The insurance business

John’s carpentry shop was the best built and best stocked in his community. It was his pride and joy. But one night fire broke out. In a few hours, his beautiful shop was reduced to smoldering ashes.

EARLIER, John had thought about buying fire insurance with some of the funds that he put into building his shop. However, he reasoned: ‘I’m very careful. And if I never have a fire, insurance will be a waste of money.’ But there was a fire. If John’s shop had been insured, very likely he could have rebuilt it. Without insurance, he could not.

What Is Insurance?

Insurance is not necessarily an investment from which one expects to get one’s money back. Nor is it gambling. A gambler takes risks, while insurance offers protection against risks that already exist. Insurance is a way to share risk with others.

Since ancient times, communities have pooled some of their resources to help individuals who suffer loss. About 3,500 years ago, Moses instructed the nation of Israel to contribute a portion of their produce periodically for “the alien resident and the fatherless boy and the widow.”

The Origins of Insurance

Insurance has existed for thousands of years. A form of credit insurance was included in the Code of Hammurabi, a collection of Babylonian laws said to predate the Law of Moses. To finance their trading expeditions in ancient times, shipowners obtained loans from investors. If a ship was lost, the owners were not responsible for paying back the loans. Since many ships returned safely, the interest paid by numerous shipowners covered the risk to the lenders.

It was likewise in a maritime setting that later one of the world’s most famous insurance providers, Lloyd’s of London, was born. By 1688, Edward Lloyd was running a coffeehouse where London merchants and bankers met informally to do business. There financiers who offered insurance contracts to seafarers wrote their names under the specific amount of risk that they would accept in exchange for a certain payment, or premium. These insurers came to be known as underwriters. Finally, in 1769, Lloyd’s became a formal group of underwriters that in time grew into the foremost market for marine risks.

Insurance Today

When people buy insurance today, they are still sharing their risk. Modern insurance companies study statistics that show the frequency of past losses—for example, losses from shop fires—to try to predict what losses their clients will experience in the future. The insurance company uses the funds paid by many clients to compensate the clients who suffer losses.

Do you need insurance? If so, what kind of insurance is right for your circumstances? And whether you have insurance or not, what precautions can help you to cope with life’s risks?