• Sheep herders developed a type of insurance 2,000 years ago.sheep image by Irina Kodentseva from Fotolia.com
  
  The American insurance industry sold $419 billion in insurance products in 2009, making it one of the largest sectors of the economy. Everyone who owns a home, automobile or small business undoubtedly purchases insurance annually, but very few people understand the principles behind insurance products. Everything relating to insurance has evolved over hundreds of years.
  
  

Spread of Risk

• Many believe that Insurance first started with a group of Middle Eastern sheep herders, more than 2,000 years ago. A group of herders tried to reduce the risk of catastrophe that would befall a family if an entire herd died from disease or an accidental fire. Each herder agreed to put up one sheep as a premium, and if a catastrophe were to befall any herder, the partners would each donate their sheep to replace the lost herd. The cost of one sheep provided peace-of-mind. Similar funds were used to protect crops, ships and goods in transit. Today, each insurance customer puts his money into a fund that is shared by everyone, should catastrophe strike other customers of the insurer.
  
  

Restitution

• The goal of insurance is to provide an insured with the means to return to the state he was in immediately before the loss. This concept of restitution causes some friction between the company and the insured. If a thief steals your decade-old TV, restitution dictates that providing you with another old television returns you to the state immediately before the loss. Insurance companies regularly offer policies that offer new replacements, or the cash to purchase a new TV of the same quality, but this enhancement comes at a higher price. When shopping for insurance, consumers should investigate the definition of restitution in their policy before making a decision based entirely on price.
  
  

Deductible

• Modern insurance products are designed to respond to serious and catastrophic losses. They are not intended to provide restitution for small annoyances and unfortunate accidents. When the number of smaller claims increases, the fund of money set aside for the catastrophic losses dwindles. Smaller claims also cost the insurance companies a lot of money to investigate and settle, further diminishing the reserve of funds. To prevent small claims from driving up premiums, insurance companies rely upon deductibles. Deductibles represent an amount of money the insured is responsible for paying on any single loss, acting as a deterrent to filing smaller nuisance claims. As a measure of good faith, many insurance companies do not require the insured to pay any deductible on large claims.