Life means exposure to risks and hazards which can threaten one’s health, life and property. The need to feel secure is one of man’s most basic needs. That is why man has always sought to “protect” himself against life’s uncertainties through insurance. Life without insurance in the industrialized countries is practically unthinkable today.
The solidarity principle
Insurance is based on what can be called the solidarity principle. A large group of individuals exposed to the same risk (for example health) pay their premiums into a common fund, the fund being responsible for providing contractually specified benefits in the event of a claim on the part of an insured suffering damage or loss.
This was the principle underlying the “insurance” of Babylonian caravans already in 1,700 BC, an insurance principle still very much alive today. The traveling merchants – who were all exposed to the same hazard – joined together. Society or the community took care of those who were hit by misfortune. What differentiated this risk group from insurance as we know it today was a commercial aspect. Institutional insurers – who are outside of the risk group itself – did not become established until the latter part of the Middle Ages.
The law of large numbers
Mathematics and statistics are the cornerstones of today’s insurance industry. The theory of probability and the statistical analysis of large numbers of individual claims make it possible to detect and calculate certain “laws” and make predictions.
The law of probability can be explained on the basis of dice: Each throw of the dice is governed by chance. Yet certain probabilities become apparent when throwing the dice many times. But the law of probability does not specifically say who, but rather only that a certain number of members of a group will be affected by a certain event. Fate or uncertainty as the triggering factor for insured loss is thus transformed into a quantifiable mean (risk).
Contracts of insurance
A contract of insurance offers insurance protection. This protection covers the financial consequences of a damaging occurrence, for example an accident or a disease. It is characteristic for a damaging occurrence that as a rule there is no way of knowing whether it will occur at all or - if it occurs - when it will do so. Persons may be insured against damaging occurrences affecting their health and consequently incurred costs for medical treatment under a contract of insurance (health or medical insurance).
Premiums and benefits
All the members of a risk group effect payment of a certain amount into a fund from which the loss or damage incurred by a member of that group is covered. The amount paid is referred to as a premium. A premium is comprised of the following components:
Risk portion: This portion of the premium is calculated on the basis of mathematical principles (actuarial statistics) and empirical values. It is designed to be sufficient to cover any loss. It is based on a long-term average.
Expense portion: Commission fees, operating and miscellaneous expenses, processing of claims; these expenses are distributed among the group of insured.
When an insured event or loss occurs, the insurance company has to make good on the benefits agreed upon. There are two types of benefits, namely monetary and service benefits:
Monetary benefits: Capital or cash payments, disability benefits, daily allowances, compensations of all types.
Service benefits: Warding off unjustified third-party claims against the insured (particularly in third-party liability insurance), legal protection, counseling services, loss adjustment assistance, advice on choice of medical specialist, hospitals, etc.