Unpredictability. Each of us lives with it, not knowing what each new day will bring. It is this very uncertainty which gave way to the development of the business of insurance. This article will give you a very brief overview of the origination and history of insurance, as well as the basic premises upon which it operates.
In ancient times, farmers of China sent their crops to market on boats. Inevitably, on occasion a boat sank along the way. The farmers began spreading their crops among numerous boats, so that if one boat sank, any one family would only lose a small portion of their crops, thus avoiding financial devastation. The loss was spread among many families, and was therefore manageable for each one.
Actual insurance contracts originated in the 13th century with ship owners who wanted to protect themselves against the possibility of catastrophic losses. As before, ships were inevitably lost at sea from time to time. The owners were aware of this, but they could not foresee which ships would be lost at what time. Wealthy individuals agreed to receive a certain amount of money from each ship owner in exchange for a promise to pay for the loss of a ship when it occurred. Insurance is, in actuality, a social vehicle for spreading the risk of financial loss among a large group of people, thus making a loss manageable for any one person of that group.
As opposed to the risk associated with investment, risk with regard to insurance matters refers to the possibility of loss. Note that it is not the loss itself, but the possibility of a loss. There are two types of risk, only one of which can be insured; speculative risk and pure risk. Speculative risk affords the opportunity for gain as well as the possibility of loss. Gambling and stock market investments are two common examples. This type of risk is not insurable. Pure risk has the possibility of loss only; thus, it is insurable. The purpose of insurance is to restore the insured to their original financial position, not to provide an opportunity for making a profit.
There are several ways of managing, or coping with, risk. It may be reduced or avoided altogether by examining its causes and eliminating them where possible. Risk can be retained when a person decides to assume financial responsibility for specific events. Or risk may be transferred to another party, such as through an insurance contract.
In the early days of insurance people could obtain an insurance policy on anyone, even complete strangers. If that person died, the policyholder reaped the benefit of the policy with no apparent financial or emotional loss. You can easily imagine the possibilities of a situation like this. (Can you spell murder?) To close this somewhat glaring loophole, a basic governing rule of insurance was instituted which states that an individual must have a legitimate interest in the preservation of the life or property insured, before that individual cam benefit from its insurance. This requirement is known as insurable interest.
As you can guess, insurance has evolved from its very early days. Its complexities can, at times, be quite confusing. Its basic premise, however, remains unchanged; to spread risk, thus making loss, when it occurs, manageable.