The dictionary at hand, American Heritage Dictionary Second College Edition, defines risk as: 1. The possibility of suffering harm or loss; danger. 2. A factor, element, or course involving uncertain danger; hazard
The Florida Insurance Code, typical among the state insurance codes of the United States, defines risk as: Uncertainty regarding loss; the probability of loss occurring for an insured or prospect.
The above dictionary does not address the essence of insurance until 2.a, Coverage by a contract binding a party to indemnify another against specified loss in return for premiums paid.
The Florida Insurance Code says that insurance is a Social device for minimizing risk of uncertainty regarding loss by spreading the risk over a large enough number of similar exposures to predict the individual chance of loss.
I write what follows from memory. It is not intended to be a scholarly investigation. It is an exposition of my opinions after having spent over 45 years involved with just about every aspect of the business of insurance. This involvement has taken me to, in addition to the United States, just about all of the countries of Europe, all of the countries of Latin America and the Caribbean and to many other countries in various parts of the world.
Insurance is very interesting as a concept that benefits humanity, as a business and as a useful mechanism that promotes other beneficial activities.
It is believed that insurance is as old as commerce. The early maritime traders, the Phoenicians, for instance employed insurance to enable financing vessels and cargos.
Marine insurance was probably the earliest form of insurance. Individuals were unable or unwilling to assume the possibility of enormous financial loss by themselves. They spread the risk of loss and the possibility of gain among many.
Lloyds of London originated as a result of the same concept. It was named after a coffee house where potential participants in insurance gathered and where they signed on as insurers of vessels and cargos.
The charter of the Insurance Company of North America (now Cigna) was signed in Independence Hall shortly after the signing of the Declaration of Independence. A domestic, American marine insurer was needed because the U.S. was at war with England.
I hope that I live long enough to write a scholarly study of insurance. It is a very interesting topic. I started as a translator at the Insurance Company of North America (INA) in the early 1960’s. In the 1950’s and 1960’s, many countries around the world were breaking away from the colonial powers. These countries were promulgating insurance and banking laws which controlled business in their jurisdictions. International and marine insurers had to follow the local laws of many countries in order to conduct their business.
I was a graduate student. My sweetheart and I produced two children very rapidly. I needed work. The translation opportunity with INA was a Godsend. I loved the work. The company liked my production. They said that I had executive potential. INA trained me in every aspect of the business. INA was the best employer I ever had.
Insurance is a mechanism for transferring the financial consequences of a risk from an individual or entity to an insurer. Most often, the person transferring the risk will pay a periodic premium in exchange for the insurer’s assumption of the risk.
Certain concepts are key in order for insurance to function well. First is the Law of Large Numbers. This assumes that if there exits a large enough number of individual units, what happens to those units is predictable. This enables the insurer to adequately price the value of the guarantee offered.
The second is related. It is the concept of Spread of Risk. It is often defined as Spreading the risks of loss of the few among the many.
Those of you who are political may think that this sounds socialistic. Well, it is. Even capitalistic businesses can make free use of socialistic concepts.
In fact, not all of the world’s insurers are capitalistic. Many of the very good ones are owned by private capital, but many excellent insurance organizations are owned in whole or in part by various governments. As a reinsurance professional, I have dealt with both sorts of companies and have not observed a great deal of difference between them.
I must say a few words about American International Group (AIG). What a sad end to a noble and historic entity! I had many friends and colleagues at the old AIG They were competent professionals and ethical participants in the insurance business.
The beginning of the end for AIG was when Hank Greenberg was put in charge. He is the one who put AIG into financial products that had no place in the realm of insurance.
AIG had already experienced a sad venture in financial guaranties in the 1980’s when it signed onto guaranties backing up a firm called Computer Leasing. Some people have difficulty learning from experience. After the Computer Leasing disaster, Lloyds and many other insurers banned participation in any financial guaranties. They were prudent in doing so. Financial guaranties are not insurance.