How Insurance Works
History of Insurance
Insurance is very simple, it’s just the ‘transfer’ of risk from one person or entity to another. Transfer of risk can be traced back as far as the 3rd millennia BC. Over the next several centuries ‘transfer of risk’ has taken many forms. Modern homeowners and property insurance as we know it today can be traced to the Great Fire of London in 1666. This fire devoured 13,000 homes and devastated the city’s economy. One year later, Europe’s first insurance company was established using contracts (ie policies) to transfer risk.
Your Insurance Policy is not a Personal Bank Account
Many people mistakenly think their insurance works like a bank account—they pay into their account monthly and if they experience a loss, the insurance carrier pays them from their personal account, but this is not the case. Insurance is about spreading the risk among everyone who buys a similar policy from the same insurance company. Quite a bit of your monthly payment is actually spent right away and goes to pay for the losses suffered by other policyholders in your company. This is a method of ‘pooling risk’ so one loss does not financially devastate a policyholder. Your insurance carrier is known as a ‘pass through’ corporation. Their job is to collect payments, pay for losses and help policyholders minimize losses. This is known as ‘minimizing the risk.’
Your Insurance Policy is a Legal Contract
An insurance policy is a legal contract between you and your insurance carrier. When you sign the application, you are signing a legal contract where you agree to pay the premium and your insurance carrier agrees to reimburse you for certain types of losses that you may or may not incur. Like all legal contracts, they can be tricky to read and understand and no two contracts are alike. But they all include wording that outlines what is covered and what is not covered and include limits to the amount paid for losses…… among other duties and rights of each party It’s important to remember that not every type of loss will be covered. In fact, many policies will ‘exclude’ the same type of losses. When reviewing a policy, make sure to look at the index and find the section that is labeled ‘Exclusions’. While some policy language may be a little tricky to understand, the ‘excluded’ section: “Our policy does not cover……” is pretty straight forward. It’s also important to note that home and property insurance never covers expenses you incur for ‘maintenance’ issues that occur ‘over time’. In general …you might have coverage if the loss is ‘sudden and accidental’.
Factors that Impact Cost
Insurance companies are like other businesses; if their costs go up, then the price they charge for an insurance policy must also rise. In particular, if the price of car repairs, home reconstruction or settling lawsuits rises; the cost of auto, homeowners/property or liability insurance must also rise. That’s why the insurance industry spends a lot of money creating and supporting programs that reduce losses, prevent injuries and save lives. Another large cost for the insurance industry is researching ways to accurately assess risk and then charge the corresponding cost to a policy. No one can know for sure when the coverage is first sold just how much of that premium will or will not be left for profit after claims are paid. When the carrier enters into an insurance contract, they are bound by the contract language to provide payment; whether or not they have collected enough premium from that particular client to cover it. The real cost of insurance is only known after claims are made and paid.
Contrary to popular belief, insurance isn’t a very profitable business. Many companies write insurance (particularly homeowners insurance) at a loss and then only make money on the earned investment income of client payments that they invest while being held for future catastrophic losses. The average profit margin is 10% lower than the median Fortune 500 Company. Working on slim profit margins means the financial viability of your insurance company should be an important part of your decision in choosing an insurance carrier; this particularly applies to a life insurance company. Because by nature of the long term of the contract, you want the carrier to be solvent 10, 20, 30 years down the road if your family needs to collect on the policy.
At Denver West Insurance Brokers, we work with many carriers and can help find the right carrier for your needs. Give us a call today. Let one of our experienced agents help with your insurance needs .