The Insurance Industry Quiz

PDF page 286: Although the concept of insurance dates back to antiquity, the insurance industry as a profession came of age in the seventeenth century, when maritime trade in valuable commodities like coffee, tea, cocoa, sugar, and silk became an immense industry, but one fraught with uncertainty. Merchants sought a means to limit their financial losses in the event their cargoes were lost at sea. In England, merchants and shippers gathered together in associations, or syndicates, to distribute the risk of loss as evenly as possible. For a fee, individual merchants and ships’ owners in these syndicates could buy insurance, essentially the right to be financially compensated by the syndicate’s fund for their loss if their shipments or vessels sank. The first such association of traders and shippers began at Samuel Lloyd’s coffee house, on Tower Street near the River Thames, in 1688. This was the origin of the huge insurance market now

PDF page 286: Although the concept of insurance dates back to antiquity, the insurance industry as a profession came of age in the seventeenth century, when maritime trade in valuable commodities like coffee, tea, cocoa, sugar, and silk became an immense industry, but one fraught with uncertainty. Merchants sought a means to limit their financial losses in the event their cargoes were lost at sea. In England, merchants and shippers gathered together in associations, or syndicates, to distribute the risk of loss as evenly as possible. For a fee, individual merchants and ships’ owners in these syndicates could buy insurance, essentially the right to be financially compensated by the syndicate’s fund for their loss if their shipments or vessels sank. The first such association of traders and shippers began at Samuel Lloyd’s coffee house, on Tower Street near the River Thames, in 1688. This was the origin of the huge insurance market now

PDF page 286: known as Lloyd’s of London, and from these early forms of group insurance sprang the profession as it exists today. From the seventeenth century to the present, the profession has faced a fundamental ethical quandary: An insurance company makes money when purchaser fees, called premiums, are numerous and claims, requests for monetary compensation for covered losses, are few. But the reality is that accidents occur, whether they take the form of shipping losses, vehicular collisions, or home or business fires. So insurance carriers set customer premiums at a high enough rate to compensate themselves with a baseline profit when claims for compensation arise. The ethical question then is what constitutes a reasonable profit. The way the industry defines “reasonable” is directly reflected in the premiums it sets, which also take into account actuarial and statistical calculations of the historic frequency of the occurrence of various claims.

PDF page 286: known as Lloyd’s of London, and from these early forms of group insurance sprang the profession as it exists today. From the seventeenth century to the present, the profession has faced a fundamental ethical quandary: An insurance company makes money when purchaser fees, called premiums, are numerous and claims, requests for monetary compensation for covered losses, are few. But the reality is that accidents occur, whether they take the form of shipping losses, vehicular collisions, or home or business fires. So insurance carriers set customer premiums at a high enough rate to compensate themselves with a baseline profit when claims for compensation arise. The ethical question then is what constitutes a reasonable profit. The way the industry defines “reasonable” is directly reflected in the premiums it sets, which also take into account actuarial and statistical calculations of the historic frequency of the occurrence of various claims.

PDF page 286: known as Lloyd’s of London, and from these early forms of group insurance sprang the profession as it exists today. From the seventeenth century to the present, the profession has faced a fundamental ethical quandary: An insurance company makes money when purchaser fees, called premiums, are numerous and claims, requests for monetary compensation for covered losses, are few. But the reality is that accidents occur, whether they take the form of shipping losses, vehicular collisions, or home or business fires. So insurance carriers set customer premiums at a high enough rate to compensate themselves with a baseline profit when claims for compensation arise. The ethical question then is what constitutes a reasonable profit. The way the industry defines “reasonable” is directly reflected in the premiums it sets, which also take into account actuarial and statistical calculations of the historic frequency of the occurrence of various claims.

PDF page 287: Insurance protections are, in fact, limited. In August 2017, Hurricane Harvey dumped fifty-two inches of rain on Houston, Texas, accompanied by fierce winds. Tens of thousands of homes, stores, factories, and other industrial sites suffered severe damage and flooding. Although normal homeowners’ and business owners’ insurance provides for loss due to hurricane winds, it does not cover loss due to flooding. As The Economist observed in the immediate aftermath of the hurricane, “whereas wind damage is covered under most standard insurance policies in America, flood insurance is a government-run add-on that far from all

PDF page 287: Insurance protections are, in fact, limited. In August 2017, Hurricane Harvey dumped fifty-two inches of rain on Houston, Texas, accompanied by fierce winds. Tens of thousands of homes, stores, factories, and other industrial sites suffered severe damage and flooding. Although normal homeowners’ and business owners’ insurance provides for loss due to hurricane winds, it does not cover loss due to flooding. As The Economist observed in the immediate aftermath of the hurricane, “whereas wind damage is covered under most standard insurance policies in America, flood insurance is a government-run add-on that far from all

PDF page 287: homeowners buy. As a result, of over $30 billion in property losses in Texas, only 40 percent may be insured.” Not only do few homeowners buy flood insurance; few private insurers offer it. After all, most insurance carriers are for-profit, and companies would make little money insuring everyone against flood damage in flood-prone areas. It would be a losing proposition for any carrier to undertake, because insurance companies enjoy their highest returns when claims are few and payouts small. But the federal government is not a commercial broker and does not intend to make a profit from extending any sort of insurance coverage. For that reason, the National Flood Insurance Act of 1968 established a way to dispense flood coverage through a federal agency. Today that supervising agency is the Federal Emergency Management Authority (FEMA), in partnership with the Department of Homeland Security (Figure 9.4). As of August 2017, just before Harvey

PDF page 287: homeowners buy. As a result, of over $30 billion in property losses in Texas, only 40 percent may be insured.” Not only do few homeowners buy flood insurance; few private insurers offer it. After all, most insurance carriers are for-profit, and companies would make little money insuring everyone against flood damage in flood-prone areas. It would be a losing proposition for any carrier to undertake, because insurance companies enjoy their highest returns when claims are few and payouts small. But the federal government is not a commercial broker and does not intend to make a profit from extending any sort of insurance coverage. For that reason, the National Flood Insurance Act of 1968 established a way to dispense flood coverage through a federal agency. Today that supervising agency is the Federal Emergency Management Authority (FEMA), in partnership with the Department of Homeland Security (Figure 9.4). As of August 2017, just before Harvey

PDF page 287: homeowners buy. As a result, of over $30 billion in property losses in Texas, only 40 percent may be insured.” Not only do few homeowners buy flood insurance; few private insurers offer it. After all, most insurance carriers are for-profit, and companies would make little money insuring everyone against flood damage in flood-prone areas. It would be a losing proposition for any carrier to undertake, because insurance companies enjoy their highest returns when claims are few and payouts small. But the federal government is not a commercial broker and does not intend to make a profit from extending any sort of insurance coverage. For that reason, the National Flood Insurance Act of 1968 established a way to dispense flood coverage through a federal agency. Today that supervising agency is the Federal Emergency Management Authority (FEMA), in partnership with the Department of Homeland Security (Figure 9.4). As of August 2017, just before Harvey

PDF page 287: struck, some five million households had taken out FEMA-sponsored flood coverage.

PDF page 288: The California Earthquake Authority serves a similar function at the state level by managing privately funded insurance against earthquakes in California. The private brokers in the program make no profit from offering this coverage, but they do earn the right to offer (and profit from) other insurance in California.