In this series I will try to unpack short term insurance for you.
Knowledge is Power
A knowledgeable client is a good client. Understanding insurance makes it easier to make decisions on what your insurance should look like. Client and broker are partners identifying risks and finding the best solution to mitigate the risk. This leads to a good claims experience.
This first video, I will look at the history of insurance and how it all started.
THIS IS NOT ADVICE. Please consult a financial advisor before making changes to any financial portfolio. I trust the knowledge you will gain here, will beneficial in the process of discussing your insurance need.
Insurance is a system of spreading the risk of one onto the shoulders of many
A shared burden is a lighter burden
Camel Traders of Babylon
Insurance goes back a very long time. Even the Camel Traders of Babylon had some form of insurance. (Link in description) called Bottomry. It dates to 4000BCE. The merchandise was financed. In the event the merchandise was lost, the loan was cancelled. The interest was considered an insurance premium.
The Sailors Discovering Trade Routes
When sailors like Columbus, Diaz, and others started circumnavigating the earth in the 15th century, the financial risk became very high. The ships were expensive and one needed capital to build it. The cargo was equally valuable. Imagine a shipwreck at the Cape of Storms and ship and cargo is lost. A huge financial setback for everybody.
The first form of insurance was to spread the cargo over many ships. That way, if one ship were lost, the owners would not lose their whole investment in the cargo as well. That was the first instance of shared burden.
There was a coffee shop in London, Lloyds, where all the merchants would meet. It became a clearing house for information. Who is sailing where; who has cargo to ship or who has capacity to ship some more cargo.
In time people saw an opportunity to insure a ship and cargo at a premium. This was a better option than the spread cargo option.
And that, in a nutshell, is how our modern insurance started. Some ships will be lost, the insurer would pay the agreed amount, but the premiums were more than the claims. That means there was a profit and reserves accumulated.
The principle is still the same – risk shared over many shoulders.
In modern times, the risk is spread between clients, insure and re-insurance companies to ensure the system can carry the load. Furthermore, it makes sense to also spread the risk over a wide geographical region and diverse industries.
To understand this, imagine all the clients live in a hurricane prone area. Then the risk is not spread well and too many simultaneous claims can hurt the system or premiums would be too high. It is the nature of insurance that if one hurts, everybody hurts. The worst conceivable thing is an insurance company going bankrupt!
For insurance to work, every stakeholder must play his or her role:
The insured premium payer must pay his premium and not try to get an advantage over other insureds
The insurer must underwrite the risk properly to ensure that they operate profitably
Re-insurers must underwrite their risk properly to ensure the integrity of the whole system
Risk must be spread over a variety of clients over a big geographical area to protect against natural disasters, such as hurricanes. It makes sense to spread the risk over diverse industries. Actuarial science ensures that one industry or region do not subsidize another.
And that is the history and principles of the wonderful product called insurance.
Please leave comments below. You are welcome to post short term related questions as well.