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An Overview of Inusrance and Its Benefits

The average person deals with risks from the moment they get out of bed in the morning, until snapping out the light at night. Some degree of risk is involved in every action we take from picking up the morning paper, driving to work, crossing the street or climbing the office stairs, and a dozens of other daily events. By and large, the average person is willing to accept and deal with the risks of everyday activities and handle them as they occur.

In everyone’s life, though, there are occasions when risks rise above the mundane. Serious health issues crop up, your house burns, you’re a party to a serious traffic accident, the bread winner in the family dies. Most people aren’t prepared to cope, on their own, with such losses. That’s true today, and has been true for thousands of years. Insurance of all types evolved out of the idea of pooling resources to share the risks that are above the normal risks of everyday life.

Around 1750 B.C. Babylonian traders organized a system to protect them against losses in case the ships carrying their goods were lost at sea or raided by pirates. Merchants paid a premium to their financial backers to secure a guarantee that their loans would be canceled if their goods failed to reach their intended destination. The Babylonian Code of Hammurabi gives us the first recorded instance of “risk management,” and “shared risk.”

By the 7th Century A.D., both the Greeks and Romans had developed their own form of insurance. Contributing members or groups contributed to pools that provided burial expenses and continuing income for member families upon the death of a loved one.

Insurance became more sophisticated and specialized in post-Renaissance Europe. All of Europe was aggressively expanding trade worldwide. An explosion of shipping was underway and the need for more complete and organized insurance solutions became apparent. England, especially London, had become a huge trade center. It was logical that the first major insurance company would originate there. Lloyd’s of London was the product of a meeting at Edward Lloyd’s Coffeehouse in 1688. The coffeehouse was a popular gathering place for the shipping community, and members of that community formed an insuring company for protecting the cargo of shippers and merchants. In its early years, a very large portion of Lloyd’s business involved insuring slave cargos.

The development of fire insurance was triggered in response to a tragic event. A massive London fire in 1666 destroyed over 13,000 homes. Reacting to the losses, Nicholas Barbon founded an organization to insure buildings made of brick and stone against loss from fire. His plan became the basic template for most fire insurance plans that followed.

In the American colonies, Benjamin Franklin was an early proponent of fire insurance. Already involved in organizing and operating a Philadelphia fire fighting company, it was logical that he also became leader in developing a plan to protect homeowners in the event of fire. Like Barbon’s London firm, Franklin’s Philadelphia Contributorship, organized in 1752, insured houses made from brick, but not from wood. The visionary Franklin also took an active role in educating the home and business owners about sensible fire prevention practices. His efforts were apparently successful as the fledgling insurance company had no claims against it in its first year of operation.

In the centuries following Ben Franklin’s pioneering insurance company, thousands of insurance companies have been formed. There companies offer coverage for nearly every risk and liability of life, from the seemingly trivial to the monumental. Individuals, families businesses and organizations face an almost daily dilemma — how much protection is needed versus how much loss or risk of loss they is acceptable. Not a an easy question to answer ifor anyone.

Is insurance a wise investment? Many purchasers of insurance feel the premiums are oppressive. It often seems like another premium statement arrives in the mail everyday. Looking at the cost of premium objectively, though, the protection they provide may be somewhat of a bargain. For instance, a $1,000 per year auto policy premium could cover full replacement, minus $500 or so, for a $30,000 auto. A bargain in anyone’s book. If insured car was involved in an accident causing only $5,000 in damages, it would take 5 years of premiums payments to recover the loss. Once more the $1,000 yearly premium translates to a real bargain. The bankroll of premiums paid by policy holders who don’t make claims for losses will cover the expenses of those who do.

The sharing of risk and balancing the premiums versus claims equation isn’t where the insurance companies produce the bulk of their profits. The profitability of that arm of insurance companies is relatively small. Today’s insurance companies are also investment companies, and it’s the investment arm that has the potential for being highly profitable.

Insurance policy holders pay their premiums in advance, leaving the insurance companies with rich cash balances held in reserve to cover potential losses. These reserves of cash, “the float,” are available for investment in financial instruments capable of returning huge dividends. Insurance companies who invest prudently and wisely are able to harvest very substantial profits for themselves and their shareholders.