Insurance is
a means of protection from financial loss. It is a form of risk
management, primarily used to hedge against the risk of a contingent
or uncertain loss.
An entity which provides insurance is known as an insurer,
insurance company, insurance carrier or underwriter. A person or entity
who buys insurance is known as an insured or as a policyholder. The insurance
transaction involves the insured assuming a guaranteed and known relatively
small loss in the form of payment to the insurer in exchange for the insurer's
promise to compensate the insured in the event of a covered loss. The loss may
or may not be financial, but it must be reducible to financial terms, and
usually involves something in which the insured has an insurable
interest established by ownership, possession, or preexisting
relationship.
The insured receives
a contract, called the insurance policy, which details the conditions
and circumstances under which the insurer will compensate the insured. The
amount of money charged by the insurer to the insured for the coverage set
forth in the insurance policy is called the premium. If the insured
experiences a loss which is potentially covered by the insurance policy, the
insured submits a claim to the insurer for processing by a claims
adjuster. The insurer may hedge its own risk by taking
out reinsurance, whereby another insurance company agrees to carry some of
the risk, especially if the primary insurer deems the risk too large for it to
carry.
Early methods
Methods for transferring or distributing risk
were practiced by Chinese and Babylonian traders as long ago as the 3rd and 2nd millennia BC, respectively. Chinese merchants travelling
treacherous river rapids would redistribute their wares across many vessels to
limit the loss due to any single vessel's capsizing. The Babylonians developed
a system which was recorded in the famous Code of Hammurabi, c. 1750 BC, and practiced by early Mediterranean sailing merchants. If a merchant received a loan to fund his shipment,
he would pay the lender an additional sum in exchange for the lender's
guarantee to cancel the loan should the shipment be stolen, or lost at sea.
Circa 800 BC, the inhabitants
of Rhodes created the 'general average'. This allowed groups of
merchants to pay to insure their goods being shipped together. The collected
premiums would be used to reimburse any merchant whose goods were jettisoned
during transport, whether due to storm or sinkage.
Separate insurance contracts (i.e., insurance policies not
bundled with loans or other kinds of contracts) were invented
in Genoa in the 14th century, as were insurance pools backed by
pledges of landed estates. The first known insurance contract dates
from Genoa in 1347, and in the next century maritime insurance
developed widely and premiums were intuitively varied with risks. These
new insurance contracts allowed insurance to be separated from investment, a
separation of roles that first proved useful in marine insurance.
Modern insurance
Insurance became far more sophisticated in Enlightenment
era Europe, and specialized varieties developed.Property insurance as
we know it today can be traced to the Great Fire of London, which in 1666
devoured more than 13,000 houses. The devastating effects of the fire converted
the development of insurance "from a matter of convenience into one of
urgency, a change of opinion reflected in Sir Christopher Wren's inclusion
of a site for 'the Insurance Office' in his new plan for London in 1667."[4] A
number of attempted fire insurance schemes came to nothing, but in
1681, economist Nicholas Barbon and eleven associates
established the first fire insurance company, the "Insurance Office for
Houses," at the back of the Royal Exchange to insure brick and frame
homes. Initially, 5,000 homes were insured by his Insurance Office.
At the same time, the first insurance schemes for
the underwriting of business ventures became available. By
the end of the seventeenth century, London's growing importance as a center for
trade was increasing demand for marine insurance. In the late 1680s,
Edward Lloyd opened a coffee house, which became the meeting place for
parties in the shipping industry wishing to insure cargoes and ships, and those
willing to underwrite such ventures. These informal beginnings led to the
establishment of the insurance market Lloyd's of London and several
related shipping and insurance businesses.
