What is insurance?

What is insurance, and how's it works

Suppose you and nine others buy a cruise. You want to cover the boat if it crashes, sinks, or another disaster. The boat's worth, say $100,000. That means you're at risk for $10,000 if you lose. So you all plan to pool your money and $10,000 each in case of defeat. This is called the risk-spreading. And insurance firms get insurance policy owners "the risk." Don't be offended; it's just a term commonly used.

Suppose there are ten boats to insure, each with ten owners, each worth $100,000. That's a total value for $1,000,000 "risks," and the risk spreads across 100 owners. Each owner still has a $10,000 wager. But now, group owners start looking at various vessels. Some have leaky tanks. Some docked next to a fueling station or left with the keys in the boat and otherwise unlocked. The responsible owners might think reckless owners should pay more than $10,000, and the more accountable owners should pay less as they establish less dangerous conditions. This is now called underwriting, assessing risk, and charging accordingly.

There are many risk factors, and the underwriters have a tremendous job, but this is how the premiums are calculated. Also, suppose the annual loss rate is one boat in ten. In that scenario, you will be willing to split the premium up to an average of $1000 a year for each owner (more for each reckless owner and, conversely, less for more responsible owners). Age, condition, place, amount of usage, and several other variables come into play, but that's how the first underwriters produced insurance.

Who are insurance parties?

The insured is the first entity. The insurance provider is called the second party, and anyone not affiliated with the first two is considered a third party. Property coverage: covers first-party property. It may be a boat, house, car, or company, but it's meant to make the property owner and insurance contract. Liability coverage is intended to shield the property owner from third-party litigation.

If a boat crashes over a skier while boating, the skier will surely sue, and the cover is intended to protect the insured. The purchased agreement specifies precisely how environmental and action risks save one for property and liability. And that's where fine printing comes in. Knowing sufficient print facts is essential. One more thing; the policy begins exactly when a policy is bound. There was a client who needs to write an auto policy immediately. The agent came to find out later that he had a traffic accident that morning, had no current car insurance, and that if he wrote a policy that day, it would retroactively cover his accident. Had the agent not had an identical binding date and time, the client may have gotten away with it.

They don't insure a guaranteed thing.

That's another subject. Insurance firms will not cover if the prospect learns of the potential risks. A young woman wanted the policy she was quoted for a while ago—the one she didn't buy. The fires were a few blocks away, and she needed to cover herself for the potential loss. Nope. It's not like that. Insurance brokers are willing to write a policy on whoever comes in the doorway. There was one tiny business that needed coverage. Owners were a little cagey about ownership and property coverage detail. Too suspect. They had to get insurance somewhere, and later, it turns out that half of the shopping center had burned down, losing one of the company in the same center—Arson's skepticism.

Insurance agents refuse to write coverage of such questionable conditions. Agents must not encourage a prospect to misrepresenting material information on an application. If you or they do, the insurance provider may cancel compensation as if they were never insured. They could happily refund your entire premium and reject the allegation. Or minimize the reward if the case warrants. All insurance plans contain this caveat.

Main takeaways

Insurance is loan-like. Put yourself in the lender's place. Tell yourself what you'd like to know about the person or company you're lending $1,000,000. Want to know how accurate they're? Are they willing to afford premiums? Honestly, reflect the risk? What's hiding that could lead to a claim? Accidents occur. That's why we're insured. Yet insurance firms don't want to cover a guaranteed loss. Consumers should be underwritten correctly.