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 ship owner 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
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
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.
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.
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
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 canceled 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.