What Is Life Insurance, Where Did It Come From, and Why Should I Care?

The following is an excerpt from Questions and Answers on Life Insurance: The Life Insurance Toolbook.

Life insurance is a type of insurance that pays money when someone passes away. That’s simple. However, to understand what life insurance is today you should look at how life insurance originated. Life insurance is one of the very oldest types of insurance/financial products in existence. It stems from the old principle that if a villager’s house burned down, the other villagers would help to rebuild the house.

The first life insurance came from this concept. Then a concept known as the tontine annuity system was founded in Paris by the 17th century Italian-born banker Lorenzo Tonti. Although essentially a form of gambling, this system has been regarded as an early attempt to use the law of averages and the principle of life expectancies in establishing annuities. Under the tontine system, associations of individuals were formed without any reference to age, and a fund was created by equal contributions from each member. The sum was invested, and, at the end of each year, the interest was divided among the survivors. The last remaining survivor received both the year’s interest and the entire amount of the principal.

However, as the amount of money that people wished to be insured for increased, and the risk potential for violent fluctuations for those involved increased as well.To minimize this effect,it was necessary that the law of large numbers be applied to this situation.This is where we see the first roots of the actuarial practice. An actuary is a mathematician employed by an insurance company to calculate premiums, reserves, dividends, and insurance, pension, and annuity rates, using risk factors obtained from experience tables. These tables are based on the company’s history of insurance claims as well as other industry and general statistical data.

This is an example of the principle known as the Law of Large Numbers