Insurance

Insurance is the business of providing protection against financial aspects of risk, such as those to property, life and health. The insured makes payments called "premiums" to an insurer, and in return is able to claim a payment from the insurer if the insured suffers some kind of loss. For example, a shipowner could insure a ship, and receive payment if the ship is damaged or destroyed. In the case of a pension the terms 'risk' and 'loss' are somewhat inappropriate, they concern the chances of living at future times and the need for money because of still being alive.

Insurance reduces risk by pooling together a large number of risks. For example, many individual people purchase health insurance policies. They each pay a small monthly or yearly premium to the insurance company, and then when a policy holder gets ill, the insurance company will provide money to cover medical treatment. For some individuals receiving insurance benefits, this may total far more money than they have ever paid into the insurance policy themselves. Others may never make a claim. When averaged out over all of the people buying policies it evens out. Insurance companies set their premiums based on their calculated payouts, aiming to take in more money than they pay out in the long run to cover expenses and, in the case of for-profit insurance companies, to make a profit.

Insurance companies also earn investment profits, because they have the use of the premium money from the time they receive it until the time they need it to pay claims. This money is referred to as "float". When the investments of float are successful, they may earn large profits, even if every penny received as premiums is eventually paid out in claims.

An insurance contract or "policy" will set out in detail the exact circumstances in which a benefit payment will be made and the amount of the premiums.

Table of contents

1 Types of insurance 2 Types of insurance companies 3 Life insurance and saving 4 Criticisms of the Insurance Industry 4.1 Lack of knowledge of Policyholders 4.2 Redlining 4.3 Health Insurance

Types of insurance

There are a number of different types of insurance:

• Property insurance, which provides protection against risks to property, such as fire, theft or weather damage. This includes specialized forms of insurance such as fire insurance, flood insurance, or boiler insurance.
• Casualty insurance, which insures against accidents, not necessarily tied to any specific piece of property.
• Liability insurance, which covers legal claims against the insured. For example, a doctor may purchase insurance to cover any legal claims against him if he were to make a mistake in treating a patient.
• Financial loss insurance, which protects individuals and companies against various financial risks. For example, a business might purchase cover to protect it from loss of sales if a fire in a factory prevented it from carrying out its business for a time. Insurance might also cover failure of a creditor to pay money it owes to the insured. Fidelity bonds and surety bonds are included in this category.
• Title insurance, which provides a guarantee on research done on public records affecting title to real property, usually in conjunction with a search done at the time of a real estate transaction, such as a sale, or a mortgage.
• Health insurance, which covers medical bills.
• Life insurance, which provides a benefit to a decedent's family or other designated beneficiary, usually to make up for their loss of his or her income.
• Annuities, which provide a stream of payments, are generally classified as insurance because they are issued by insurance companies and regulated as insurance. 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 opposite of life insurance.
• Credit Insurance, which pays some or all of a loan back when certain things happen to the borrower like unemployment, disability, or death.
• Terrorism insurance
• Political risk insurance

A single policy may cover risks in one or more of the above categories. For example, car insurance would typically cover both property risk (covering the risk of theft or damage to the car) and liability risk (covering legal claims from say, causing an accident). A homeowner's insurance policy in the US typically includes property insurance covering damage to the home and the owner's belongings, liability insurance covering certain legal claims against the owner, and even a small amount of health insurance for medical expenses of guests who are injured on the owner's property.

Potential sources of risk that may give rise to claims are known as perils. Examples or perils might be fire, theft, earthquake, hurricane and many other potential risks. An insurance policy will set out in detail which perils are covered by the policy and which are not.

Types of insurance companies

Insurance companies may be classified as

• Life insurance companies, who sell life insurance, annuities and pensions products.
• Non-life or general insurance companies, who sell other types of insurance.

In most countries, life and non-life insurers are subject to different regulations, tax and accounting rules. The main reason for the distinction between the two types of company is that life business is very long term in nature - cover for life assurance or a pension can cover risks over many decades. By contrast, non-life insurance cover usually covers shorter periods, such as one year.

Companies may sell both life and non life insurance, in which case they are sometimes known as composite insurance companies.

Reinsurance companies sell insurance cover to other insurance companies. This helps insurance companies to spread their risks, and protects them from very large losses. The reinsurance market is dominated by a few very large companies, with huge reserves.

Life insurance and saving

As well as paying out a sum of money on death, many life insurance contracts also pay out a sum of money after a given time (in which case it is known as an endowment policy), and may also pay out a cash value if the policy is cancelled early. In many countries, such as the US and the UK, tax law provides that the interest on this cash value is not taxable.

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. Wealthy individuals buy life insurance policies as a means for avoiding income taxes and estate taxes.

If the tax benefit exceeds the fees charged by the insurance company for maintaining the policy, then the policy serves as a life insurance tax shelter. There is much controversy surrounding this practice, and the financial industry is deeply divided about whether or not these practices work as advertised.

Criticisms of the Insurance Industry

Lack of knowledge of Policyholders

Insurance policies can be complex, and a lot of policyholders, especially poorer ones, do not understand all the fees included in a policy. As a result, people may buy policies at unfavorable terms. In response to these issues, governments often make detailed regulations which set down minimum standards for policies and govern how they may be advertised and sold.

Redlining

Location is one of the variables used to set rates. This is considered unfair by many. Insurers are also starting to use credit "scores" to set rates.

Health Insurance

Health insurance is one of the most controversial forms of insurance because of the conflict between the need for the insurance company to remain solvent versus the need of its customers to remain healthy, which many view as a basic human right. This conflict exists because of the unpredictability of how patients respond to medical treatment; hypothetically, if a large number of customers of a particular insurance company were to contract a rare disease costing 100 million dollars to fight for each patient, then the insurance company would be faced with the choice of either charging all its future customers astronomical premiums (thus losing customers and going out of business); paying all claims without complaint (thus going out of business); or fighting the customers in an attempt to deny the costly treatment (thus outraging patients and their families, and becoming a target for lawsuits and legislation).

Many countries have made the societal choice to avoid this important conflict by nationalizing the health industry so that doctors, nurses, and other medical workers become state employees, all funded by taxes; or setting up a national health insurance plan that all citizens pay into with tax payments, and which pays private doctors for health care. These national health care systems have their problems, too, however; many countries have citizen groups which protest bureaucracy and cost-cutting measures that delay medical treatment unduly.

Some common complaints about private health insurance companies include:

1. Insurance companies do not normally announce their health insurance premiums more than a year in advance. This means that, if you get sick, you may find your premiums raised a lot. This defeats the purpose of having insurance in the first place.
2. If insurance companies try to charge different people different amounts based on your health, people will feel they are unfairly treated. Some states require that insurance companies cover all who apply at the same cost; this rule has the effect (called adverse selection) that healthy people subsidize sick ones, and thus only really sick people buy insurance and the premiums are very expensive.
3. By the time a claim is made, it is in the best interest of the insurance company to use lots of paperwork and bureaucracy to attempt to deny the claim. Some percentage of people will give up, leading to lower costs for the insurance company.
4. Health insurance is only available at a reasonable cost through an employer-sponsored group plan. This means that unemployed individuals and self-employed individuals are at a big disadvantage.
5. Experimental treatments are generally not covered. This is especially criticized by those who have already tried, and not benefited from, all "normal" medical treatments for their condition.
6. The HMO ("health maintenance organization") type of health insurance plan has been criticized for excessive cost-cutting policies, the least popular of which is having accountants or other administrators essentially making medical decisions for customers by deciding which types of medical treatment will be covered and which will not.