In society, we interact with insurance in many ways, and the intent is always to reduce financial loss. The process of investing in insurance began hundreds of years ago when merchants formed associations, known as guilds, between them and craftsmen to protect their products against loss.

These guilds began to mutually protect merchandise being transported between the United Kingdom (U.K.) and the New World. Bottomry was formerly used to describe insurance, which would refer to the merchandise stored at the bottom of ships.

Following a catastrophic fire that destroyed most of London, guilds evolved into mutual insurance companies known as Friendly Societies in the U.K., and bottomry simply became known as insurance.

In 1735, the Friendly Society became the first insurance company in the United States (U.S.). In 1752, Benjamin Franklin, a firefighter, organized and established the Philadelphia Contributionship to insurance houses from loss by fire. This is the oldest insurance carrier still in existence in the U.S.

Insurance is a type of investment, which allows an investor to transfer financial risk. Specifically, it is a contract between an individual or business and the insurer (insurance company). People and businesses purchase insurance to manage risk and reduce financial loss. Most individuals are familiar with insurance when thinking about protecting:

  • Health
  • Home
  • Family
  • Personal items such as cars, boats, motorcycles, and jewelry 

Within the insurance industry, there are three main types of insurance:

  • Property/Casualty Insurance – includes insurance to protect business, auto, home, and personal items. This protects investors from having to pay the full cost of repair for significant damage or total loss due to an accident or natural disaster.
  • Life/Disability Insurance – includes traditional life insurance, annuities, and disability. Life insurance and annuities generally include paying a person a specific amount of money, for, or at a predetermined amount of time. Disability insurance is included within life and health insurance, which is used to protect against financial hardship due to illness or injury.
  • Health Insurance – includes private health insurance and government-issued programs such as Children’s Health Insurance Program (CHIP). Health insurance will help afford the cost of doctors’ visits, medication, and testing, usually a specific dollar amount or percentage.

Some widely used terms an individual or business purchasing insurance should be familiar with are:

Premiums: Money charged for the insurance coverage reflecting expectation of loss.    

Policy: a written contract ratifying the legality of an insurance agreement.

Insured: party(ies) covered by an insurance policy.

Term: period of time for which policy is in effect.

Deductible: Portion of the insured loss (in dollars) paid by the policyholder

Moral Hazard: personality characteristics that increase probability of losses. For example, not taking proper care to protect insured property because the insured knows the insurance company will replace it if it is damaged or stolen is a moral hazard.

Morale Hazard: negligence or disregard on the part of the insured which could lead to probable loss.

Claim: a request made by the insured for insurer remittance of payment due to loss incurred and covered under the policy agreement.


The Insurers

An insurer is the person or company who is authorized within a state, territory, or country to create legally binding insurance policies. Insurance policies are products created to protect policyholders against financial loss by allowing for risk to be transferred to the insurer.

Insurers will first design a policy to identify what the roles and responsibilities are of the company and of the person or individual who is covered by the policy. Many times, insurers will work with other insurance companies within their industry to diversify the risk of loss on a policy.

Insurers identify risk as either being a pure or speculative risk.

  •  Pure Risk are circumstances where there is a possibility of loss or no loss, but no possibility of gain. These include natural disasters, fires, car accidents, or death.
  • Speculative Risk focuses on conscious choice and is not just a result of uncontrollable circumstances. An example of a speculative risk would be investing in the stock market.

Insurers will only underwrite pure risks.

The following terms have been adopted within the insurance industry, in order to identify the role of an insurance provider:

  • Insured: a person or organization covered by insurance.
  • Underwriter: person or company who identifies, examines and classifies the degree of risk represented by a proposed insured in order to determine whether or not coverage should be provided and, if so, at what premium rate.
  • Indemnification: a general legal principle related to insurance that holds that the individual recovering under an insurance policy should be restored to the approximate financial position prior to the loss. Legal principle limiting compensation for damages be equivalent to the losses incurred.
  • Intermediary: a person, corporation or other business entity, not licensed as a medical provider, that arranges, by contracts with physicians and other licensed medical providers, to deliver health services for a health insurer and its enrollees via a separate contract between the intermediary and the insurer.
  • Reinsurance: a transaction between a primary insurer and another licensed (re) insurer, where the reinsurer agrees to cover all or part of the losses and/or loss adjustment expenses of the primary insurer. The assumption is in exchange for a premium.
  • Reinsurer: company assuming reinsurance risk.
  • Package Policy: two or more distinct policies combined into a single contract.
  • Covered Lives: The total number of lives insured, including dependents, under individual policies and group certificates.

Life Insurance

Life insurance is an investment product where an individual is able to purchase a policy based on a specific term. Life insurance policies require the insurer to pay out a specific dollar amount triggered  by the death of the policyholder.

There are two main types of life insurance.

  • Term: It pays only if death occurs during the term of the policy, which is usually from one to 30 years. Most term policies have no other benefit provisions.
  • Whole life: Whole life or permanent insurance pays a death benefit whenever the policyholder dies.

Investors purchase life insurance for one or more of the following reasons:

  1.   Create an inheritance for family heirs
  2.   Pay final living and burial expenses. This sometimes includes federal and state “death” taxes.
  3.   Replace lost income for dependents, commonly for a living spouse with children.
  4.   Charitable contributions to a charity who is listed as the beneficiary of a life insurance policy.



An annuity is a contract between you and an insurance company that requires the insurer to make payments to you, either immediately or in the future. People typically buy annuities to help manage their income in retirement.

There are two phases to annuities: the accumulation phase and the payout phase.

  • During the accumulation phase, you make payments that may be split among various investment options. In addition, variable annuities often allow you to put some of your money in an account that pays a fixed rate of interest.
  • During the payout phase, you get your payments back, along with any investment income and gains. You may take the payout in one lump-sum payment, or you may choose to receive a regular stream of payments, generally monthly. 

Insurance companies sell annuities, as do some banks, brokerage firms, and mutual fund companies. Make sure you read and understand your annuity contract. All fees should be clearly stated in the contract. Your most important source of information about investment options within a variable annuity is the mutual fund prospectus.

Realize that if you are investing in a variable annuity through a tax-advantaged retirement plan, such as a 401(k) plan or an Individual Retirement Account, you will get no additional tax advantages from a variable annuity. In such cases, consider buying a variable annuity only if it makes sense because of the annuity’s other features.

Annuities come in three basic categories:

  •       Fixed annuity: The insurance company promises you a minimum rate of interest and a fixed amount of periodic payments.
  •       Variable annuity: The insurance company allows you to direct your annuity payments to different investment options, usually mutual funds. Your payout will vary depending on how much you put in, the rate of return on your investments, and expenses.
  •       Indexed annuity: This annuity combines features of securities and insurance products. The insurance company credits you with a return that is based on a stock market index, such as the Standard & Poor’s 500 Index. 


Risks of Annuities

All investments carry a level of risk. Make sure you consider the financial strength of the insurance company issuing the annuity. You want to be sure the company will still be around, and financially sound, during your payout phase.

Variable annuities have a number of features that you need to understand before you invest. Understand that variable annuities are designed as an investment for long-term goals, such as retirement. They are not suitable for short-term goals because you typically will pay substantial taxes and charges or other penalties if you withdraw your money early. Variable annuities also involve investment risks, just as mutual funds do.


Insurance Regulation

The main purposes of insurance regulation include:

  • maintain insurer solvency
  • protect consumers
  • regulate premium rates

Insurance in the United States has traditionally been regulated by individual states. States work directly with the National Association of Insurance Commissioners (NAIC), which is responsible for developing fundamental rules and regulations for the industry as a whole.

State regulators are responsible for confirming that insurance companies are able to remain sustainable over the long-term to prevent bankruptcy. Regulation protects insurance consumers from unfair and discriminatory treatment. Did you know that individual states regulated insurance?

Fixed and Indexed annuities are regulated by state insurance commissioners, while variable annuities are regulated by the Securities and Exchange Commission (SEC).

Insurance is regulated under two basic systems:

Competitive Rating (file-and-use): Competitive rating relies on marketplace forces to keep insurance rates consistent with underlying costs. The competitive rating law does not mean the regulator gives up oversight of insurance companies. Regulators maintain power to reject any rates they deem to be inadequate, excessive or unfairly discriminatory, and may require insurers to refund excessive rates to policyholders and pay fines if rates are not deemed appropriate.

Prior Approval: In prior approval states, rates must be filed with regulators who must then individually approve or disapprove the filing before it can go into effect. The system essentially relies on the regulators’ judgment and the existing political environment.

Insurance supports the economy by:

  • Protecting economic interdependence among businesses by insuring supply chains, which become increasingly vulnerable with more complex technological components
  • Stabilizing insurer exposure to loss by spreading or diversifying transferred risk.
  • Providing significant social benefits, such as compensation for injuries at work and rebuilding property after catastrophes. Insurance contributes to the rebuilding of people’s livelihoods, as well as to the economy as a whole
  • Investing in economy-boosting construction projects and events to take place.

Insurance Risk

The largest risk to a policyholder of an insurance contract is the risk of insurer insolvency, which means the insurance company that has guaranteed the policy goes bankrupt and is unable to pay insurance claims.

In addition to insolvency, policyholders face the following risks:

  • Lapse: A termination of a policy due to failure to pay the required renewal premium. Lapse risk creates risk to both the insurer and policyholder. The policyholder will not have any coverage and the insurer will not receive premiums, which it uses to pay claims. A lapse by one policyholder will not affect the insurer; however, a collective lapse or inability from a large number of policyholders to pay premiums may create a risk of insolvency for the insurer.
  • Rate increases: Policyholders may experience an increase in their rates due to economic changes that have nothing to do with their contract.
  • Policy cancellation: Insurers continuously review policies to manage risk. Insurance providers may cancel policies that are viewed to have higher risk. Insurers will list their reasons for potentially canceling  a policy as part of a contract. Each state insurance commissioner will govern policy cancellations to guarantee that an insurer’s reasons for cancellation are nondiscriminatory. 

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