Insurance is a means of protection from financial loss. It is a form of risk management, primarily used to hedge against the risk of a contingent or uncertain loss.
An entity which provides insurance is known as an insurer, insurance company, insurance carrier or underwriter. A person or entity who buys insurance is known as an insured or as a policyholder. The insurance 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 the insured in the event of a covered loss. The loss may or may not be financial, but it must be reducible to financial terms, and usually involves something in which the insured has an insurable interest established by ownership, possession, or pre-existing relationship.
• Insurance brokerage – Insurance brokers shop for insurance (generally corporate property and casualty insurance) on behalf of customers. Recently a number of websites have been created to give consumers basic price comparisons for services such as insurance, causing controversy within the industry.
• Insurance underwriting – Personal lines insurance underwriters actually underwrite insurance for individuals, a service still offered primarily through agents, insurance brokers, and stock brokers. Underwriters may also offer similar commercial lines of coverage for businesses. Activities include insurance and annuities, life insurance, retirement insurance, health insurance, and property insurance and casualty insurance.
• Finance & Insurance – a service still offered primarily at asset dealerships. The F&I manager encompasses the financing and insuring of the asset which is sold by the dealer. F&I is often called “the second gross” in dealerships who have adopted the model
• Reinsurance – Reinsurance is insurance sold to insurers themselves, to protect them from catastrophic loss.
1 Large number of similar exposure units
2 Definite loss
3 Accidental loss
4 Large loss
5 Affordable premium
6 Limited risk of catastrophically large losses
Methods of insurance
According to the study books of The Chartered Insurance Institute, there are variant methods of insurance as follows:
1. Co-insurance – risks shared between insurers
2. Dual insurance – having two or more policies with overlapping coverage of a risk (both the individual policies would not pay separately – under a concept named contribution, they would contribute together to make up the policyholder’s losses. However, in case of contingency insurances such as life insurance, dual payment is allowed)
3. Self-insurance – situations where risk is not transferred to insurance companies and solely retained by the entities or individuals themselves
4. Reinsurance – situations when the insurer passes some part of or all risks to another Insurer, called the reinsurer
TYPES OF 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
Health insurance policies cover the cost of medical treatments. Dental insurance, like medical insurance, protects policyholders for dental costs. In most developed countries, all citizens receive some health coverage from their governments, paid through taxation. In most countries, health insurance is often part of an employer’s benefits.
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.
• 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).
• 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.
• 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.
Amicable Society for a Perpetual Assurance Office, Serjeants’ Inn, Fleet Street, London, 1801
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 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 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 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.
• 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.Index-based insurance uses models of how climate extremes affect crop production to define certain climate triggers that if surpassed have high probabilities of causing substantial crop loss. When harvest losses occur associated with exceeding the climate trigger threshold, the index-insured farmer is entitled to a compensation payment.
• 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 U.S. insurers 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.
• 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.
• Renters’ insurance, often called tenants’ insurance, is an insurance policy that provides some of the benefits of homeowners’ insurance, but does not include coverage for the dwelling, or structure, with the exception of small alterations that a tenant makes to the structure.
• 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. 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 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 or general 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 or environmental impairment 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.
Often a commercial insured’s liability insurance program consists of several layers. The first layer of insurance generally consists of primary insurance, which provides first dollar indemnity for judgments and settlements up to the limits of liability of the primary policy. Generally, primary insurance is subject to a deductible and obligates the insured to defend the insured against lawsuits, which is normally accomplished by assigning counsel to defend the insured. In many instances, a commercial insured may elect to self-insure. Above the primary insurance or self-insured retention, the insured may have one or more layers of excess insurance to provide coverage additional limits of indemnity protection. There are a variety of types of excess insurance, including “stand-alone” excess policies (policies that contain their own terms, conditions, and exclusions), “follow form” excess insurance (policies that follow the terms of the underlying policy except as specifically provided), and “umbrella” insurance policies (excess insurance that in some circumstances could provide coverage that is broader than the underlying insurance).
Credit insurance repays some or all of a loan when the borrower is insolvent.
• 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.
• Collateral protection insurance (CPI) insures property (primarily vehicles) held as collateral for loans made by lending institutions.
• 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. In car insurance, all-risk policy includes also the damages caused by the own driver. 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.
• Defense Base Act (DBA) insurance provides coverage for civilian workers hired by the government to perform contracts outside the United States and Canada. DBA is required for all U.S. citizens, U.S. residents, U.S. 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.
• 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 United States, 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.
• Tax insurance is increasingly being used in corporate transactions to protect taxpayers in the event that a tax position it has taken is challenged by the IRS or a state, local, or foreign taxing authority
• Title insurance provides a guarantee that title to real property is vested in the purchaser 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.
• 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. 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.
• 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):
o National Insurance
o Social safety net
o Social security
o Social Security debate (United States)
o Social Security (United States)
o Social welfare provision
• 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.