INSURANCE

a system under which the insurer, for a consideration usually agreed upon in advance, promises to reimburse the insured or to render services to the insured in the event that certain accidental occurrences result in losses during a given period. It thus is a method of coping with risk. Its primary function is to substitute certainty for uncertainty as regards the economic cost of loss-producing events. Insurance relies heavily on the law of large numbers. In large homogeneous populations it is possible to estimate the normal frequency of common events such as deaths and accidents. Losses can be predicted with reasonable accuracy, and this accuracy increases as the size of the group expands. From a theoretical standpoint, it is possible to eliminate all pure risk if an infinitely large group is selected. From the standpoint of the insurer, an insurable risk must meet the following requirements: 1. The objects to be insured must be numerous enough and homogeneous enough to allow a reasonably close calculation of the probable frequency and severity of losses. 2. The insured objects must not be subject to simultaneous destruction. For example, if all the buildings insured by one insurer are in an area subject to flood, and a flood occurs, the loss to the insurance underwriter may be catastrophic. 3. The possible loss must be accidental in nature, and beyond the control of the insured. If the insured could cause the loss, the element of randomness and predictability would be destroyed. 4. There must be some way to determine whether a loss has occurred and how great that loss is. This is why insurance contracts specify very definitely what events must take place, what constitutes loss, and how it is to be measured. From the viewpoint of the insured person, an insurable risk is one for which the probability of loss is not so high as to require excessive premiums. What is excessive depends on individual circumstances, including the insured's attitude toward risk. At the same time, the potential loss must be severe enough to cause financial hardship if it is not insured against. Insurable risks include losses to property resulting from fire, explosion, windstorm, etc.; losses of life or health; and the legal liability arising out of use of automobiles, occupancy of buildings, employment, or manufacture. Uninsurable risks include losses resulting from price changes and competitive conditions in the market. Political risks such as war or currency debasement are usually not insurable by private parties but may be insurable by governmental institutions. Very often contracts can be drawn in such a way that an uninsurable risk can be turned into an insurable one through restrictions on losses, redefinitions of perils, or other methods. a contract for reducing losses from accident incurred by an individual party through a distribution of the risk of such losses among a number of parties. In return for a specified consideration, the insurer undertakes to pay the insured or his beneficiary some specified amount in the event that the insured suffers loss through the occurrence of a contingent event covered by the insurance contract or policy. By pooling both the financial contributions and the insurable risks of a large number of policyholders, the insurer is typically able to absorb losses incurred over any given period much more easily than would the uninsured individual. While the destruction of an automobile in a traffic accident imposes a heavy financial loss on an individual, for example, one such loss is of relatively small consequence to an insurer who is collecting sufficient premiums on a large number of automobiles. Insurable risks constitute a subclass of all risks to persons and property and have the following characteristics: first, the risks must be such that pooling is both feasible and advantageous to the two parties. This means that the accidents insured against must be of sufficient frequency and similarity to allow for reasonably precise statistical estimation of the liabilities the insurer can expect to suffer across the entire group of those insured; that the losses resulting must be potentially so severe as to produce an incentive for the insured to insure against them; and that the accidents covered must not be so probable as to minimize (through exorbitant premiums) the advantage gained by the individual in pooling his risks with those of others. Second, the class of insured objects must be such that the likelihood of their simultaneous destruction is minimized. (Historically, many fire insurance companies failed through the overconcentration of their policyholders in one particular city or even neighbourhood, in an era of frequent citywide conflagrations.) Third, the possible losses must be truly accidental in nature and not such that the insured could cause them to occur. Fourth, the risks covered by the insurance contract must be such as to allow for determination of whether and to what degree losses have in fact been incurred as a result of accidents insured against. Moreover, the insurance agreement must meet the more general requirements of the law of contracts, such as the legal competence of the two parties, legality of purpose, and so on. There are many different kinds of insurance. Their diversity may most easily be seen by considering them under the three overlapping categories of objects insured, contingencies insured against, and manner of payment for both premiums and benefits. Objects insured may be further divided between property and person (including corporate persons such as incorporated businesses). Property insured includes almost every form of tangible property: personal effects, homes and other real estate, bank deposits, automobiles, plate-glass windows, airplanes and ships, all manner of goods in transit, and so on. Aspects of the person insured include life and limb, health, employment and ability to work, retirement income, and, for businesses, assets subject to employee fraud and embezzlement, to name only a few. Contingencies insured against include a large variety of natural accidents such as fire, explosion, flood, wind, lightning, earthquake, disease, and so on, as well as a very large class of contingencies arising from legal liability for negligent behaviour, among which are professional malpractice, debtor insolvency, personal accidents, and even personal liability of corporate directors for mismanagement of a corporation. The manner of payment of premiums and benefits varies somewhat from policy to policy in any area of insurance, but the most significant variations are to be found in the numerous forms of life insurance. Term insurance, under which a person is covered for a fixed contribution over a fixed period of years, has much the same form as any type of casualty insurance, in that no associated benefits are accrued. Whole life insurance typically requires premiums for a fixed period of years and stays in effect throughout the life of the insured or until maturation, accumulating a cash value along the way. Universal life policies, which have tended to replace endowment contracts, offer a combination of savings and insurance protection so configured that the policyholder may increase or decrease each of the two elements as savings or death-protection needs change over the owner's life. Annuities differ from life insurance in that these contracts are used to liquidate a principal sum rather than provide a death benefit. The life insurer pays the owner at regular intervals an income composed of both interest and principal so designed that the owner will not outlive the income. The policy anticipates that the principal sum will have been exhausted by the time of the owner's death. The earliest forms of insurance were the so-called bottomry contracts on shipping, which have been discovered in cuneiform records dating as far back as the third millennium BC. This type of insurance normally took the form of a loan to the shipowner, the repayment of which was made contingent on the safe completion of the voyage. The development of the bottomry contract into full-fledged marine insurance and likewise its extension to land journeys began in the late European Middle Ages as a consequence of and spur to the expansion of long-distance trading. In this, it paralleled the spread of other commercial innovations such as bills of exchange and other credit mechanisms. The next form of insurance to emerge was fire insurance, encouraged by London merchants in response to the Great Fire of 1666. By this time the joint stock company was an established legal form, and many of the new fire insurance companies adopted this structure. Others (the mutual insurance societies) retained the outward form of mutual self-help traditional to the medieval urban guilds. The 17th century saw a proliferation of fire and (as the sciences of demography and statistics emerged) life insurance organizations on a corporate basis, in contrast to the more or less ad hoc syndicates of underwriters providing marine insurance in earlier periods. (Lloyd's of London, perhaps the world's most renowned insurance establishment, is unique in its retention of the latter form.) Casualty insurance further expanded in the 19th century to cover the implements and products of new industrial technologies: steam engines and boilers, railroads, plate-glass windows, and so on. In the late 19th and early 20th centuries, the growing political power of workers and labour unions helped foster various forms of social insurance, such as social security, workers' compensation, unemployment and disability insurance, and health insurance. Another feature of the insurance industry in the 20th century has been the greatly expanded role of various liability insurance contracts, notably those for automobiles. Additional reading Basic surveys of the insurance field are given in Mark R. Greene and James S. Trieschmann, Risk & Insurance, 8th ed. (1992); Emmett J. Vaughan, Fundamentals of Risk and Insurance, 6th ed. (1992); George E. Rejda, Principles of Insurance, 3rd ed. (1989); Robert I. Mehr, Emerson Cammack, and Terry Rose, Principles of Insurance, 8th ed. (1985); James L. Athearn, S. Travis Pritchett, and Joan T. Schmit, Risk and Insurance, 6th ed. (1989); and David L. Bickelhaupt, General Insurance, 11th ed. (1983).Marine insurance is discussed in Roderick McNamara, Robert A. Laurence, and Glenn L. Wood, Inland Marine Insurance, 2 vol. (1987); Arthur E. Brunck, Victor P. Simone, and C. Arthur Williams, Jr., Ocean Marine Insurance, 2 vol. (1988); and Frederick Templeman, Templeman on Marine Insurance: Its Principles and Practice, 6th ed. by R.J. Lambeth (1986).Property and liability insurance is the subject of William H. Rodda et al., Commercial Property Risk Management and Insurance, 3rd ed., 2 vol. (1988); Donald S. Malecki et al., Commercial Liability Risk Management and Insurance, 2nd ed., 2 vol. (1986); Bernard L. Webb, Stephen Horn II, and Arthur L. Flitner, Commercial Insurance, 2nd ed. (1990); and Barry D. Smith, James S. Trieschmann, and Eric A. Wiening, Property and Liability Insurance Principles (1987).Risk management is analyzed in Mark R. Greene and Oscar N. Serbein, Risk Management: Text and Cases, 2nd ed. (1983); Neil A. Doherty, Corporate Risk Management (1985); George L. Head and Stephen Horn II, Essentials of Risk Management, 2nd ed., 2 vol. (1991); C. Arthur Williams, Jr., and Richard M. Heins, Risk Management and Insurance, 6th ed. (1989); and Robert L. Carter and Neil A. Doherty (eds.), Handbook of Risk Management (1974 ), with monthly revisions published for loose-leaf updating.Life and health insurance are examined in Robert I. Mehr and Sandra G. Gustavson, Life Insurance: Theory and Practice, 4th ed. (1987); Francis T. O'Grady (ed.), Individual Health Insurance (1988); Dani L. Long and Gene A. Morton, Principles of Life and Health Insurance, 2nd ed. (1988); and Muriel L. Crawford and William T. Beadles, Law and the Life Insurance Contract, 6th ed. (1989).Studies of group insurance include Jerry S. Rosenbloom, The Handbook of Employee Benefits: Design, Funding, and Administration, 3rd ed. (1992); Davis W. Gregg and Vane B. Lucas (eds.), Life and Health Insurance Handbook, 3rd ed. (1973); Burton T. Beam, Jr., Group Benefits: Basic Concepts and Alternatives, 4th ed. (1991); and Deborah J. Chollet, Employer-Provided Health Benefits: Coverage, Provisions, and Policy Issues (1984).Specialized topics of insurance practices are the focus of Everett D. Randall (ed.), Issues in Insurance, 4th ed., 2 vol. (1987); Pat Magarick, Casualty Insurance Claims: Coverage, Investigation, Law, 3rd ed. (1988); Newton L. Bowers, Jr., et al., Actuarial Mathematics (1986); and Bernard L. Webb et al., Principles of Reinsurance, 2 vol. (1990).Government regulation of insurance is the focus of discussion in Kenneth J. Meier, The Political Economy of Regulation: The Case of Insurance (1988); Jrg Finsinger and Mark V. Pauly (eds.), The Economics of Insurance Regulation: A Cross-national Study (1986); and Spencer L. Kimball and Werner Pfennigstorf, The Regulation of Insurance Companies in the United States and the European Communities: A Comparative Study (1981).International insurance is surveyed in Paul P. Rogers, Bruno Schnfelder, and Ehrenfried Schtte, Insurance in Socialist East Europe (1988); Bernard Wasow and Raymond D. Hill (eds.), The Insurance Industry in Economic Development (1986); Robert M. Crowe (ed.), Insurance in the World's Economies (1982); Michael E. Hogue and Douglas G. Olson (eds.), World Insurance Outlook (1982); Wenlee Ting, Multinational Risk Assessment and Management: Strategies for Investment and Marketing Decisions (1988); Werner Pfenningstorf and Donald G. Gifford, A Comparative Study of Liability Law and Compensation Schemes in Ten Countries and the United States (1991); and Norman A. Baglini, Global Risk Management: How U.S. International Corporations Manage Foreign Risks (1983). Mark Richard Greene