Take a closer look at... insurance

This industry deals with huge risks, in every area of life – from extreme weather, to online crime, to celebrity calamities. Hannah Langworth tells you more

What's insurance all about?

Insurance can help you protect your home against fire, and your luggage while you're on holiday, but these are only small parts of this industry. Insurance is about assessing risk, which doesn't just mean dealing with people who want to make sure their car will be fixed if they dent it. People in this industry work in connection with incredibly complex risks of many different types which can be worth as much as tens of billions of pounds, and which can involve any area of the world.

Let's take a topical example to illustrate the importance of the industry - London 2012. A massive international event like the Olympic Games poses a number of multibillion pound risks. Is the stadium going to fall down? What if it pours with rain, meaning that some events have to be cancelled, and the transmission of television pictures by satellite is affected? What if there's a terrorist attack? What if London's transport network can't cope? If any of these events occur, there will be massive financial implications for the organisers, and potentially other parties as well. But the potential costs of all of these risks can - and will - be covered by insurance.

How exactly does insurance work?

The way in which risks are covered by insurance, even huge ones such as those faced by the organisers of London 2012, is essentially the same as the way in which you or I might protect our car, or our pet's health.

An insurance company will assess the risks in question, decide whether or not they're prepared to offer insurance against them - that is, agree to pay out a sum of money to cover the damage caused if they occur - and at what price. The deal they're prepared to offer is known as a "policy", and the sums paid by the person or business purchasing the insurance as their "premiums".

An insurance company pools all the premiums it receives for all the insurance policies it issues. It then invests this pool of funds to ensure that it generates enough money to pay any claims that might be made in relation to the policies it issues and, crucially, that it can have easy access to these funds whenever a claim is made. An insurance company may also purchase its own insurance policies to ensure that it will have the funds to meet all the claims made on it, a process known as reinsurance.

Because it's so important that individuals and businesses can rely on their insurance policies, the industry is closely monitored to ensure, to the extent possible, that any claims made will be met.

What are the main kinds of insurance?

As you'll know from your own experience, individuals often take out insurance to protect their home or their car, or to cover themselves against various things going wrong when they travel abroad. Providing insurance to cover potential future medical or dental expenses is also a big business.

Businesses face essentially the same risks - they'll also want to protect themselves in the event of damage to their property, and to ensure that they'll receive a financial payout in the event of something beyond their control having an extreme adverse effect on their business, such as terrorist attacks or unexpected bad weather.

There are also various specialist types of insurance for businesses in particular sectors. For example, doctors or lawyers may take out insurance to cover the costs of professional negligence claims. Companies involved in shipping may take out specialised policies to guard against the particular risks they face, such as to cover the potential loss of particularly valuable cargo. Businesses involved in agriculture may take out insurance in case of adverse patterns of rainfall.

Why is insurance a big deal in the UK?

The UK's insurance market is one of the largest in the world, and employs well over a quarter of a million people. The industry is one of UK plc's star performers - the UK's economy as a whole is no longer one of the globe's largest, but the British insurance industry is in the world's top three - not as large as that of the US, but vying for second place with Japan's.

The UK's insurance market leads the way in the insurance of what are known as "special risks". These involve unique assets which, unlike standard home or car insurance, require an insurance company to design and price a bespoke insurance package to protect them. For example, last year American football player Troy Polamalu had his tresses insured for a hair-raising $1 million (approximately £640,000) - his sponsors Head and Shoulders were keen to make sure they'd be financially protected if anything happened to their star's mane.

Other unusual items which have been protected through insurance include Bruce Springsteen's voice (£3.5 million), and the tongue of Costa Coffee's chief taster (£10 million).

What is Lloyds of London?

All three of these special insurance policies were arranged through Lloyds of London. Many people mistakenly think that Lloyds of London is an insurance company, but in fact it's an insurance market, within which many different insurance companies do business, often joining together as "syndicates" to take on large risks.

Based in a spectacular postmodernist building on the edge of the City, Lloyds of London is the Square Mile's insurance centre, the heart of the insurance industry in the UK, and one of the world's leading centres for insurance, particularly of special risks.

What are the big issues in insurance today?

Here are what we think are some of the most significant issues that the insurance industry is grappling with today:

Climate change

Climate change, and the increasingly erratic weather it's causing, is a huge issue for people across the globe - and the insurance industry. We're seeing more droughts in Africa and more hurricanes in the Caribbean, while in the UK flooding is becoming more common. The insurance industry has to consider these phenomena, and take them into account as it designs and prices insurance policies. For example, will there be areas in the UK to which insurance companies won't offer coverage in the future because they get flooded so often? Is it possible to predict more accurately where and when hurricanes will occur so that better insurance policies can be created?

Political risk

Political turmoil is hugely significant to the insurance industry. For example, over the last few years Somali pirates have posed massive problems for shipping activity off the coast of East Africa, while in Europe the sovereign debt crisis is causing considerable economic and political uncertainty. Insurance companies will be assessing both sets of events carefully on an ongoing basis in order to provide appropriately priced coverage against various eventualities to companies operating in these parts of the world.

Pensions

Thanks to medical advances and social changes, people in the UK are living much longer than they did a few decades ago. Good news? Yes, but the question of where the money is going to come from to look after us all in our old age is a real issue. The retired population will potentially form a much larger part of the overall population in the future, so the state and healthcare providers are at risk of being put under a unmanageable financial burden. But this financial risk is one which the insurance industry can play a part in providing for.

Cyber crime

Cyber crime - that is, activities such as the theft of information held online and online identity fraud - is a growing problem. The government take it so seriously that they pledged £500 million towards combatting it at the end of last year. Given the extent of the damage this type of activity could potentially do, many companies are choosing to purchase bespoke cyber insurance policies in order to protect themselves.

Solvency II

Solvency II is an EU Directive which aims to harmonise the regulation of the insurance industry across Europe - and, understandably, it's a big issue in the insurance market. The directive aims to put in place tighter controls to reduce the risk of an insurer being unable to meet a claim.

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