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How Insurance Companies Work

How Insurance Companies Work

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Insurance companies play a major role in your financial well-being, and the financial and healthcare systems. For starters, they offer financial security when worse comes to worse, such as illnesses or accidents. If you’re insured, your medical expenses are covered — at least in theory.

Additionally, insurance takes care of costly medical bills from dentists, optometrists, and more, though you may need separate coverage. Insurance is also a legal requirement for some people, such as vehicle liability covers. But before you purchase a policy, you need to understand how insurers work.

How Insurance Firms Operate and Make Money

Insurance cushions you and your property from loss, damage, and theft. They make money by paying out less for claims than they bring in from customers’ premiums. 

Your point of contact with an insurance company is likely going to be an agent. Agents should be knowledgeable about a company’s offerings, offering up-to-date information about specific products or services. 

Remember, an insurance company is a business like any other and it needs profits to stay afloat. For this to happen, insurers utilize the following profit models:

  • Investment income: Insurers generate this income by reinvesting customer premiums in financial markets. But instead of investing on a single policy basis, insurance companies pool funds from different policies to build a portfolio. That way, it’s easier to settle large claims using the total premiums. 
  • Underwriting: These earnings come from selling insurance policies. Insurance companies can only generate profits when claims stay below premiums.
  • Coverage lapses: The insurer profits from a policy’s expiry. If a customer doesn’t make any claims during their policy period, the insurer can keep the premiums. Additionally, insurance companies can cash in when delayed premium payments result in inactive policies.
  • Cash value cancellations: If a client demands their money before a policy expires, insurers are only obligated to return profits generated from the investment. This means all the premiums belong to the insurance company.

Understanding Your Insurance Policy

You need to understand the fine print before you sign any insurance contract. Here are some terms you might encounter.

  • Premium: This is what you pay for insurance coverage. The insurer bears the financial consequences of particular events in exchange for monthly, quarterly, semi-annual, or yearly premiums. You could also opt for limited premium payment. Instead of paying premiums throughout the policy term, limited plans allow you to send money for a pre-determined period, for instance, 10, 15, or 20 years. Another option is a single premium plan where you make a lump-sum payment for the entire policy duration. 
  • Deductible: It’s a mandatory out-of-pocket expense before the policy covers your claims. Deductibles can be a dollar amount or a portion of the insurance costs. Ordinarily, policyholders can choose their deductibles. While low deductibles increase your monthly payments, higher amounts reduce monthly remittances.
  • Endorsement/Rider: It’s an amendment to an ongoing insurance contract. For example, you can boost your coverage from $500 to $1,000 to increase your protection. Alternatively, you could limit coverage to exclude what you don’t need and save money.

Another option is adding or removing people. For instance, you can add a spouse to your coverage when you get married or remove them after divorce. You could also change locations. Assuming you have multiple properties, you can bundle different locations in one policy to reduce costs. Riders can occur at the point of purchase, during renewal time, or mid-term. Remember, endorsements affect your insurance premiums and policy rates. As such, contact your insurer with any pricing concerns.

  • Waiting Period: It’s the duration policyholders must wait before their coverage takes effect. Waiting periods vary with the available benefits. Taking the case of health insurance, the waiting period depends on the specific illness, pre-existing conditions, medical procedures, and insurance company.
  • Insuring Clause: This section of the insurance policy defines the extent of the coverage and the risks accepted by the insurance company. If you have multiple policies, insuring clauses determine how damages will be shared.

Insuring clauses contain different components. For example, they describe legal liability, including acts of negligence, breaches of confidentiality, and criminal behavior. Moreover, clause agreements highlight the insurer’s legal expenses when defending policyholders against a claim. That includes the awarded damages after the insured loses a lawsuit.

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