Insurance is a means of providing protection against financial loss. Individuals and businesses face an uncertain future. Insurance helps reduce the financial effects of that uncertainty. For example, life insurance helps replace income that is lost to a family if a working parent dies. Health insurance helps pay large and unexpected medical bills. Automobile insurance helps cover the costs of damages resulting from a car accident. Businesses also buy insurance in an attempt to avoid disruptions in their operations and maintain profits.
People who wish to be insured against particular types of losses make payments, called premiums, to an insurance company. In return, these people receive a policy from the company. The policy is a promise by the insurance company to indemnify (pay) the individual for damages, loss, or harm caused by specific events called perils. The individuals paying premiums are called policyholders. The amount of money paid by the insurance company to the policyholders is known as the benefit or the claim.
Insurance works on a principle known as loss pooling. Grouping a large number of people into a “pool” allows the losses experienced by a few people to be spread out over the larger group. The people pooled together must all be exposed to the same potential loss. For example, all of the people in the pool for car insurance have the potential for a car accident. In effect, the members of the group help pay the average loss of the group. This practice reduces the potential financial loss to which each individual policyholder is exposed.
An insurance mathematician called an actuary uses the laws of probability to estimate expected future claims for a group of policyholders. Probability is a branch of mathematics that tries to express in numbers how likely or unlikely an event is to happen. Actuaries are also helped by a rule of probability called the law of large numbers. For insurance, this law means that as a group grows larger, the average loss for the group becomes more predictable and more stable. For example, 1 out of 10 drivers is likely to have an accident every year. Within a pool of 10 drivers, one might expect to see anything from no accidents to 10 accidents in a year. However, if the pool is increased to 10,000 drivers, it is likely that the number of accidents will average 1 per 10 drivers. These types of mathematical rules help actuaries determine what the losses in a year might be. They also help an insurance company decide how much it needs to charge customers to make a profit. See Probability.
Policyholders typically pay premiums at the beginning of the policy period before the insurer knows how many claims will be made. The insurance company uses the premiums to invest in stocks, bonds, and other assets (items of value). The company pays benefits on customer claims from the premiums collected and from the income earned on investments.
Although a policyholder may never receive any payments from an insurance company, insurance can give policyholders a feeling of security. Policyholders know that if they experience a loss, the insurer will indemnify them. In this way, their financial position is protected. As a result, insured people can feel more comfortable owning property, driving a car, operating a business, and engaging in many other activities without worrying about the financial losses that might result.
Insurance generally covers only situations involving pure risk. Pure risk is the uncertainty as to whether or not a loss will occur. Examples of pure risk include fire, flood, and accidents. Insurance does not cover gambling and other risks where individuals have the opportunity of profit or loss. These types of risk are called speculative risk.
Life insurance
The death of a wage earner in a family could cause many families financial hardship because of the loss of income. A life insurance policy can help meet the needs of the family by providing a death benefit. A death benefit is the total amount of money an insurer owes the beneficiary (the person or persons named in the policy) when an insured person dies. Typically, insurance companies pay death benefits in a lump sum. However, they may pay such benefits in regular installments to provide for a specific level of income to survivors.
Survivors can use payments from an insurance policy for immediate cash needs. These needs include paying off the deceased person’s last medical bills, funeral expenses, estate and inheritance taxes, or any unpaid debts. Proceeds can also support the wage earner’s children and surviving spouse. Businesses often buy life insurance to cover key employees or to provide money to continue the business if a partner dies.
Major types of life insurance.
There are two major types of life insurance. They are term life insurance and cash value life insurance. Term life insurance provides temporary protection. Cash value life insurance is a more permanent type of coverage.
Term life insurance
provides a death benefit only if the insured person dies within the period covered by the policy. The policy period of term life insurance ranges from just one year to a number of years. Common multiyear policies include 10- and 20-year terms. A term life insurance policy does not have a savings component. Consequently, the premium for a term life insurance policy is lower than for other types of life insurance for the same amount of coverage.
Most term insurance policies are renewable at the end of the policy period. As a result, policyholders can continue the policy for another term once the policy period expires. Each time the policy is extended, the premiums increase because the policyholder is getting older. These premium increases reflect the higher likelihood of death at older ages. Also, term insurance policies can often be converted into a permanent form of life insurance.
A variation of term insurance is decreasing term insurance. With these policies, the death benefit declines over the policy period. Such insurance is desirable if the policyholder’s financial obligations are likely to decrease over time. This type of insurance is common for credit life insurance. Such insurance covers the unpaid balance of a loan or mortgage if the borrower dies.
Group life insurance plans are offered through employers, labor unions, professional associations, and other organizations. In most cases, the premiums for group life policies cost less than the premiums for individual policies. This is partly because group plans have lower administrative costs. Employers often provide term life insurance to employees. Some companies may help pay part of the employee’s required premiums.
Cash value life insurance
provides the policyholder with the ability to build savings through a life insurance policy. It also pays death benefits. Types of cash value life insurance differ according to what the potential returns are on the savings part of the insurance.
Premiums can also differ with cash value life insurance. The premiums on whole life insurance, also known as straight life insurance, are payable as long as the insured is still living. A limited payment policy provides for lifetime protection even though premium payments stop after a specified period. The period is usually 20 or 30 years or at a certain age, such as age 65. After this period, the policy is considered paid-up. No more premiums are required to keep the policy in force for the remaining life of the insured person. Because they are paid over a shorter period, the premiums for limited payment policies are higher than for straight life policies.
Unlike most term life insurance premiums that rapidly increase at older ages, whole life premiums do not increase with the age of the insured. Policyholders overpay in the early years of the contract because the cost of coverage—that is, the probability that policyholders will die at a younger age—is low. The high premiums paid in the early years help fund the cost of coverage at older ages. They are also the source of cash value for whole life policies. The build-up of cash values of a traditional whole life policy is guaranteed in the contract by the insurer.
How life insurance premiums are determined.
Life insurance premiums are based on the probability of a policyholder dying at a given age. These probabilities are given in statistical tables called mortality tables. Insurance companies also make assumptions on the returns they expect to earn on premiums paid as well as the expenses associated with doing business.
An individual’s premium is also affected by his or her insurability. Insurability is the perceived risk the insurance company takes in providing coverage for that person. Individuals with such medical conditions as high blood pressure or diabetes may be charged higher premiums. People who do not smoke or drink alcoholic beverages typically get lower premiums. An individual’s occupation and leisure activities may also affect his or her premiums.
Dividends.
If an insurance company pays out fewer death benefits than predicted or earns higher investment returns than anticipated, the insurer may refund part of the premiums to policyholders. These payments are known as dividends. Policies that are eligible for dividends are called participating policies. They are common in life insurance. Policies that do not pay dividends are known as nonparticipating policies.
An owner of a participating policy may receive the dividends in cash. An owner may also allow dividends to accumulate with the insurance company, which pays interest on the amount. A policyholder may also use the dividends to help reduce the premiums on the policy or to purchase additional insurance.
Buying life insurance.
The purchase of life insurance is important for any individual who has unfulfilled financial obligations. Young parents with children often have substantial life insurance needs. Even if both parents are in the workforce, the family’s standard of living is likely to be threatened upon the death of either wage earner. Determining the amount of life insurance for a particular individual often requires the assistance of financial planners or insurance agents. These experts can help assess an individual’s needs based on his or her circumstances. When making such an assessment, these experts take into account other financial resources the policyholder may have available.
Each type of life insurance has advantages and disadvantages. Many insurance experts recommend term insurance for people on a limited budget who may have a substantial need for life insurance protection. New parents with young children fall into this category. Cash value products provide for lifetime protection. However, higher required premiums may leave young families underinsured. Although term insurance may be cheaper, cash value insurance provides a type of forced savings plan. Policyholders must continue to pay the premium to keep insurance in force. As they do so, they are building cash value that can be used later.
People sometimes consider a strategy known as buy term and invest the difference when deciding on what kind of insurance to buy. This strategy invests the difference between the higher premiums of traditional whole life insurance and the lower premiums of term insurance. Because whole life policies generally have low investment return guarantees, policyholders may be able to earn better returns by investing the money themselves. But this strategy transfers investment risk from the insurance company to the individual. Also, the individual must have the financial discipline to actually invest the money.
Riders
are amendments (changes) to standard life insurance contracts. Riders help shape the policy to meet the needs of policyholders. Riders often require an additional premium. A waiver of premium rider pays the cost of life insurance if the policyholder becomes disabled. Another rider is an accidental death rider or double indemnity clause. This type of rider doubles the face value of the policy if the insured person dies as the result of an accident rather than sickness or disease. Many life insurance policies have a living benefits provision. This provision allows policyholders who are terminally ill or confined to a nursing home to receive benefits before they die.
Annuities
are products sold by life insurance companies to provide retirement income to individuals. Annuities provide a stream of regular payments that continues while the annuitant (the owner of the annuity) remains alive. An annuity protects an individual from the risk of living longer than anticipated. An annuitant cannot outlive his or her income.
There are several types of annuities. With a single premium immediate annuity, the owner can make a single deposit to transform a lump sum into an immediate lifetime stream of income. With a deferred annuity, the owner accumulates money—usually during his or her working lifetime—by periodically contributing funds to an insurer. The income from the annuity is deferred (put off). The invested funds are turned into an annuity in the future, typically at the policyholder’s retirement.
When an annuitant dies, the payments from an annuity may stop. But some types of annuities guarantee that at least the money contributed by the annuitant will be returned. If the annuitant dies before receiving the full amount contributed, the beneficiary (receiver of payment named in the policy) receives the balance. A life annuity with installments certain provides payments during the lifetime of the annuitant or for a fixed number of years, whichever is longer. If the annuitant dies before receiving the guaranteed number of payments, the insurance company continues the payments to the beneficiary.
A joint and survivorship annuity provides income while two people are alive. Often, when one of the two individuals dies, the survivor then receives smaller payments until his or her death. Variable annuities can protect annuitants against inflation. Inflation is a continual increase in prices throughout a nation’s economy. Insurance companies invest the funds for variable annuities mainly in stocks. The annuity payments vary according to investment performance. Ideally, as inflation increases, stock prices increase and provide higher payments to annuitants.
Health insurance
Health insurance pays all or part of the cost of hospitalization, surgery, laboratory tests, medicines, and other medical care. The high cost of medical care makes it important for people to have adequate health insurance. People without such coverage could suffer a major financial hardship in case of a serious illness or accident.
In numerous countries, the government provides health care for the nation’s people. These countries include Australia, Canada, Ireland, New Zealand, and the United Kingdom. In Canada, nearly all people are covered by provincial government health insurance. In the United Kingdom, the National Health Service provides government-funded medical services to all residents. In countries with government health care programs, private insurance companies offer coverage of medical care not included in government plans. Such coverage includes the cost of prescription drugs and vision care.
In the United States, elderly or poor people qualify for Medicare or Medicaid. Both Medicare and Medicaid are health insurance programs administered by the federal government. For information on public health insurance, see the section Social insurance in this article. See also Medicare and Medicaid. The federal government also provides subsidies (financial support), mainly in the form of tax credits, that cover a portion of the cost of health insurance for some middle- and low-income families.
How private health insurance is provided.
Private health insurance in the United States is offered mainly by insurance companies, medical service plans, managed care plans, and self-insured employers.
Most people with private health insurance in the United States are covered under group plans obtained through their employer. Such plans typically cover not only the insured person but also a spouse and children and other dependents. Group health insurance generally costs less than individual coverage because administrative costs and other expenses are lower. Employees can pay for premiums using pretax funds. Such funds are not counted as taxable income. Individuals can also purchase private health insurance through health insurance exchanges. The exchanges are systems in which insurance companies offer a variety of competing health plans at more affordable rates than had previously been available.
Insurance companies.
Many companies that sell health insurance policies provide cash benefits to the insured person. Such benefits are called indemnity benefits. Indemnity plans reimburse policyholders for covered medical expenses, such as the costs for hospitalization or physician services. In many cases, the cash benefits do not cover the entire cost of medical care. The policyholder must pay the balance. A policyholder’s portion of charges is called a co-payment.
Medical service plans
provide service benefits for members. A service benefit is a direct payment on behalf of the insured member to the hospital or physician that provided the medical service. In most cases, health insurance policies with service benefits offer more generous coverage than those with cash benefits. However, the premiums are usually higher. Unlike insurance companies, many medical service plans operate on a nonprofit basis. Blue Cross and Blue Shield plans are the largest medical service plans in the United States (see Blue Cross and Blue Shield).
Managed care plans
attempt to control the cost of health care by providing and financing the care. The most widely used types of managed care plans are health maintenance organizations (HMO’s) and preferred provider organizations (PPO’s).
An HMO is a network of medical providers that offers a full range of health care services for a prepaid monthly or yearly fee. Such services include hospitalization, surgery, medication, and visits to a physician’s office. HMO’s limit the ability of their members to use providers outside the HMO network. Members enjoy lower co-payments and reduced paperwork when staying in-network. HMO’s can be sponsored by insurance companies, medical service plans, or medical groups.
PPO’s are plans that negotiate with a group of medical providers. PPO’s provide discounts to groups if they send employees to contracted providers that belong to the PPO. PPO members can go out of the preferred network and still receive medical care benefits. However, the member’s share of the cost for medical services is significantly lower if they use preferred providers.
Self-insured employers
do not transfer the financial risk to health insurance companies. Instead, they simply pay the health care costs of their employees directly. In this way, companies can avoid some of the administrative expenses levied by insurers. In addition, self-insured plans have more flexibility in designing benefit plans. Self insurance tends to be used by larger employers that have more predictable claims experience than smaller groups.
Basic types of health insurance.
Health insurance varies according to the benefits policies provide. There are four main types of benefits. They are hospital expense benefits, surgical expense benefits, outpatient expense benefits, and major medical expense benefits.
Hospital expense benefits
are the most common type of medical insurance benefits. They cover many hospital expenses, including room and board, laboratory tests, X rays, medication, nursing services, and the use of an operating room. The benefits may take the form of cash or services. Some policies limit benefits to fixed daily payments for a stated number of days each year.
Surgical expense benefits
cover such services as a surgeon’s operating fees. Some policies determine benefits based on a schedule (list) of covered procedures. Others pay the total cost of surgical fees up to what the insurance company considers a reasonable and customary limit. This limit is the average cost of a medical service in the same geographic location. Any charges beyond the schedule or reasonable and customary fees are the responsibility of the insured.
Outpatient expense benefits
cover fees charged by physicians for nonsurgical care in their office, a hospital, or a patient’s home. These benefits also cover the cost of X rays and laboratory and diagnostic tests for a policyholder who is not hospitalized.
Major medical expense benefits
are designed to cover a significant portion of medical expenses resulting from a serious illness or accident. However, many policies pay only a percentage of the medical expenses until the policyholder has paid a specified amount called an out-of-pocket maximum. The maximum limits the amount that individuals pay during any particular year. Most major medical policies also have a deductible. A deductible is an initial sum of money for which the policyholder is responsible.
Other types of health insurance
include disability income insurance, dental insurance, and long-term care insurance. Disability income insurance partially replaces earned income that is lost when the insured person cannot work because of an accident or illness. Dental insurance plans help cover the costs of dental work. Most dental policies have several levels of benefits. These benefits may include services to prevent and diagnose problems. Such services include periodic exams, cleaning, and X rays. Dental insurance may also pay for such restoration as fillings and root canals. Typically, dental plans cover a larger portion of the costs for periodic exams than for restoration services. Long-term care (LTC) insurance provides coverage for nursing home care and related expenses.
Some employers offer flexible spending accounts (FSA’s). These accounts allow employees to spend pretax dollars on care of their dependents and on certain medical expenses. Medical savings accounts (MSA’s) are designed for self-employed individuals and employees of certain small firms who are covered by a high deductible health plan (HDHP). HDHP’s provide coverage for catastrophic (very serious) illnesses. With an MSA, an individual sets aside money for routine medical expenses and builds savings for future health care.
Property and liability insurance
Many individuals and businesses buy property and liability insurance to protect their assets against financial loss. Property insurance provides direct payment if a policyholder’s possessions are damaged, destroyed, or lost as a result of perils listed in the policy. Property insurance policies may pay losses on the basis of what it would cost to repair or replace the property. They may also restrict payment to the actual cash value (ACV) of the property. ACV is the replacement cost of the property less depreciation (loss of value through age or use).
Liability insurance protects individuals and businesses against possible financial losses if their actions result in bodily injury to or damage to the property of others. A victim of such actions could sue the person or persons responsible. If a court determines that the defendant is negligent—that is, caused the harm by carelessness—it may order a certain amount of money, called damages, to be paid to the victim. Liability insurance can protect individuals and businesses for the cost of these damages. Liability insurance also provides for a policyholder’s legal defense costs. Liability insurance thus protects a policyholder’s personal assets. Otherwise, the policyholder would have to use the assets to pay the damages. Because the amount of damages could be significant, liability losses can reduce personal assets quickly. As a result, insurers recommend that policyholders carry high liability limits.
Insurance companies sell several types of property and liability insurance, including homeowners’ insurance and automobile insurance.
Homeowners’ insurance
provides protection against losses from damage to an owner’s home and its contents. People who rent may buy a type of homeowners’ insurance called renters’ insurance. Such insurance covers only the policyholder’s personal property. It does not cover the apartment building. Homeowners’ and renters’ policies are known as package policies or multiple-line insurance. They provide both property and liability coverage for a variety of perils.
In named perils policies, causes of loss listed on the policy are covered. These losses might include fire, tornadoes, vandalism, theft, explosion, riot or civil disturbance, and damage by automobiles, aircraft, and other vehicles. Open perils policies insure against all risks unless specifically excluded. War and nuclear radiation are two usual exclusions. Both named perils and open perils homeowners’ policies exclude coverage from damage caused by earthquakes and floods. However, people may purchase such coverage separately.
Homeowners’ policies have limits for the amount of coverage on such items as cash, securities (stocks and bonds), coin collections, jewelry, silverware, guns, and furs. Property owners who wish to fully insure such valuables may buy additional coverage.
An insurance company typically requires a policyholder to provide proof of the ownership and document the value of lost or damaged property before it pays compensation. Therefore, policyholders should have evidence of their possessions, such as lists, sales receipts, appraisals, photographs, or videos. The evidence should be kept in a safe-deposit box or other secure place outside the home.
Homeowners’ liability insurance protects policyholders if they become legally liable for bodily injury or property damage to others. Examples include accidental injury to a visitor while on the policyholder’s property or accidental damage by the insured to the property of another. The insurance company may pay a small amount of damages even if the person claiming injury does not sue the policyholder. The insurance company also pays the policyholder’s legal expenses.
Automobile insurance
is the most widely purchased property and liability insurance. It is one of the most important kinds of insurance because of the serious injuries and extensive property damage that can result from auto accidents. Drivers are legally responsible for any costs arising from accidents they cause. Automobile insurance protects a policyholder and his or her family members against financial losses while using or in a car. It may also provide compensation if a policyholder’s car is stolen, vandalized, or damaged in a collision or by storms or other perils.
Most auto insurance policies are package policies and offer both property and liability coverage. Benefits vary according to the type of policy. However, nearly all policies provide four kinds of coverage. They are liability coverage, collision and comprehensive coverage, uninsured or underinsured motorists coverage, and medical payments coverage. No-fault coverage is also available in some U.S. and Australian states and Canadian provinces.
Liability coverage
protects policyholders who cause bodily injury to others or damage to property while operating an automobile. Nearly all U.S. states and Canadian provinces require motorists to have such insurance before they may own or drive a car.
Collision and comprehensive coverage
pays for losses resulting from damage to a policyholder’s automobile. Collision insurance provides protection if the car hits another car or object or runs off the road. Comprehensive insurance covers losses from such perils as fire, theft, flood, and hail. Nearly all collision and comprehensive insurance has a deductible requiring the policyholder to pay for some of the loss.
Uninsured or underinsured motorists coverage
pays benefits to a policyholder injured by a driver who does not carry liability insurance or who carries liability insurance whose benefit payment limits are not sufficient to cover the loss. Injuries caused by a hit-and-run driver are also covered.
Medical payments coverage
provides a small sum for the medical expenses of policyholders and their passengers injured in an auto accident. It pays benefits even if the policyholder is not at fault.
No-fault insurance
allows victims of an automobile accident to collect damages automatically from their own insurance company without determining who was at fault in the accident. With no-fault insurance, policyholders may give up some of their rights to sue other parties who may be responsible for the damages. See No-fault insurance.
Other types of property and liability insurance
include personal umbrella liability insurance, commercial multiple-peril insurance, business income insurance, marine insurance, crime insurance, surety bonds, and product and professional liability insurance.
Personal umbrella liability insurance
provides a level of protection that applies after other personal liability coverage, such as homeowners’ and auto insurance, are exhausted. Personal umbrella liability policies typically have millions of dollars of liability protection in the event of a judgment for a huge amount of damages against the insured.
Commercial multiple-peril insurance
provides property and liability coverage of business risks. It is the business equivalent of homeowners’ insurance. However, it is designed to cover the unique risks that happen with commercial activities.
Business income insurance
provides coverage for indirect losses caused by direct physical damage to businesses that must close temporarily for repairs and restoration. During this time, the company cannot operate as usual. Business income insurance helps recover lost business income.
Marine insurance
consists of two types of insurance. Both deal with risks involved in transportation. Ocean marine insurance covers commercial and recreational vessels operating on oceans and rivers, and in harbors. It includes both property and liability coverage. It compensates for the loss of a vessel and its cargo. Although it has the word marine in its name, inland marine insurance provides protection against losses connected with land transportation. It covers cargo as well as bridges, railroads, and other facilities involved in transporting cargo.
Crime insurance
protects businesses against losses from certain crimes. They include such acts as theft, burglary, forgery, and embezzlement. Embezzlement is the crime committed when someone entrusted with another’s money or property illegally takes it for personal use. Businesses may buy a type of crime insurance called fidelity bonds. Such bonds protect against losses caused by dishonest acts by employees who handle money or valuable merchandise. Banks, brokerages, and other financial institutions purchase a broader type of crime insurance called blanket bonds.
Surety bonds
guarantee that the insured will fulfill obligations as promised. One of the most important types of surety bonds is a contract performance bond. Under such a bond, the insurance company, sometimes called a surety, promises to see that a project is completed if the insured contractor fails to finish it according to the terms of the contract.
Other types of surety bonds include bail bonds and fiduciary bonds. Bail is security deposited with a court to obtain the release of an arrested person. The bail paid is an attempt to ensure that the person will reappear to stand trial. For a fee, typically 10 percent of the required bail, a bail bond agent agrees to pay the full bail amount if the accused fails to appear for his or her court date. Fiduciary bonds guarantee the performance of people who are appointed by a court to be responsible for another’s property. Such people include executors of wills, administrators of trusts, and guardians. The insurer pays out an amount specified by the bond if the fiduciary does not faithfully perform his or her duties.
Product and professional liability insurance
protect manufacturers and professionals against losses from certain kinds of lawsuits. Product liability insurance protects manufacturers from suits in which consumers claim injuries from using defective (flawed or imperfect) products. Professional liability insurance is sometimes called malpractice insurance. It protects such professionals as physicians, accountants, and lawyers against losses from lawsuits in which a patient or client accuses them of error or negligence.
U.S. government insurance programs
There are several types of government insurance programs in the United States. Among the most widespread are those that fall under a broad category called social insurance.
Social insurance
programs are administered or supervised by the government. Most social insurance programs were developed in response to complex social problems that were not insurable by private insurance. Government insurance programs provide benefits for the unemployed, the disabled, and the families of deceased workers. In addition, many countries provide a minimum standard of living for retirees. Social insurance programs differ from public assistance programs. Public assistance programs are financed by general taxes and pay benefits according to need. Instead, social insurance programs are financed mainly by special taxes paid by workers and employers. Benefits from these programs are paid to all people entitled to receive them, regardless of need.
The major forms of social insurance in the United States are old-age, survivors, and disability insurance (OASDI); Medicare; workers’ compensation; and unemployment insurance.
Old-age, survivors, and disability insurance
pays benefits to retired workers and their dependents, to disabled workers and their dependents, and to the survivors of workers who die. Nearly all American workers are covered by OASDI. Benefits are based on a worker’s average earnings. They are financed by a payroll tax shared by workers and employers.
Medicare
is a health insurance program that covers nearly all Americans aged 65 or older as well as certain disabled people. Medicare includes hospital insurance (Part A) and supplementary medical insurance (Part B). Part A focuses on medical care provided in hospitals. Part B helps pay doctor bills and other medical costs not covered by Part A. Part B is optional. It requires an additional premium from those eligible. Medicare Advantage Plans (Part C) are Medicare-approved private insurance plans that retirees can choose instead of the traditional plan (Parts A and B). Medicare prescription drug coverage (Part D) provides assistance in paying for medicine prescribed by a physician. See Medicare.
Many elderly people supplement their Medicare coverage with private insurance called Medigap insurance. Medigap insurance pays hospital bills, doctor bills, and other medical expenses not covered under Medicare.
Workers’ compensation
is available for employees who are injured in a job-related accident or who contract a disease as a result of their job. Workers’ compensation pays the cost of medical care. It also replaces lost income resulting from disability. In addition, it pays for rehabilitation services, which are designed to restore people to health. Employers pay the cost of the insurance. The programs are administered on a state-by-state basis. See Workers’ compensation.
Unemployment insurance
is a joint federal-state program that provides cash payments for a limited number of weeks to workers who lose their job involuntarily. It is financed by a payroll tax paid by employers. Unemployment insurance provides temporary income to workers to help maintain their standard of living. It may also help limit slumps in business activity by enabling unemployed people to buy goods and services. Such purchases help preserve existing jobs. See Unemployment insurance.
Other government insurance programs.
Certain agencies of the U.S. government provide types of insurance. For example, the Federal Deposit Insurance Corporation (FDIC) insures customers’ bank deposits up to a maximum of $250,000 for each depositor. Farmers can obtain coverage against crop losses from flood, drought, and other natural perils through the Federal Crop Insurance Corporation (FCIC). Homeowners can get protection from flood damage through the National Flood Insurance Program in areas where floods often occur.
The insurance industry
Insurance companies play a vital role in a nation’s economy. They contribute to economic stability by compensating individuals and businesses for financial losses that might otherwise cause financial ruin. Insurance companies also guarantee repayment of loans and the completion of commercial projects and public works. Without the ability to transfer the financial consequences of uncertainty to insurers, businesses would be reluctant to produce certain goods and provide certain services that are risky. Insurance companies are also a significant source of investment capital. They invest billions of dollars in stocks, bonds, mortgages, government securities, and other income-producing enterprises.
Types of insurance companies.
Many insurance companies are stock insurance companies or mutual insurance companies. A stock insurance company is owned by stockholders, who share in profits earned by the company. A mutual insurance company is owned by the policyholders. Profits earned by a mutual company are returned to the policyholders as dividends or used to reduce future premiums.
Other types of insurance organizations include cooperative insurance companies and Lloyd’s of London. Cooperative insurance companies are also called fraternal benefit societies. They consist of members of a group, such as a social or religious organization. They operate for the benefit of the members of the group. Lloyd’s of London is not an insurance company. It instead is an insurance marketplace where individuals and businesses can meet to negotiate contracts that transfer risk. See Lloyd’s.
How insurance is sold.
Most insurance companies sell policies through agents and brokers. Exclusive agents sell only one company’s policies. Independent agents sell policies for several companies. Large businesses or other commercial organizations with extensive insurance needs frequently buy insurance through a broker. Brokers represent policyholders rather than insurance firms. They typically help in finding appropriate insurance coverage for more complex risks.
Government regulation.
The insurance industry is heavily regulated in the United States and Canada. In the United States, the state governments have nearly complete control of insurance regulation. Each state has a department that regulates and licenses insurance companies operating within the state. In Canada, both the federal government and the provincial governments regulate the industry. In Canada, the federal government deals chiefly with matters involving the financial stability of insurance companies. Provincial governments supervise companies in their province and may license companies and agents or regulate insurance rates.
Insurance companies are regulated mainly because policyholders pay premiums in advance of an insurer’s promises. Government regulations help ensure that the companies remain financially sound and can meet the obligations promised to policyholders. State insurance departments periodically examine each company’s financial statements, review its investments, and see that it has adequate funds in reserve to pay future claims. The government enforces laws concerning trade and marketing practices of agents and insurance companies. Such laws are designed to prevent the sale of policies with unfair or misleading terms and to help guarantee that people who need insurance can obtain it.
Careers in the industry.
Insurance agents and brokers serve as intermediaries (go-betweens) between insurance consumers and companies. Specialty careers in insurance include those of actuaries, underwriters, and claims adjusters. Actuaries are mathematicians who use statistical tables to calculate premium rates based on different risk situations. Actuaries also set insurance company reserves. Underwriters decide whether a company will accept an individual risk. They must also decide on an appropriate premium for each potential policyholder. Claims adjusters investigate reported claims. They also determine the extent of a company’s liability and the amount it should pay based on coverage terms.
Insurance companies also employ accountants, computer specialists, investment analysts, lawyers, engineers, and advertising and public relations specialists. Nearly all these workers, as well as actuaries, underwriters, and claims adjusters, have a college degree. Many have a graduate degree and professional designations such as Chartered Life Underwriter (CLU) or Chartered Property Casualty Underwriter (CPCU). To earn a CLU or a CPCU designation, a person must pass a series of exams. Other insurance workers include administrative staff.
History
Earliest insurance.
Insurance is thousands of years old. The Code of Hammurabi, a collection of Babylonian laws of the 1700’s B.C., included a form of credit insurance. If a sailing merchant borrowed money to pay for cargo, the loan was forgiven if misfortune struck during a voyage. The borrower paid an extra amount for this protection in addition to the interest on the amount borrowed. Ancient Greek and Roman organizations provided their members with old-age pensions and disability insurance. During the Middle Ages, from about A.D. 400 through the 1400’s, guilds (associations) formed by craftworkers offered some types of insurance, including fire and theft insurance, to their members.
The growth of insurance.
In the early 1600’s, the French mathematicians Blaise Pascal and Pierre de Fermat developed the theory of probability, which is now widely used to determine insurance rates. The English astronomer Edmond Halley compiled the first mortality table in 1693, helping to lay the groundwork for life insurance.
Modern marine insurance and the practice of underwriting began about 1690 in a London coffee house owned by Edward Lloyd. There, ship owners and merchants would meet. A statement of a ship’s cargo was recorded on a piece of paper and read by the coffee house patrons. Those willing to share the risk of insuring the cargo signed under the statement. The term underwriting comes from this practice. The Great Fire of London in 1666 led the British physician and economist Nicholas Barbon to open England’s first fire insurance office.
Insurance in the United States.
In 1752, the American statesman and scientist Benjamin Franklin helped found the American Colonies’ first mutual fire insurance company. It was called the Philadelphia Contributionship for the Insurance of Houses from Loss by Fire. The colonies’ first life insurance company was the Presbyterian Ministers’ Fund, established in 1759. The U.S. life insurance industry grew slowly in the first half of the 1800’s. Many religious leaders condemned life insurance. They believed it was morally wrong to place a monetary value on human life. In 1840, the total value of life insurance policies in the United States was less than $5 million. By 1865, the total value of such insurance was about $600 million.
Other types of insurance also grew rapidly beginning in the mid-1800’s. A series of disastrous fires during the middle and late 1800’s led to a rapid increase in the number of fire insurance policies.
Greater regulation.
During the mid-1800’s, many states began to establish insurance departments. They also started to pass laws regulating the insurance industry as a result of dishonesty by some companies.
In 1868, the Supreme Court of the United States reinforced the rights of states to regulate the insurance industry in its ruling in the case of Paul v. Virginia. Samuel Paul was an insurance agent selling policies of New York insurers to policyholders in Virginia. The State of Virginia argued that Paul could not sell the policies in Virginia because he did not have a Virginia insurance license. Paul argued that insurance was interstate commerce and therefore regulated by Congress, not the states. But the Supreme Court disagreed. It ruled that insurance contracts do not represent a form of interstate commerce, thus giving states the right to regulate the insurance industry.
In 1944, the Supreme Court overturned Paul v. Virginia in the antitrust case of U.S. v. Southeastern Underwriters Association. The court declared that insurance was in fact interstate commerce and therefore subject to federal regulation. The court’s decision created uncertainty about the regulatory framework built by the states. However, the McCarran-Ferguson Act of 1945 declared that regulatory power belonged to the states. The act is now the legal basis for state regulation.
The Great Depression, a worldwide economic slump of the 1930’s, led to greater interest in financial security and insurance products. In 1935, Congress passed the Social Security Act to provide old-age benefits and unemployment compensation. During World War II (1939-1945), the federal government prohibited wage increases in most industries. Workers were scarce during the war, and many employers began to offer their employees various benefits to try to encourage workers to accept or stay in a job with their firm. These benefits included group life and health insurance.
Starting in 1970, several U.S. states adopted no-fault automobile insurance. In 1986, the U.S. Congress passed the Consolidated Omnibus Budget Reconciliation Act (COBRA). COBRA gives workers who lose their jobs the right to keep health benefits provided by their former employers’ group health plans for limited periods under certain circumstances. Workers using COBRA to keep insurance typically pay their own premiums, as before, and the premiums formerly paid by their employers.
The Health Insurance Portability and Accountability Act of 1996 (HIPAA) allowed workers improved access to health care when changing employers. Previously, many group insurance plans had limited or denied coverage to people who already had health problems, known as preexisting conditions. As a result, people with preexisting conditions could not qualify for some health insurance if they lost or changed their jobs. HIPAA imposed strict conditions and time limits for such denials.
Health care reform.
In 2010, Congress passed the Patient Protection and Affordable Care Act (PPACA), commonly known as Obamacare. The law provided for the creation of state-based health-insurance marketplaces called exchanges. Self-employed people, people without employer insurance plans, and small employers can buy insurance on the exchanges. The PPACA also includes an employer mandate. The mandate requires nearly all employers with 50 or more workers to offer them health insurance or pay a fine. The PPACA provides for government subsidies (financial support) for small employers and lower-income individuals to help cover their insurance costs. It also prohibits insurance companies from denying coverage to individuals because of preexisting conditions.
Insurance today.
A number of problems involving insurance exist today. Many personal and commercial policies exclude disasters caused by humans. This exclusion has caused economic problems. For example, such environmental risks as contamination from nuclear power plants, oil spills, and the disposal of hazardous wastes are excluded. As a result, the risk from such industries cannot be shared. Insurance companies also face the difficulty of assessing risks that stem from the increased use of and dependence on computers.
Social insurance programs in the United States and many other wealthy, industrialized countries will face severe difficulties in providing future benefits. An increasing elderly population and the rapid growth of the costs of medical care contribute to these difficulties. In the 1990’s, increased use of managed care plans slowed the rising cost of medical care. Nevertheless, the aging population probably will put severe pressures on both private insurers and government programs in the United States.
Such natural disasters as hurricanes, earthquakes, tornadoes, and wildfires have caused big losses for both property owners and property insurers. This is especially true in such high risk areas as the U.S. states of California and Florida, where increases in construction costs have accelerated.
Today, the insurance industry has continued to be part of the trend toward fewer but larger financial services organizations. This trend began in 1999, with the passage of the Financial Services Modernization Act. This law allowed insurance companies, banks, and securities firms to combine within a larger financial services holding company. Previously, insurance, banking operations, and investment services had been separated by law.
