When you look at your insurance policy you may think that insurance is hard to understand. Your policy documents may have many pages and industry specific terminology, but that doesn’t mean that insurance is impossible for you to grasp.
In order to have a general understanding of how insurance policies work, you will need to understand four major parts of the insuring process. These factors are risk pooling, underwriting, indemnification, and policy reserves.
Insurance Part 1: Risk Pooling
The most fundamental concept of writing successful insurance policies is risk pooling. When you pool risks, you spread them out into a large pool of people. For instance, everyone in your neighborhood puts a dollar into a jar to pay for the injuries of the next person who trips on the sidewalk; if your neighborhood has 50 different people living in it, you will collect $50. You can most likely concede that all 50 people will not trip over the sidewalk, but it’s certainly plausible that one or two will. The $50 you collected would never pay for the injuries of all 50 people, but it could pay for the bandages and ointments of the one or two that do. By spreading the risk into this large pool of individuals and collecting money from each, you’ve successfully reduced the impact of the incident on the person it actually happened to.
The same can be said for insurance. Not every policyholder will have claims, and not every policyholder will have a claim that is as costly as another, but ever policyholder will pay a premium. This protects the insurance company from having more claims than they do resources to pay for them.
Insurance Part 2: Underwriting
Before your agent can write your new policy, the amount of risk you present to an insurance carrier must be determined; this process is called underwriting. During the underwriting process, you will be asked to submit information to the insurer to help them determine your individual risk. The information you must submit will vary depending on the type of insurance you are applying for.
Underwriters have some leeway when evaluating your application for coverage. If you present standard risk, then you’re charged standard premiums. If you are exposed to more risk than other people in your situation, however, they can charge you additional premiums either through permanent premium charges or temporary extras. Temporary extras are used when you are doing something deemed risky on a temporary basis, like flying lessons.
Insurance Part 3: Indemnification
Another aspect that is vital to insurance is the indemnity, or protection, it offers policyholders. If insurance did not offer protection, no one would purchase it. As a policyholder, you are assured to receive coverage for insurable events based on the terms and conditions of your policy. Your end of the bargain is simply to pay your premium on time and keep up with any preventative maintenance that you can in order to prevent insurable incidents from occurring.
Indemnification is never about creating a profit for the policyholder, it is about making them whole after an insurable event. No matter what kind of insurable damage you suffer or what property is damaged, the policyholder will only receive enough compensation to make them whole, or as they were before the event.
Insurance Part 4: Policy Reserves
Insurance companies do a lot of different things with the premiums they receive from policyholders. They use them to pay commissions, pay staff payroll, office overhead, advertising, and many other expenses. To be sure insurers leave money for the claims they are obligated to pay, insurance companies are required to set aside a certain amount of premiums into policy reserves. Policy reserves are determined based on the likely claims that the insurer will have based on past experience as well as a few other contributing factors. Insurers will also factor in future premium payments and interest earnings to the total amount that they set aside.
In a nutshell that is how insurance works. While there are other terms and processes that you can explore to help broaden your understanding of this valuable and necessary product, these four concepts are the heart and soul of the insurance industry and all you really need to get by.
For more information about Worchester auto insurance, give Knight-Dik Insurance Agency a call at 800-286-6353.