Modern insurers charge a premium in exchange for a promise to pay out a larger sum of money if necessary. A risk-averse person will often prefer to pay a small sum today instead of incurring a larger cost later on. Some types of insurance are even mandatory by law. For example, car owners have to buy the basic type of insurance but they are not obliged to buy fully comprehensive insurance. Some choose not to or to ‘self-insure’ — they undertake to cover certain costs themselves. Most people have insurance even if they also insure themselves for some risks. The insurance industry is now an important part of all developed economies. However, this was not always the case — the early history of insurance was beset with scandals and controversy.
The basic idea behind an insurance scheme is the pooling of risk. If a number of individuals enter the scheme, then hopefully only a few of them will need to make a claim. For instance, a large number of people have car insurance. Only a proportion of these people will have an accident in any one year. As long as the payments into the scheme cover the claims, then the scheme is viable in the long run. The idea of pooling risks predates private insurers. Many early communities used some form of cooperation (or social insurance) to deal with risks. There was always the possibility that an individual would become unable to work and fall into poverty. There were social and religious reasons to give charity to these people; however, there was no guarantee. Under the Elizabethan Poor Laws, communities were obliged to help poor people who were too infirm to support themselves and taxes were imposed to raise funds.
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