Click on one of the four sections below to understand the basic concepts behind insurance and to find out how Lloyd's fits in.
Insurance is one of the ways that businesses and individuals reduce the financial impact of a risk occurring. While an insurance policy does not remove a risk, it does provide the policyholder with some security should the worst happen.
Insurance works like this: A business that provides insurance – known as the ‘insurer’ – agrees to take on the risk on behalf of the business or individual concerned – known as the ‘insured’. It does this by providing the insured with an insurance contract, sometimes called a ‘policy’. In this contract the insurer will state what risks it has agreed to insure against and how much it will pay if the risk happens so that the insured is put back into the same position as if the risk had not happened. The policy may also include a list of things that are not insured against, known as ‘exclusions’. So for example, if someone buys insurance in case their car is stolen, the insurance may have an exclusion if the insured was careless and left the keys in the car, making it easy for the car to be stolen. In return, the insurer receives a fee from the insured, and this is called the insurance ‘premium’.
The insurer will collect premiums on a number of policies and pool these funds, which it then invests to make the pot of money grow. Should any insured person make a claim on a policy, the insurer will pay out on that claim from the pool of funds. The insurer is in business to make a profit and will be hoping that the total premiums it receives in any one year together with any money it can make by investing the money will exceed the total claims it has to pay out.
Insurers in the UK and in most countries are very closely supervised to make sure that they do keep enough money to pay all their claims.
To be included in an insurance policy, a risk must be capable of being measured in monetary terms. It must also be something that is not certain to happen. So to take a very simple example, you cannot insure against the risk that the sun is going to set. That is certainly going to happen and it is not something for which you can buy insurance. Also the insured person must have a direct interest in any loss – you cannot take out life insurance on the life of a complete stranger, for example.
The insurer will look at all the circumstances surrounding a risk before deciding whether or not to provide insurance cover against it, and this whole process is called ‘underwriting’. Underwriters are the specialists employed by the insurer to carry out this task and they will want to understand a number of things about the risk such as how likely is it to happen, what steps are already taken to reduce the risk and what are the financial consequences of it happening.
The underwriters at Lloyd’s are among the best in the world. The risks that they cover are usually brought into the Lloyd’s market by brokers, and the underwriters and brokers together will use their considerable knowledge and expertise to agree the right insurance cover at the right price and on the right terms.
Running a business of any kind involves a certain amount of risk. There is a risk that your premises will be damaged in a fire. There is a risk that one of your employees will trip and have an accident. There is a risk that the goods you export will be left stuck on a dockside somewhere due to a dock workers’ strike.
Should any of these risks happen, they will have a financial impact on your business and they could have wider implications. Take a factory fire, for instance. Not only would there be the cost of repairing any damage done by the fire, but what has happened to your orders while the repairs were being made? Perhaps one of your competitors has taken advantage of the situation and stolen some of your regular customers.
Risks are inevitable but they are also manageable. Any business owner takes steps to manage the impact of a risk. In the example of fire risk, this means installing smoke alarms and sprinkler systems as well as training staff to spot and prevent fire hazards.
Business owners will also look to reduce the financial consequences of a risk happening, and this is where insurance comes in. A good insurance policy will cover the business for many of the costs they have to meet as a result of the risk occurring. In effect, the business is looking to ‘transfer’ the risk away from themselves and onto someone else for the payment of a fee.
And the need to transfer risk is not only relevant to businesses. It is also relevant to individuals. For example, as individuals, there is a risk that we may damage our cars in an accident. There is also a risk that we will become unwell and need medical treatment or that our houses will get damaged in a storm. Of course, we hope these things will never happen and, fortunately, most of the time it never does. But when things go wrong it can be expensive and so for many of these eventualities insurance is there to take the financial risk on our behalf.
This transfer of risk is the basis of all insurance, and is something that Lloyd’s has been doing for more than 300 years.
Insurers manage the risks they take on through the process of reinsurance - read on to learn more.
Insurers take out their own insurance - this is called reinsurance.When you look at the risks that insurers take on, it is not surprising that they themselves might want to have insurance. When insurers insure a risk again, it is called reinsurance. A third of all business carried out at Lloyd’s is reinsurance.
Reinsurance is an extension of the concept of insurance, in that it passes on part of the risk for which the original insurer is liable. Reinsurance contracts are slightly more specialist than insurance contracts but the for most part they work in exactly the same way – it is just that the ‘insured’ is another insurer, known as the ‘reinsured’ (See The Basics of Insurance for an explanation of how insurance contracts work).
A contract of reinsurance is between the insurer and reinsurer only and legally there is no direct link between the original insured and any reinsurer. The original insurer is still the one who must pay any claim to the insured – the insurer must then make its own separate claim against the reinsurer.
Reinsurance is important for a number of reasons, including:
To protect against large claims. For example, in the case of a fire in a large oil refinery or a large city hit by an earthquake, insurers will spread the risk by reinsuring part of what they have agreed to insure with other reinsurers so that the loss is not so severe for any one insurer.
To avoid undue fluctuations in underwriting results. Insurers want to ensure a balanced set of results each year without ‘peaks and troughs’. They can therefore get reinsurance which will cover them against any unusually large losses. This keeps a cap on the claims the insurer is exposed to having to pay itself.
To obtain an international spread of risk. This is important when a country is vulnerable to natural disasters and an insurer is heavily committed in that country. Insurance may be reinsured to spread the risk outside the country.
To increase the capacity of the direct insurer. Sometimes insurers want to insure a risk but are not able to do so on their own. By using reinsurance, the insurer is able to accept the risk by insuring the whole risk and then reinsuring the part it cannot keep for itself to other reinsurers.
Like the direct insurance market, reinsurance usually involves specialist brokers who have expert knowledge of the market and access to reinsurance underwriters on behalf of their clients.
Starting with its roots in marine insurance, Lloyd’s has grown over 300 years to become the world’s leading market for specialist insurance.
How does Lloyd's fit intp this increasingly risk-conscious world? In an increasingly risk-conscious world, hundreds of good ideas would never get off the ground without a way to reduce risk. Risk can’t be eliminated but it can be managed and reduced. At its simplest that is what insurance helps you do.
But what happens to risks that are hard to price, large or otherwise difficult to quantify and understand? Lloyd’s specialises in exactly these risks. You would be hard pressed to find more expertise and know-how on this subject. Understanding and pricing complex risk is the heart of the Lloyd’s market.
Over 300 years ago Lloyd’s started out in Edward Lloyd’s Coffee House as a place where people with exposure to risks could meet people with capital who, for a price, would agree to insure them. That’s exactly what Lloyd’s is today: a face-to-face market, with all the dynamism and imagination that a market generates.
Today the Lloyd’s market covers some of the world’s largest, most individual and complicated risks. From oil rigs and bridges to celebrity body parts, from airlines and sporting events to global banks, millions of people at home and at work are covered at Lloyd’s.
