation efforts. While in theory insurers could
encourage investment in loss reduction, some commentators have argued
that in practice insurers had historically not aggressively pursued loss
control measures – particularly to prevent disaster losses such as
hurricanes—because of concerns over rate reductions and legal battles.
However, since about 1996 insurers have begun to take a more active role
in loss mitigation, such as through
building codes.
[23]
Insurers' business model
Underwriting and investing
The business model is to collect more in premium and investment
income than is paid out in losses, and to also offer a competitive price
which consumers will accept. Profit can be reduced to a simple
equation:
- Profit = earned premium + investment income - incurred loss - underwriting expenses.
Insurers make money in two ways:
- Through underwriting, the process by which insurers select the risks to insure and decide how much in premiums to charge for accepting those risks
- By investing the premiums they collect from insured parties
The most complicated aspect of the insurance business is the
actuarial science of ratemaking (price-setting) of policies, which uses
statistics and
probability
to approximate the rate of future claims based on a given risk. After
producing rates, the insurer will use discretion to reject or accept
risks through the underwriting process.
At the most basic level, initial ratemaking involves looking at the
frequency and
severity
of insured perils and the expected average payout resulting from these
perils. Thereafter an insurance company will collect historical loss
data, bring the loss data to
present value, and compare these prior losses to the premium collected in order to assess rate adequacy.
[24] Loss ratios
and expense loads are also used. Rating for different risk
characteristics involves at the most basic level comparing the losses
with "loss relativities"—a policy with twice as many losses would
therefore be charged twice as much. More complex
multivariate analyses
are sometimes used when multiple characteristics are involved and a
univariate analysis could produce confounded results. Other statistical
methods may be used in assessing the probability of future losses.
Upon termination of a given policy, the amount of premium collected minus the amount paid out in claims is the insurer's
underwriting profit on that policy. Underwriting performance is measured by something called the "combined ratio"
[25]
which is the ratio of expenses/losses to premiums. A combined ratio of
less than 100 percent indicates an underwriting profit, while anything
over 100 indicates an underwriting loss. A company with a combined ratio
over 100% may nevertheless remain profitable due to investment
earnings.
Insurance companies earn
investment
profits on "float". 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 (gathering 400 insurance companies and 94% of UK insurance services) has almost 20% of the investments in the
London Stock Exchange.
[26]
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 periods over time is commonly known as the
underwriting, or insurance, cycle.
[27]
Claims
Claims and loss handling is the materialized utility of insurance; it
is the actual "product" paid for. Claims may be filed by insureds
directly with the insurer or through
brokers or agents.
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.
Incoming claims are classified based on severity and are assigned to
adjusters whose settlement authority varies with their knowledge and
experience. The 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 if so, the
reasonable monetary value of the claim, and authorizes payment.
The policyholder may hire their own
public adjuster
to negotiate the settlement with the insurance company on their behalf.
For policies that are complicated, where claims may be complex, the
insured may take out a separate insurance policy add on, called loss
recovery insurance, which covers the cost of a public adjuster in the
case of a claim.
Adjusting liability insurance claims is particularly difficult because there is a third party involved, 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 the judge.
If a claims adjuster suspects under-insurance, 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. As part of this balancing act,
fraudulent insurance practices
are a major business risk that must be managed and overcome. Disputes
between insurers and insureds over the validity of claims or claims
handling practices occasionally escalate into litigation (see
insurance bad faith).
Marketing
Insurers will often use
insurance agents
to initially market or underwrite their customers. Agents can be
captive, meaning they write only for one company, or independent,
meaning that they can issue policies from several companies. The
existence and success of companies using insurance agents is likely due
to improved and personalized service.
[28]
Types of insurance
Any risk that can be quantified can potentially be insured. Specific
kinds of risk that may give rise to claims are known as perils. An
insurance policy will set out in detail which perils are covered by the
policy and which are not. Below are non-exhaustive lists of the many
different types of insurance that exist. A single policy may cover risks
in one or more of the categories set out below. For example,
vehicle insurance
would typically cover both the property risk (theft or damage to the
vehicle) and the liability risk (legal claims arising from an
accident). A
home insurance
policy in the US typically includes coverage for damage to the home and
the owner's belongings, certain legal claims against the owner, and
even a small amount of coverage for medical expenses of guests who are
injured on the owner's property.
Business
insurance can take a number of different forms, such as the various
kinds of professional liability insurance, also called professional
indemnity (PI), which are discussed below under that name; and the
business owner's policy (BOP), which packages into one policy many of
the kinds of coverage that a business owner needs, in a way analogous to
how homeowners' insurance packages the coverages that a homeowner
needs.
[29]
Auto insurance
Auto insurance protects the policyholder against financial loss in
the event of an incident involving a vehicle they own, such as in a
traffic collision.
Coverage typically includes:
- Property coverage, for damage to or theft of the car
- Liability coverage, for the legal responsibility to others for bodily injury or property damage
- Medical coverage, for the cost of treating injuries, rehabilitation and sometimes lost wages and funeral expenses
Most countries, such as the
United Kingdom,
require drivers to buy some, but not all, of these coverages. When a
car is used as collateral for a loan the lender usually requires
specific coverage.
Gap insurance
Main article:
Gap insurance
Gap insurance covers the excess amount on your auto loan in an
instance where your insurance company does not cover the entire loan.
Depending on the companies specific policies it might or might not cover
the deductible as well. This coverage is marketed for those who put low
down payments,
have high interest rates on their loans, and those with 60 month or
longer terms. Gap insurance is typically offered by your finance company
when you first purchase your vehicle. Most auto insurance companies
offer this coverage to consumers as well. If you are unsure if GAP
coverage had been purchased, you should check your vehicle lease or
purchase documentation.
Health insurance
Health insurance policies cover the cost of medical treatments.
Dental insurance, like medical insurance protects policyholders for
dental costs. In the US and Canada, dental insurance is often part of an
employer's benefits package, along with health insurance.
Accident, sickness, and unemployment insurance
Workers' compensation, or employers' liability insurance, is compulsory in some countries
- Disability insurance
policies provide financial support in the event of the policyholder
becoming unable to work because of disabling illness or injury. It
provides monthly support to help pay such obligations as mortgage loans and credit cards.
Short-term and long-term disability policies are available to
individuals, but considering the expense, long-term policies are
generally obtained only by those with at least six-figure incomes, such
as doctors, lawyers, etc. Short-term disability insurance covers a
person for a period typically up to six months, paying a stipend each
month to cover medical bills and other necessities.
- Long-term disability insurance covers an individual's expenses for
the long term, up until such time as they are considered permanently
disabled and thereafter. Insurance companies will often try to encourage
the person back into employment in preference to and before declaring
them unable to work at all and therefore totally disabled.
- Disability overhead insurance allows business owners to cover the overhead expenses of their business while they are unable to work.
- Total permanent disability 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.
- Workers' compensation insurance replaces all or part of a worker's wages lost and accompanying medical expenses incurred because of a job-related injury.
Casualty
Casualty insurance insures against accidents, not necessarily tied to
any specific property. It is a broad spectrum of insurance that a
number of other types of insurance could be classified, such as auto,
workers compensation, and some liability insurances.
- Crime insurance is a form of casualty insurance that covers 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.
- Political risk insurance is a form of casualty insurance that can be taken out by businesses with operations in countries in which there is a risk that revolution or other political conditions could result in a loss.
Life
Main article:
Life insurance
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.
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. In most states, a person cannot purchase a policy on another person without their knowledge.
Annuities provide a stream of payments and are generally classified
as insurance because they are issued by insurance companies, are
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.
Certain 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.
In many countries, such as the United States 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 the United States, 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.
Burial insurance
Burial insurance is a very old type of life insurance which is paid
out upon death to cover final expenses, such as the cost of a
funeral. The
Greeks and
Romans introduced burial insurance c. 600 CE when they organized
guilds
called "benevolent societies" which cared for the surviving families
and paid funeral expenses of members upon death. Guilds in the
Middle Ages served a similar purpose, as did friendly societies during Victorian times.
Property
Property insurance provides protection against risks to property, such as
fire,
theft or
weather damage. This may include specialized forms of insurance such as fire insurance,
flood insurance,
earthquake insurance,
home insurance, inland marine insurance or
boiler insurance. The term
property insurance may, like casualty insurance, be used as a broad category of various subtypes of insurance, some of which are listed below:
- Aviation insurance protects aircraft hulls and spares, and associated liability risks, such as passenger and third-party liability. Airports
may also appear under this subcategory, including air traffic control
and refuelling operations for international airports through to smaller
domestic exposures.
- Boiler insurance
(also known as boiler and machinery insurance, or equipment breakdown
insurance) insures against accidental physical damage to boilers,
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 arising from any cause (including the
negligence of the insured) not otherwise expressly excluded. Builder's
risk insurance is coverage that protects a person's or organization's
insurable interest in materials, fixtures and/or equipment being used in
the construction or renovation of a building or structure should those
items sustain physical loss or damage from an insured peril.[30]
- Crop insurance
may be purchased by farmers to reduce or manage various risks
associated with growing crops. Such risks include crop loss or damage
caused by weather, hail, drought, frost damage, insects, or disease.[31]
- Earthquake insurance is a form of property insurance that pays the policyholder in the event of an earthquake
that causes damage to the property. Most ordinary home insurance
policies do not cover earthquake damage. Earthquake insurance policies
generally feature a high deductible. Rates depend on location and hence the likelihood of an earthquake, as well as the construction of the home.
- Fidelity bond
is a form of casualty insurance that covers policyholders for losses
incurred as a result of fraudulent acts by specified individuals. It
usually insures a business for losses caused by the dishonest acts of
its employees.
- Flood insurance
protects against property loss due to flooding. Many insurers in the US
do not provide flood insurance in some parts of the country. In
response to this, the federal government created the National Flood Insurance Program which serves as the insurer of last resort.
- Home insurance,
also commonly called hazard insurance or homeowners insurance (often
abbreviated in the real estate industry as HOI), provides coverage for
damage or destruction of the policyholder's home. In some geographical
areas, the policy may exclude certain types of risks, such as flood or
earthquake, that require additional coverage. Maintenance-related issues
are typically the homeowner's responsibility. The policy may include
inventory, or this can be bought as a separate policy, especially for
people who rent housing. In some countries, insurers offer a package
which may include liability and legal responsibility for injuries and
property damage caused by members of the household, including pets.[32]
- Landlord insurance
covers residential and commercial properties which are rented to
others. Most homeowners' insurance covers only owner-occupied homes.
- 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. When the owner of the cargo and the carrier are
separate corporations, marine cargo insurance typically compensates the
owner of cargo for losses sustained from fire, shipwreck, etc., but
excludes losses that can be recovered from the carrier or the carrier's
insurance. 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.
- Supplemental natural disaster insurance covers specified expenses
after a natural disaster renders the policyholder's home uninhabitable.
Periodic payments are made directly to the insured until the home is
rebuilt or a specified time period has elapsed.
- Surety bond insurance is a three-party insurance guaranteeing the performance of the principal.
The demand for terrorism insurance surged after
9/11
- Terrorism insurance provides protection against any loss or damage caused by terrorist activities. In the United States in the wake of 9/11, the Terrorism Risk Insurance Act
2002 (TRIA) set up a federal Program providing a transparent system of
shared public and private compensation for insured losses resulting from
acts of terrorism. The program was extended until the end of 2014 by
the Terrorism Risk Insurance Program Reauthorization Act 2007 (TRIPRA).
- Volcano insurance is a specialized insurance protecting against damage arising specifically from volcanic eruptions.
- Windstorm insurance is an insurance covering the damage that can be caused by wind events such as hurricanes.
Liability
Liability insurance is a very broad superset that covers legal claims
against the insured. Many types of insurance include an aspect of
liability coverage. For example, a homeowner's insurance policy will
normally include liability coverage which protects the insured in the
event of a claim brought by someone who slips and falls on the property;
automobile insurance also includes an aspect of liability insurance
that indemnifies against the harm that a crashing car can cause to
others' lives, health, or property. 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 wilful or intentional acts by
the insured.
- Public liability
insurance covers a business or organization against claims should its
operations injure a member of the public or damage their property in
some way.
- Directors and officers liability insurance
(D&O) protects an organization (usually a corporation) from costs
associated with litigation resulting from errors made by directors and
officers for which they are liable.
- 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.
- Errors and omissions insurance
(E&O) is business liability insurance for professionals such as
insurance agents, real estate agents and brokers, architects,
third-party administrators (TPAs) and other business professionals.
- Prize indemnity insurance
protects the insured from giving away a large prize at a specific
event. Examples would include offering prizes to contestants who can
make a half-court shot at a basketball game, or a hole-in-one at a golf tournament.
- Professional liability insurance, also called professional indemnity insurance
(PI), protects insured professionals such as architectural corporations
and medical practitioners against potential negligence claims made by
their patients/clients. Professional liability insurance may take on
different names depending on the profession. For example, professional
liability insurance in reference to the medical profession may be called
medical malpractice insurance.
Credit
Credit insurance repays some or all of a
loan when certain circumstances arise to the borrower such as
unemployment,
disability, or
death.
- Mortgage insurance
insures the lender against default by the borrower. Mortgage insurance
is a form of credit insurance, although the name "credit insurance" more
often is used to refer to policies that cover other kinds of debt.
- Many credit cards offer payment protection plans which are a form of credit insurance.
- Trade credit insurance
is business insurance over the accounts receivable of the insured. The
policy pays the policy holder for covered accounts receivable if the
debtor defaults on payment.
Other types
- All-risk insurance is an insurance that covers a wide range of
incidents and perils, except those noted in the policy. All-risk
insurance is different from peril-specific insurance that cover losses
from only those perils listed in the policy.[33] In car insurance, all-risk policy includes also the damages caused by the own driver.
High-value horses may be insured under a bloodstock policy
- Bloodstock insurance covers individual horses
or a number of horses under common ownership. Coverage is typically for
mortality as a result of accident, illness or disease but may extend to
include infertility, in-transit loss, veterinary fees, and prospective
foal.
- Business interruption insurance covers the loss of income, and the expenses incurred, after a covered peril interrupts normal business operations.
- Collateral protection insurance (CPI) insures property (primarily vehicles) held as collateral for loans made by lending institutions.
- Defense Base Act
(DBA) insurance provides coverage for civilian workers hired by the
government to perform contracts outside the US and Canada. DBA is
required for all US citizens, US residents, US Green Card holders, and
all employees or subcontractors hired on overseas government contracts.
Depending on the country, foreign nationals must also be covered under
DBA. This coverage typically includes expenses related to medical
treatment and loss of wages, as well as disability and death benefits.
- Expatriate insurance
provides individuals and organizations operating outside of their home
country with protection for automobiles, property, health, liability and
business pursuits.
- Kidnap and ransom insurance
is designed to protect individuals and corporations operating in
high-risk areas around the world against the perils of kidnap,
extortion, wrongful detention and hijacking.
- Legal expenses insurance
covers policyholders for the potential costs of legal action against an
institution or an individual. When something happens which triggers the
need for legal action, it is known as "the event". There are two main
types of legal expenses insurance: before the event insurance and after the event insurance.
- Livestock
insurance is a specialist policy provided to, for example, commercial
or hobby farms, aquariums, fish farms or any other animal holding. Cover
is available for mortality or economic slaughter as a result of
accident, illness or disease but can extend to include destruction by
government order.
- Media liability insurance is designed to cover professionals that
engage in film and television production and print, against risks such
as defamation.
- Nuclear incident insurance covers damages resulting from an incident involving radioactive materials and is generally arranged at the national level. (See the nuclear exclusion clause and for the US the Price-Anderson Nuclear Industries Indemnity Act.)
- Pet insurance insures pets against accidents and illnesses; some companies cover routine/wellness care and burial, as well.
- Pollution insurance usually takes the form of first-party coverage
for contamination of insured property either by external or on-site
sources. Coverage is also afforded for liability to third parties
arising from contamination of air, water, or land due to the sudden and
accidental release of hazardous materials from the insured site. The
policy usually covers the costs of cleanup and may include coverage for
releases from underground storage tanks. Intentional acts are
specifically excluded.
- 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.
- 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, loss of personal belongings,
travel delay, and personal liabilities.
- Tuition insurance insures students against involuntary withdrawal from cost-intensive educational institutions
- Interest rate insurance protects the holder from adverse changes in interest rates, for instance for those with a variable rate loan or mortgage
- Divorce insurance is a form of contractual liability insurance that pays the insured a cash benefit if their marriage ends in divorce.
Insurance financing vehicles
- Fraternal insurance is provided on a cooperative basis by fraternal benefit societies or other social organizations.[34]
- No-fault insurance
is a type of insurance policy (typically automobile insurance) where
insureds are indemnified by their own insurer regardless of fault in the
incident.
- Protected self-insurance is an alternative risk financing mechanism
in which an organization retains the mathematically calculated cost of
risk within the organization and transfers the catastrophic risk with
specific and aggregate limits to an insurer so the maximum total cost of
the program is known. A properly designed and underwritten Protected
Self-Insurance Program reduces and stabilizes the cost of insurance and
provides valuable risk management information.
- Retrospectively rated insurance is a method of establishing a
premium on large commercial accounts. The final premium is based on the
insured's actual loss experience during the policy term, sometimes
subject to a minimum and maximum premium, with the final premium
determined by a formula. Under this plan, the current year's premium is
based partially (or wholly) on the current year's losses, although the
premium adjustments may take months or years beyond the current year's
expiration date. The rating formula is guaranteed in the insurance
contract. Formula: retrospective premium = converted loss + basic
premium × tax multiplier. Numerous variations of this formula have been
developed and are in use.
- Formal self-insurance is the deliberate decision to pay for otherwise insurable losses out of one's own money.[citation needed]
This can be done on a formal basis by establishing a separate fund into
which funds are deposited on a periodic basis, or by simply forgoing
the purchase of available insurance and paying out-of-pocket.
Self-insurance is usually used to pay for high-frequency, low-severity
losses. Such losses, if covered by conventional insurance, mean having
to pay a premium that includes loadings for the company's general
expenses, cost of putting the policy on the books, acquisition expenses,
premium taxes, and contingencies. While this is true for all insurance,
for small, frequent losses the transaction costs may exceed the benefit
of volatility reduction that insurance otherwise affords.[citation needed]
- Reinsurance is a type of insurance purchased by insurance companies or self-insured employers to protect against unexpected losses. Financial reinsurance is a form of reinsurance that is primarily used for capital management rather than to transfer insurance risk.
- Social insurance
can be many things to many people in many countries. But a summary of
its essence is that it is a collection of insurance coverages (including
components of life insurance, disability income insurance, unemployment
insurance, health insurance, and others), plus retirement savings, that
requires participation by all citizens. By forcing everyone in society
to be a policyholder and pay premiums, it ensures that everyone can
become a claimant when or if he/she needs to. Along the way this
inevitably becomes related to other concepts such as the justice system
and the welfare state.
This is a large, complicated topic that engenders tremendous debate,
which can be further studied in the following articles (and others):
- Stop-loss insurance provides protection against catastrophic or
unpredictable losses. It is purchased by organizations who do not want
to assume 100% of the liability for losses arising from the plans. Under
a stop-loss policy, the insurance company becomes liable for losses
that exceed certain limits called deductibles.
Some communities prefer to create virtual insurance amongst
themselves by other means than contractual risk transfer, which assigns
explicit numerical values to risk. A number of
religious groups, including the
Amish and some
Muslim groups, depend on support provided by their
communities when
disasters
strike. The risk presented by any given person is assumed collectively
by the community who all bear the cost of rebuilding lost property and
supporting people whose needs are suddenly greater after a loss of some
kind. In supportive communities where others can be trusted to follow
community leaders, this tacit form of insurance can work. In this manner
the community can even out the extreme differences in insurability that
exist among its members. Some further justification is also provided by
invoking the
moral hazard of explicit insurance contracts.
In the
United Kingdom,
The Crown (which, for practical purposes, meant the
civil service)
did not insure property such as government buildings. If a government
building was damaged, the cost of repair would be met from public funds
because, in the long run, this was cheaper than paying insurance
premiums. Since many UK government buildings have been sold to property
companies, and rented back, this arrangement is now less common and may
have disappeared altogether.
Insurance companies
Certificate issued by Republic Fire Insurance Co. of New York c. 1860
Insurance companies may be classified into two groups:
- Life insurance companies, which sell life insurance, annuities and pensions products.
- Non-life, general, or property/casualty insurance companies, which sell other types of insurance.
General insurance companies can be further divided into these sub categories.
- Standard lines
- Excess lines
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.
In the United States, standard line insurance companies are insurers
that have received a license or authorization from a state for the
purpose of writing specific kinds of insurance in that state, such as
automobile insurance or homeowners' insurance.
[35]
They are typically referred to as "admitted" insurers. Generally, such
an insurance company must submit its rates and policy forms to the
state's insurance regulator to receive his or her prior approval,
although whether an insurance company must receive prior approval
depends upon the kind of insurance being written. Standard line
insurance companies usually charge lower premiums than excess line
insurers and may sell directly to individual insureds. They are
regulated by state laws, which include restrictions on rates and forms,
and which aim to protect consumers and the public from unfair or abusive
practices.
[35]
These insurers also are required to contribute to state guarantee
funds, which are used to pay for losses if an insurer becomes insolvent.
[35]
Excess line insurance companies (also known as Excess and Surplus)
typically insure risks not covered by the standard lines insurance
market, due to a variety of reasons (e.g., new entity or an entity that
does not have an adequate loss history, an entity with unique risk
characteristics, or an entity that has a loss history that does not fit
the underwriting requirements of the standard lines insurance market).
[35] They are typically referred to as non-admitted or unlicensed insurers.
[35]
Non-admitted insurers are generally not licensed or authorized in the
states in which they write business, although they must be licensed or
authorized in the state in which they are domiciled.
[35]
These companies have more flexibility and can react faster than
standard line insurance companies because they are not required to file
rates and forms.
[35] However, they still have substantial regulatory requirements placed upon them.
Most states require that excess line insurers submit financial
information, articles of incorporation, a list of officers, and other
general information.
[35]
They also may not write insurance that is typically available in the
admitted market, do not participate in state guarantee funds (and
therefore policyholders do not have any recourse through these funds if
an insurer becomes insolvent and cannot pay claims), may pay higher
taxes, only may write coverage for a risk if it has been rejected by
three different admitted insurers, and only when the insurance producer
placing the business has a surplus lines license.
[35]
Generally, when an excess line insurer writes a policy, it must,
pursuant to state laws, provide disclosure to the policyholder that the
policyholder's policy is being written by an excess line insurer.
[35]
On July 21, 2010, President
Barack Obama signed into law the
Nonadmitted and Reinsurance Reform Act of 2010 ("NRRA"), which took effect on July 21, 2011 and was part of the
Dodd-Frank Wall Street Reform and Consumer Protection Act.
The NRRA changed the regulatory paradigm for excess line insurance.
Generally, under the NRRA, only the insured's home state may regulate
and tax the excess line transaction.
[36]
Insurance companies are generally classified as either
mutual or proprietary companies.
[37]
Mutual companies are owned by the policyholders, while shareholders
(who may or may not own policies) own proprietary insurance companies.
Demutualization
of mutual insurers to form stock companies, as well as the formation of
a hybrid known as a mutual holding company, became common in some
countries, such as the United States, in the late 20th century. However,
not all states permit mutual holding companies.
Other possible forms for an insurance company include
reciprocals, in which policyholders reciprocate in sharing risks, and Lloyd's organizations.
Insurance companies are rated by various agencies such as
A. M. Best.
The ratings include the company's financial strength, which measures
its ability to pay claims. It also rates financial instruments issued by
the insurance company, such as bonds, notes, and securitization
products.
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 product 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.
The financial stability and strength of an insurance company should
be a major consideration when buying 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 provide information and rate the
financial viability of insurance companies.
Across the world
Life insurance premiums written in 2005
Non-life insurance premiums written in 2005
Global insurance premiums grew by 2.7% in inflation-adjusted terms in
2010 to $4.3 trillion, climbing above pre-crisis levels. The return to
growth and record premiums generated during the year followed two years
of decline in real terms. Life insurance premiums increased by 3.2% in
2010 and non-life premiums by 2.1%. While industrialised countries saw
an increase in premiums of around 1.4%, insurance markets in emerging
economies saw rapid expansion with 11% growth in premium income. The
global insurance industry was sufficiently capitalised to withstand the
financial crisis of 2008 and 2009 and most insurance companies restored
their capital to pre-crisis levels by the end of 2010. With the
continuation of the gradual recovery of the global economy, it is likely
the insurance industry will continue to see growth in premium income
both in industrialised countries and emerging markets in 2011.
Advanced economies account for the bulk of global insurance. With
premium income of $1,620bn, Europe was the most important region in
2010, followed by North America $1,409bn and Asia $1,161bn. Europe has
however seen a decline in premium income during the year in contrast to
the growth seen in North America and Asia. The top four countries
generated more than a half of premiums. The United States and Japan
alone accounted for 40% of world insurance, much higher than their 7%
share of the global population. Emerging economies accounted for over
85% of the world’s population but only around 15% of premiums. Their
markets are however growing at a quicker pace.
[38] The country expected to have the biggest impact on the insurance share distribution across the world is China. According to
Sam Radwan
of Enhance International, low premium penetration (insurance premium as
a % of GDP), an ageing population and the largest car market in terms
of new sales, premium growth has averaged 15–20% in the past five years,
and China is expected to be the largest insurance market in the next
decade or two.
[39]
Regulatory differences
Main article:
Insurance law
In the United States, insurance is regulated by the states under the
McCarran-Ferguson Act, with "periodic proposals for federal intervention", and a nonprofit coalition of state insurance agencies called the
National Association of Insurance Commissioners works to harmonize the country's different laws and regulations.
[40] The National Conference of Insurance Legislators (NCOIL) also works to harmonize the different state laws.
[41]
In the
European Union,
the Third Non-Life Directive and the Third Life Directive, both passed
in 1992 and effective 1994, created a single insurance market in Europe
and allowed insurance companies to offer insurance anywhere in the EU
(subject to permission from authority in the head office) and allowed
insurance consumers to purchase insurance from any insurer in the EU.
[42] As far as
insurance in the United Kingdom, the
Financial Services Authority took over insurance regulation from the General Insurance Standards Council in 2005;
[43] laws passed include the Insurance Companies Act 1973 and another in 1982,
[44] and reforms to
warranty and other aspects under discussion as of 2012.
[45]
The
insurance industry in China was nationalized in 1949 and thereafter offered by only a single state-owned company, the
People's Insurance Company of China,
which was eventually suspended as demand declined in a communist
environment. In 1978, market reforms led to an increase in the market
and by 1995 a comprehensive Insurance Law of the People's Republic of
China
[46] was passed, followed in 1998 by the formation of
China Insurance Regulatory Commission (CIRC), which has broad regulatory authority over the insurance market of China.
[47]
In India IRDA is insurance regulatory authority. As per the section 4
of IRDA Act 1999, Insurance Regulatory and Development Authority
(IRDA), which was constituted by an act of parliament. National
Insurance Academy, Pune is apex insurance capacity builder institute
promoted with support from Ministry of Finance and by LIC, Life &
General Insurance companies.
Controversies
Insurance insulates too much
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), a concept known 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.
[citation needed]
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 or at the direction of the insured. Even if a provider
desired 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.
[citation needed]
Complexity of insurance policy contracts
Insurance 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.
For example, most insurance policies in the English language today have been carefully drafted in
plain English;
the industry learned the hard way that many courts will not enforce
policies against insureds when the judges themselves cannot understand
what the policies are saying. Typically, courts construe ambiguities in
insurance policies against the insurance company and in favor of
coverage under the policy.
Many institutional insurance purchasers buy insurance through an
insurance broker. While on the surface it appears the broker represents
the buyer (not the insurance company), and typically counsels the buyer
on appropriate coverage and policy limitations, in the vast majority of
cases a broker's compensation comes in the form of a commission as a
percentage of the insurance premium, creating a conflict of interest in
that the broker's financial interest is tilted towards encouraging an
insured to purchase more insurance than might be necessary at a higher
price. 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. A tied agent,
working exclusively with one insurer, represents the insurance company
from whom the policyholder buys (while a free agent sales policies of
various insurance companies). Just as there is a potential conflict of
interest with a broker, an agent has a different type of conflict.
Because agents work directly for the insurance company, if there is a
claim the agent may advise the client to the benefit of the insurance
company. Agents generally cannot offer as broad a range of selection
compared to an insurance broker.
An independent insurance consultant advises insureds on a
fee-for-service retainer, similar to an attorney, and thus offers
completely independent advice, free of the financial conflict of
interest of brokers and/or agents. However, such a consultant must still
work through brokers and/or agents in order to secure coverage for
their clients.
Limited consumer benefits
In United States, economists and consumer advocates generally
consider insurance to be worthwhile for low-probability, catastrophic
losses, but not for high-probability, small losses. Because of this,
consumers are advised to select high
deductibles
and to not insure losses which would not cause a disruption in their
life. However, consumers have shown a tendency to prefer low deductibles
and to prefer to insure relatively high-probability, small losses over
low-probability, perhaps due to not understanding or ignoring the
low-probability risk. This is associated with reduced purchasing of
insurance against low-probability losses, and may result in increased
inefficiencies from
moral hazard.
[48]
Redlining
Redlining
is the practice of denying insurance coverage in specific geographic
areas, supposedly because of a high likelihood of loss, while the
alleged motivation is unlawful discrimination.
Racial profiling or
redlining
has a long history in the property insurance industry in the United
States. From a review of industry underwriting and marketing materials,
court documents, and research by government agencies, industry and
community groups, and academics, it is clear that race has long affected
and continues to affect the policies and practices of the insurance
industry.
[49]
In July 2007, The
Federal Trade Commission (FTC) released a report presenting the results of a study concerning credit-based
insurance scores
in automobile insurance. The study found that these scores are
effective predictors of risk. It also showed that African-Americans and
Hispanics are substantially overrepresented in the lowest credit scores,
and substantially underrepresented in the highest, while Caucasians and
Asians are more evenly spread across the scores. The credit scores were
also found to predict risk within each of the ethnic groups, leading
the FTC to conclude that the scoring models are not solely proxies for
redlining. The FTC indicated little data was available to evaluate
benefit of insurance scores to consumers.
[50]
The report was disputed by representatives of the Consumer Federation
of America, the National Fair Housing Alliance, the National Consumer
Law Center, and the Center for Economic Justice, for relying on data
provided by the insurance industry.
[51]
All states have provisions in their rate regulation laws or in their
fair trade practice acts that prohibit unfair discrimination, often
called redlining, in setting rates and making insurance available.
[52]
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.
[citation needed]
Thus, "discrimination" against (i.e., negative 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
