Insurance policies are used to hedge against the risk of financial losses, both big and small, that may result from damage to the insured or her property, or from liability for damage or injury caused to a third party.
There are a multitude of different types of insurance policies available, and virtually any individuals or businesses can find an insurance company willing to insure them, for a price. The most common types of personal insurance policies are auto, health, homeowners and life insurance policies. Most individuals in the United States have at least one of these types of insurance.
Businesses require special types of insurance policies that insure against specific types of risks faced by the particular business. A fast food restaurant, for example, needs a policy that covers damage or injury that occurs as a result of cooking with a deep fryer.
An auto dealer is not subject to this type of risk but does require coverage for damage or injury that could occur during test drives. There are also insurance policies available for very specific needs, such as kidnap and ransom (K&R), medical malpractice and professional liability insurance, also called errors and omissions insurance.
Insurance Policy Components
When choosing a policy, it is important to understand how insurance works. Two of the most important components of all insurance policies are the premium and the deductible. A firm understanding of these two concepts goes a long way to helping you choose the policy that is best for you.
A policy's premium is simply its price, typically expressed as a monthly cost. The premium is determined by the insurance company based on your, or your business', risk profile. For example, if you own several expensive automobiles and have a history of reckless driving, you pay more for an auto policy than someone with a single mid-range sedan and a perfect record.
However, different insurers may charge different premiums for similar policies, so finding the price that is right for you requires some legwork.
The second important policy component is the deductible. Whenever you make a claim, you are required to meet a minimum out-of-pocket expense, or deductible, before the insurance company pays for your losses. Deductibles can apply per-policy or per-claim depending on the insurer and the type of policy.
Policies with very high deductibles are typically cheaper because the high out-of-pocket cost means insureds are less likely to make small claims. When it comes to health insurance, for example, people who have chronic health issues or need regular medical attention should look for policies with lower deductibles. Though the annual premium is higher than a comparable policy with a higher deductible, cheaper access to medical care throughout the year may be worth the trade-off.
Insurance Premium
An insurance premium is the amount of money that an individual or business must pay for an insurance policy. The insurance premium is considered income by the insurance company once it is earned, and also represents a liability in that the insurer must provide coverage for claims being made against the policy.
The amount of insurance premium that is required for insurance coverage depends on a variety of factors. Insurance companies examine the type of coverage, the likelihood of a claim being made, the area where the policyholder lives or operates a business, the behavior of the person or business being covered, and the amount of competition that the insurer faces.
Actuaries employed by an insurance company can determine, for example, the likelihood of a claim being made against a teenage driver living in an urban area compared to one in a suburban area. In general, the greater the risk associated with a policy the more expensive the insurance policy will be.
Policyholders are often given a number of options when it comes to paying an insurance premium. Some insurers allow the policyholder to pay the insurance premium in installments, for example monthly or semi-annual payments, or may require the policyholder to pay the total amount before coverage starts.
Insurance premiums may increase after the policy period ends. The insurer may increase the premium if claims were made during the previous period, if the risk associated with offering a particular type of insurance increases, or if the cost of providing coverage increases.
Insurers use the insurance premium to cover the liabilities associated with the policies that they underwrite, as well as to invest the premium in order to generate higher returns. Insurers will invest the premiums in assets with varying levels of liquidity and return, with the amount of liquid assets often set by state insurance regulators. Regulators want to make sure that policyholders will be able to have their claims paid for, and thus require insurers to retain adequate reserves.
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