Introduction to Insurance Chapter 1 InVEST Textbook

How Insurance Began Began in the late 1600s in a London coffee house owned by Edward Lloyd Wealthy merchants would make arrangements with each other to share risks of loss of a shipment If there was a loss (ship sinks, damage, etc.) each person would reimburse the shipper for his/her percentage of the value. But, if the voyage was successful, each would receive a bonus or profit.

Ben Franklin Credited as the inventor of the U.S. insurance industry In 1752, he organized one of the first fire insurance companies which is still in operation today

Firemarks Franklin’s company, the Philadelphia Contributorship for the Insurance of Houses from Loss by Fire sold insurance and would place a plaque near the front of the owners door indicating they purchased insurance form the fire company Picture is of the orginal firemark mentioned above

Firemarks When a fire occurred, all the fire companies (including Franklins) would get in their fire trucks (horse drawn) and go by the house looking for the symbol If the house had the same symbol that appeared on the truck, the fire company would extinguish the fire If not, they kept on going!

Benefits and Cost of Insurance Today, insurance functions as a way to reimburse people when their property is damaged or they suffer some other kind of unforeseen loss. Helps individuals and businesses resume their normal standard of living and operations

Benefits and Cost of Insurance If your home burned down and you didn’t have insurance, you may not have the means to pay for the repairs, and would be unlikely to have funds to make other purchases. Not only would you be affected, but others from whom you ordinarily buy things from would also be impacted. There would be a negative ripple effect on the economy.

Benefits and Costs of Insurance Encourages activities and devices that will reduce the amount of losses and their economic impact For instance, seatbelts! Insurance companies were the major force behind requiring seat belts as standard equipment in all cars.

Benefits and Costs of Insurance Sometimes, insurance can encourage loss for financial gain For instance, the crime of arson. An unscrupulous person could intentionally burn down their own house to gain access to their insurance policy proceeds. This wouldn’t happen if there wasn’t an insurance policy, so its considered a cost of insurance

How the Insurance Industry is Organized Divided into two major divisions Property & Casualty – provides protection to individuals and businesses for loss to their assets Life & Health – protects people from financial loss due to premature death, sickness or disease

General Principles of Insurance Insurable interest – exist whenever the occurrence of a certain event, such as a fire or theft, results in a financial loss to a person or organization. In order to purchase legally valid insurance, one must posses an insurance interest in the item being insured If you own a car, and that car is damaged in an automobile accident, the value of the car declines and you suffer a financial loss. Therefore, you possess an insurance interest in that car and may purchase insurance to protect against the financial loss.

General Principles of Insurance Indemnity – determines how much you can collect Let’s say your car is damaged in an auto accident. Although you may want the insurance company to replace your car with a new one, this would violate the principle of indemnity since a new car is more valuable than an older one. The insurance company determines the value of the damaged automobile (including a deduction for depreciation) and pays you that amount. Indemnity is the second guiding priciple of insurance. This is similar to insurable interest, but rather than defining under what circumstances you can collect on an insurance policy, the principle of indemnity determines how much you can collect.

Contracts of Indemnity Insurance policies are designed to put someone back in the same general financial condition he or she was in before the loss occurred. You shouldn’t be able to profit by collecting the insurance Without each of these underlying principles, there is little that would separate the purchase of insurance from gambling. Think what would happen if people did not need to have an insurable interest in the houses they insured for loss by fire. You would simply drive around town, and find the oldest, most rundown house you could, buy a fire insurance policy and wait for the place to burn down. It’s the doctrine of insurable interest that prevents you from doing that.

Basic Insurance Terms Among the most fundamental insurance concepts are the meanings of the words risk, peril, hazard, loss, insurance and insurance policy

Risk A risk exists whenever there is uncertainty about the outcome Pure risk exists whenever there are only two possible outcomes: loss, or no loss. This is the type of risk insurance deals with. Speculative risk there is a third possible outcome, gain. A risk exists whenever there is an uncertainty abou the outcome. “taking a risk” means not knowing exactly what will happen. Facing risks is part of life, and is the basic problem dealt with insurance. Risk comes in two forms, only one of which is addressed by insurance. Pure risk exists whenever there are only two possible outcomes: loss, or no loss. With speculative risk, there is a third possible outcome, gain. When you purchase a company’s stock, the value of the stock could decline (loss), it could stay the same (no loss) or it could appreciate (gain). Insurance does not deal with speculative risk, since the potential for gain or profit contained in these situations would be a violation of the general principles of insurable interest and indemnity.

Managing Risk Avoidance – eliminate loss exposure Loss Control – try to reduce losses Transfer to Others – transfer responsibility to another person Retention – paying some or all losses out of pocket Insurance – transfer loss to an insurance company A risk exists whenever there is an uncertainty abou the outcome. “taking a risk” means not knowing exactly what will happen. Facing risks is part of life, and is the basic problem dealt with insurance. Risk comes in two forms, only one of which is addressed by insurance. Pure risk exists whenever there are only two possible outcomes: loss, or no loss. With speculative risk, there is a third possible outcome, gain. When you purchase a company’s stock, the value of the stock could decline (loss), it could stay the same (no loss) or it could appreciate (gain). Insurance does not deal with speculative risk, since the potential for gain or profit contained in these situations would be a violation of the general principles of insurable interest and indemnity.

Peril A peril is the cause of a loss Fire Flood Theft Earthquake A peril is the cause of a loss. Fire, flood, theft and earthquake are all perils or events that can cause a loss to property and people.

Hazard A hazard is a condition that makes a peril more likely to happen or that increases the seriousness of a loss. Leaving the door to your house unlocked when no one is there is a hazard since it increases the likelihood that a theft will take place. Building houses with wood shake roofs increases the amount of damage that the structure will suffer if there is a brush fire and is, therefore, a hazard. Some hazards are the result of the physical characteristics of a policy, such as old wiring in a home that could lead to a fire. Other hazards are created by people, such as when a person burns down his or her own house or when someone files a false insurance claim. This is called a moral hazard, since it arises out of a peron’s habits or tendencies and increases the likelihood of losses.

Loss Loss is a simple decline in value Reduction in quantity, quality or value of something, a loss is said to occur This can occur to tangible items, such as houses, cars or equipment (direct loss) or it can result from damage to tangible items (indirect loss). An example is when you must take up residence in a hotel (indirect loss) because your house was damaged by fire (direct loss) or when you have to rent a car (indirect loss) while yours is in the shop being repaired following a collision (direct loss).

Insurance Insurance is a social and contractual device that transfers the risk of a financial loss from individuals or businesses to an insurer.

Insurance Policy An insurance policy is a document issued by an insurance company to its policy holder that provides details about what is covered under the contract. The type of coverage (such as automobile liability insurance), the limits (maximum amount that will be paid for a particular loss) and any deductibles (the amount the insured must pay his or herself) are all stated in the policy.

Insurance Terminology Claim – notify insurance of a loss Commercial Insurance – insuring your business and workers Deductible – portion of loss insurer will not cover Liability – being held financially responsible Premium – Cost consumers pay for insurance Underwriting – process insurance company uses to determine who will be covered and at what price The type of coverage (such as automobile liability insurance), the limits (maximum amount that will be paid for a particular loss) and any deductibles (the amount the insured must pay his or herself) are all stated in the policy.