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Insurance Laws and Practices

Notes pay if he injures a third party in a car accident for which he is responsible. Historically, economic
risk was managed through informal agreements within a defined community. If someone’s
barn burned down and a herd of milking cows was destroyed, the community would pitch in to
rebuild the barn and to provide the farmer with enough cows to replenish the milking stock.
This cooperative (pooling) concept became formalized in the insurance industry. Under a formal
insurance arrangement, each insurance policy purchaser (policyholder) still implicitly pools his
risk with all other policyholders. However, it is no longer necessary for any individual
policyholder to know or have any direct connection with any other policyholder. In this unit,
we will study about the meaning and evolution of the concept of evolution.
In the next unit, you will study about the insurable risk and various kinds of risk. The unit will
also explain the need for insurance and the importance of insurance in business. The next unit
will also summarize the requirements of an insurable risk.

1.1 Evolution of Insurance

You need to know that insurance is a form of risk management, primarily used to hedge against
the risk of a contingent loss. In essence, insurance is simply the equitable transfer of a risk of a
loss, from one entity to another, in exchange for a premium.

Gambling transactions also hedge against risk, but it offers the possibility of either a loss or a
gain. Gambling creates losers and winners, whereas in insurance offers financial support sufficient
to replace loss, not to create pure gain. Gamblers can continue spending, buying more risk than
they can afford, but insurance buyers can only spend up to the limit of what carriers would
accept to insure; their loss is limited to the amount of the premium.
Gamblers, by creating new risk transfer, are risk seekers. Insurance buyers are risk avoiders,
creating risk transfer in terms of their need to reduce exposure to large losses.
Remember, the early methods of transferring or distributing risk were practiced by Chinese
traders as early as the 3rd millennia B.C. These merchants travelling treacherous river rapids
would cleverly distribute their wares across many vessels to spread the loss due to any single
vessel’s capsizing. Modern profit insurance was manifested in Babylon almost 2000 years B.C.,
in a contract of loan of trading capital to travelling merchants. The contract contained a clause
that the risk of loss due to robbery in transit was borne by the party providing the loan. In
consideration for bearing this risk, the lender calculated interest on the loan at an exceptionally
high rate.

Roman Life Depicted

You will find out that the Greeks and Romans introduced the origins of health and life insurance
to us around 600 AD, when they organized guilds/ benevolent societies which afforded members
certain benefits, such as proper burial rites, or a financial contribution towards burial costs or
travelling expenses of members of the army. In exchange for this benefit, members of the
society made regular contributions to it.
During this time, Achaemenian (Iranian) monarchs were the first to ‘insure’ their people to
some extent, formalising the process by registration thereof at court. In accordance with tradition,
during Norouz – the beginning of the Iranian New Year – the heads of different ethnic groups
presented gifts to the monarch. The purpose of these gifts was to ensure (insure) that whenever
the gift-giver was in trouble, the monarch (and the court) would help him. In return, whenever
the giver was in trouble or needed finance, the court would check the gift’s registration, and
could even – if the amount exceeded 10,000 Derrik – double that in return.

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