Insurance

The term insurance refers to a guarantee against the financial consequences of material or intellectual loss. The process of insuring property or ventures against loss involves an insurer which promises to pay out a benefit (normally a sum of money) to another party (the insured) if specific hazards occur.

In exchange, the policyholder normally pays the insurer a fee known as the premium. The contract through which the insurer agrees to hedge the insured against specific material losses is known as an insurance policy.

In order for insurance to work, risk must be distributed between multiple policyholders.

Simplified example of insurance:

John wants to protect his family from the financial consequences of him dying unexpectedly through an accident or illness. John and 999 other individuals convince an insurance provider to insure their lives over 20-year insurance terms. The insurance company promises to pay out a lump-sum of 200,000 Swiss francs to the legal heirs of their policyholders in the event of an untimely demise. Each of the 1000 policyholders like John pay 1000 francs per year to the insurance provider in exchange for the life insurance, a total of 1 million francs per year. Over their 20-year terms, the 1 million francs of annual insurance premiums total 20 million francs paid in to the insurance provider.

Just before the end of the term, John has a stroke and dies. Because John’s life insurance agreement covers death caused by strokes, John’s family receives the 200,000-franc benefit. Along with John, another 39 of the 1000 individuals who purchased life insurance from the insurance provider die of covered causes within their 20-year insurance terms. The insurance provider pays out 8 million francs (40 x CHF 200,000) in benefits to the beneficiaries of the policyholders who die within the term. The insurance provider keeps the remaining 12 million francs. If 100 of the policyholders had died within the insurance term, the premiums paid would only just cover the benefits paid out (100 x CHF 200,000 = CHF 20 million). If more than 100 of the 1000 policyholders died, the premiums paid would not be sufficient to cover the promised benefits. In this case, the insurance provider would make a loss or – if it did not have sufficient assets to cover claims – become insolvent.

The example above can be applied to any insurance type – including health insurance, car or motorcycle insurance, and personal property insurance. It clearly shows the relation between cost and risk. The higher the risk of a covered hazard occurring, the more the insurance provider must charge in premiums.

Types of insurance schemes

There are three main types of insurance schemes: Stock insurance schemes; mutual insurance schemes; social security insurance schemes.

Stock insurance schemes are typically run by commercial insurance corporations. Shareholders own stock in the insurance company. The stock insurance company sells insurance to third-party individuals, using its own capital to guarantee payment of benefits. As with other corporations, profits are distributed to the company’s shareholders in the form of dividends based on the number of shares owned by each shareholder.

Mutual insurance is the oldest form of insurance. A mutual insurance scheme is owned by its policyholders. In the strict use of the term, mutual insurance is a direct agreement between policyholders, with policyholders sharing the risk of loss. In this strict form of mutual insurance, premiums either are not paid, or premiums are paid to an escrow agent which acts as an intermediary to ensure that money is available and that benefits are paid out to beneficiaries. If no hazards occur, there is no cost for policyholders. When a covered hazard occurs, all policyholders must cover their share of the benefit, in keeping with their mutual insurance agreement. Today, mutual insurance is primarily provided by mutual insurance companies which operate much like stock insurance companies, with the difference that at least part of profits are distributed to policyholders as dividends or premium reductions.

Social security insurance schemes are typically operated or supervised by national or municipal governments. Social security insurance schemes stand apart from stock insurance and mutual insurance schemes in that they are politically controlled. Social security schemes are typically subsidized or guaranteed by tax revenues. Premiums and benefits are typically dictated by government bodies.

Types of insurance

It is technically possible to insure almost anything against almost any hazard or circumstance. There are insurance providers which specialize in custom insurance, meaning each situation is assessed individually and custom insurance policies are written up to match the needs of policyholders. However, the vast majority of insurance providers offer standardized policies. Some offer insurance riders (optional add-ons) which extend the coverage provided by standard policies.

Common standardized insurance types include:

Health insurance: The insurance provider covers the cost of healthcare on behalf of the policyholder. In Switzerland, basic health insurance is compulsory for all residents.

Life insurance: The insurance provider pays out a one-time benefit or a regular pension to a beneficiary if the policyholder dies.

Liability insurance: The insurance provider covers the policyholder’s financial liabilities within the scope of the insurance agreement. Car liability insurance (which covers liability claims by third parties when a policyholder causes an accident while driving) and personal liability insurance (which covers a broad range of other liability claims) are two examples of liability insurance.

Loss of income insurance: The insurance provider pays out a benefit over a predetermined period if a covered hazard results in the policyholder losing their source of income (due to becoming disabled, for example). Unemployment insurance – which provides an income when you become unemployed – is a common form of loss of income insurance.

Travel insurance: The insurance provider covers costs resulting from covered hazards affecting travel bookings.

Old-age insurance: This insurance is typically provided by social security insurance schemes. The insurance provider pays out a benefit in the form of a recurring pension from the time the policyholder reaches a predetermined age.

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