The History and Principles of Insurance

Insurance as we know it today could be traced to the Great Fire of London, that in 1666 devoured 13,200 houses. After this disaster Nicholas Barbon opened an office to insure buildings. In 1680 he established England’s 1st fire insurance company, “The Fire Office”, to insure brick and frame homes. The first insurance firm in the United States provided fire insurance was formed in Charles Town (modern day Charleston), South Carolina, in 1732.

In 1752, Benjamin Franklin founded the Philadelphia Aid for the Insurance of Houses from Loss by Fire. It refused to insure some buildings in which the risk of fire was too great, like 100% wooden buildings.

The Principles of Insurance:

The exact time or occurrence of the loss need to be uncertain. The value of losses ought to be relatively unsurprising. In order to determine premiums or in other words to calculate price levels, insurers must be able to estimate them. Insurers require to know the price it would be called upon to pay once the insured event occurs. Most types of insurance have maximal levels of payouts, with several exceptions such as health insurance.

The loss should be significant: The legal principle of De minimis (From Latin:about minimal things) dictates that negligible matters are not covered.The payment paid by the insured to the insurer for assuming the risk is known as the ‘premium’.

Potential causes of chance that may give rise to insurance claims are named “perils”. Examples of perils might be fire, theft, earthquake, hurricane and numbers of additional possible risks. An insurance policy will set out in details which perils are covered by the policy and which are not. The damage must not be a catastrophic in scale, If the insurer is insolvent, it will be unable to pay the insured. In the United States, there are Guaranty Funds to reimburse insured victims whose insurance companies are bankrupt. This program is managed by the National Association of Insurance Commissioners (NAIC).

Indemnification (compensation)

Anyone wishing to transport risk (an individual, corporation, or organization of any type) becomes the ‘insured’ party once risk is assumed by an ‘insurer’, the insuring party, by means of a contract, defined as an insurance ‘policy’. This legal agreement sets out terms specifying the total of coverage (reimbursement) to be rendered to the insured, by the insurer upon assumption of risk, in the event of a loss, and 100% the specific perils covered against (indemnified), for the duration of the contract.

When insured parties experience a loss, for a specified peril, the coverage allows the policyholder to produce a ‘claim’ against the insurer for the amount of damage when specified by the policy contract.

Financial viability of insurance companies

Financial stability and posture of the insurance company need to be a major factor When purchasing an insurance contract. An insurance premium paid currently provides coverage for damges which can arise few years in the future. Due to that, the financial strength of the insurance carrier is most significant. In the past few years, a few of insurance companies became unable to pay, neglecting their policyholders with out coverage (or coverage merely from a government backed insurance pool with less the Priciples and History of InsuranceS-favorable payouts for losses). A number of independent rating agencies, like Best’s, provide facts and rate the financial strength of insurance firms.

Risks Assessment

The insurer uses actuarial science to quantify the risk they are prepared to consider. Information is gathered to approximate future insurance claims, ordinarily with reasonable accuracy. Actuarial science employs statistics and probability to analyze the risks associated with the range of perils covered, and these scientific principles are utilized by insurers, in combination with other factors, to decide rate composition.

The Gambling Analogy

Certain people erroneously assume insurance a type of wager (particularly as associated with moral hazard) which executes over the policy period of time. The insurance company bets that you or your property will not suffer a damage while you put money on the opposite outcome. Virtually all house owner’s insurance does not cover floods. Using insurance, you are managing risk that you may not otherwise prevent, and that does not lend itself the chance of benefit (pure risk). In other words, gambling isn’t an insurable risk.

The “insurance” of Social Solidarity

A few of religious groups among them the Amish and Muslims refrain from insurance and instead depend on support provided by their society when disasters strike. This could be thought of as “social insurance”, as the risk of any given person is assumed collectively by the community who will completely bear the cost of reconstruction. In closed, mutual help communities in which other people might actually step in to rebuild total lost property, this arrangement could function. The majority of societies could not effectively support this type of models and it will not function for catastrophic risks.

(Source: http://en.wikipedia.org/wiki/Insurance).

Is Insurance a Form of Gambling? The Ned Flanders Approach to Travel

For those of us that have grown up with the concept of insuring important or expensive things, the idea that it is a form of gambling is usually quite foreign. After all, there is a world of difference between the glazed eyes and bad decisions that fill pokies venues, and the sensible mainstream idea of insurance. Actually, insurance can be likened to gambling – but only in a very abstract sense. Today we explore the Ned Flanders approach to travel and travel insurance… and why for most of, his ar-diddly-arguments just don’t hold up!

The Ned Flanders Approach to Insurance

Actually, the school of thought that says that insurance is a form of gambling is much older than Ned Flanders (ultra-religious neighbour of The Simpsons). However, the pop culture reference to Ned’s belief is quite likely the first time that many of us in the West have encountered the concept. In the Simpsons episode from 1996, Hurricane Neddy, a Hurricane hits Springfield but destroys only the Flanders’ house. When Marge asks about insurance, Maude says that Ned didn’t believe in it – he considered it a form of gambling.

The rationale behind this is that when you take out home insurance, travel insurance, etc, you are effectively making a bet with the insurance company that a specific event will not occur (the destruction of your house, falling ill while you are overseas, etc). The insurance company is betting that it will not occur.

The Difference Between Insurance and Gambling

The idea that insurance is like gambling seems to be nothing more than an exercise in twisting logic, when you look at the purpose of insurance compared to the purpose of gambling. People buy insurance because:

They want to mitigate financial loss in the event that something (fairly unlikely) happens. In travel insurance, this would be the risk of getting sick or being injured, being the victim of crime, or having logistical difficulties that involve financial loss.

People gamble because:

They want to win a large amount of money without working for it (possibly the reason that religions often object to it).

What is an Aleatory Contract?

An aleatory contract is a more precise name for the form of agreement that travel insurance represents. Its definition is ‘a contract in which the performance of one or both parties is contingent on a particular event’. These contracts can mean a major ‘win’ for one party, and a loss for the other. With the current insurance environment though, the win and loss ratio is usually a lot more even that that seen in gambling.

So, what is the purpose of insurance?

Travel insurance, and insurance in general, provides a vital social service. If people had no option but to take on the risk of owning a house, owning a car, being liable for their own overseas medical expenses, etc, they might never do any of the above activities. Consider that while Australia has socialized health care, almost every other country in the world does not… and medical bills can run into the tens of thousands very quickly. Without the small expense of travel insurance, very few people would leave their home country. We would have a fraction of the understanding of other cultures, languages, and religions that make our world so rich today.

Rather than thinking of holiday insurance as gambling, it is much more useful to consider that you are ‘paying for peace of mind’. You are paying a small amount, to mitigate the enormous financial loss that could occur in the future. When you look at it this way, it is definitely worthwhile!