The Who, What, When, Where, Why of Insurance. Just the Basics, Please.
Nearly everyone has insurance. There’s insurance for the house or renter’s insurance, car insurance, health insurance, liability, life insurance. There are more kinds of insurance then you can shake a stick at, there’s even pet insurance. Let’s look at insurance basics and see: What is it? Who needs it? Why we have it? How does it work? This is the first of a series, so please let us know what you want to learn about insurance.
What is it?
Insurance: Business Dictionary used more legalese then I will. For the full definition check that link. I’ll summarize it as a risk-transfer mechanism that ensures full or partial financial compensation for the loss or damage caused by events beyond the control of the insured party. Under contract, the insured is indemnified from loss when a sum is paid.
If I want my “stuff” to stay healthy, or at least like it is right now, I pay someone a fee to protect it. If damage happens, during the covered time, a company pays me money to restore my “stuff” to normal. I move the risk from me personally, to the company.
Insurance can be yawn, a bore. So we’ll start off by keeping it interesting.
I think of it in the way Dr. Seuss said in “Oh, the Places You’ll Go!”:
“I’m sorry to say so
But, sadly, it’s true
Can happen to you…
You’ll be left in a lurch…
You’ll come down from the Lurch
With an unpleasant bump.
And chances are, then
That you’ll be in a slump”.
Insurance replaces the bang-ups, hang-ups, and lurches that happen in life, and helps get you out of a slump.
Who needs it?
Anyone needs insurance who wants to defer risk.
- If the dog drinks antifreeze and has an emergency vet visit,
- If your death impacts dependents (mom, dad, or kids),
- If a wreck changes your transportation status, or
- If a hail storm means that you need a new roof.
Each of these items could be game changers in the Game of Life. If you don’t want to pay for these damages out of pocket then you can displace that risk by paying a premium to offset the expense.
These things don’t happen to everyone, but guess what I am doing right now? I am replacing the roof. I am learning, firsthand, about the process. The insurance company has enough data to know how many people will experience these setbacks, and how much it will cost to recover from them. With enough time and information the company can spread its risk among all its customers. The key is getting the right kind of insurance, with the right coverage, to win at Game of Life. Can you just spin the dial instead? Sure, but, life gets more complicated.
When did it start?
Let’s spin the dial backward to see how insurance started. The earliest forms of displacing risk may have come from Chinese and Babylonian traders. Chinese merchants would redistribute their wares across many vessels to offset risk in the event of a capsizing ship. If a merchant received a loan for his wares, he could also pay an additional fee should his goods be lost or stolen at sea, and the lender’s promise to cancel his debt.
Lloyd’s of London got its start in a coffee shop, helping similar merchants. Merchants wanted a guarantee that goods displaced at the bottom of the sea would be replaced, so a guarantee was made for a fee. If the voyage reached its destination without incident the fee was retained, but if disaster happened the price of goods was fully recovered. No single investor wanted responsibility for the whole risk, so a group of underwriters pledged what percentage of responsibility it had in the total risk.
In America, Benjamin Franklin was “Father” of some of the earliest fire insurance policies to offset the colonists risk of losing their homes. The catalyst was the great fire of 1730 in Philadelphia, and the situation gave rise to insurance policies and terms, many guaranteed by Franklin himself. Franklin reported in his Gazette that there was no wind, had there been better equipment the fire could likely have been contained. The fire brigade was born.
Why have it?
Let’s briefly cover some reasons to have insurance. We won’t go in-depth about the kinds of coverage here, but we will touch on the main reasons people choose to offset risk.
- Homeownership: banks want to ensure they are in first lien position on your home until the mortgage is paid in full.
- Disability maintains your current standard of living
- Healthcare: doctor costs, eye care, dental care, prescription drugs etc. *
- Life: provides for your family or dependents in case of death.
- Business: manages the risks of owning and running a small business.
- Travel: take vacations without worry of flight cancellations or other concerns.
- Car repairs, healthcare costs, or legal expenses associated with collisions unless they have coverage.
Car Insurance is multifaceted. The kinds of insurance are offered here. If you’re looking to buy a car, there’s a series on our resource page about that too.
- Full coverage doesn’t really exist. It is commonly understood as a combination of liability, comprehensive and collision.
- Liability insurance is as basic as coverage gets. It covers damages to another person resulting from an accident you cause. It is mandatory in every state, but minimum limits vary, depending on your location.
- Comprehensive is designed to cover your auto caused by something other than a collision. It could cover fire, theft, vandalism. If you hit an animal, or if your car is stolen this may apply.
- Collision reimburses for damage to the personal auto due to the fault of the insured driver.
- Collateral protects auto lenders from financial loss if the buyer has a lapse in coverage or is uninsured.
- Gap coverage is an option for a person who likes to drive a new car. The car goes down in value as soon as you drive off the lot. If your car is damaged the replacement is based on market or book value. If your brand new car is in a collision a week later there is a gap between the market value and the replacement value.
- New car replacement is a possibility, but it isn’t free. Some companies offer this option if your car is less than a year old, not leased, and under 15,000 miles.
- Better car replacement also isn’t free. In many cases you still pay the deductible. It is possible if your car is a complete loss. If your vehicle is older, or has higher miles, you can get money for a better one.
How does it work?
In general, insurance helps defer risk by spreading the risk around to a number of people in the same area with similar risks. When you take out an insurance policy you pay a monthly or annual premium. That premium goes into a bigger pool along with the premiums of many thousands of other policyholders. Hopefully you never have to draw out of the pool, but if you do have a claim the pool of funds are used to help you get back to normal.
The amount of funds available is determined by the kind of policy you have. It is important to know your policy, and what it covers, in case of an event. Your insurer may repair, replace, or issue a cash settlement in accordance with your policy. A healthy evaluation of your policy guidelines on an annual basis may be the difference between the getting normal and paying in should a claim need to be filed.
Your premium is the amount you pay the insurance company for your coverage. It reflects what the insurer believes the likelihood is that you will make a claim. It also includes the bonuses, discounts, multi policy discounts, or other bonuses the company may offer.
I mentioned earlier that I am in the process of a roof replacement. Guess what? Several of my neighbors are also getting their roofs replaced. The risk in my area just increased, and the pool of funds will be significantly depleted because of this event. Do you think my home insurance will go up next year? I am not much of a betting gal, but I would bet on it. The insurance company will likely increase premiums to help offset the expenditure to help people’s homes become normal after this event. Our premiums increased this year even though we didn’t have a claim because there were a lot of claims in this area last year.
I get it. Not many people I know get giddy at the prospect of analyzing insurance. I dread these meetings with my husband as we evaluate our insurance coverage each January. We schedule the time to make sure we are on track in case of an event. And, I suggest that you evaluate insurance too, at least annually. You won’t be wondering what kind of coverage you have if you need to file a claim. You will be glad you took the time to evaluate.
Insurance can be complicated. Hopefully this helps you understand the types of insurance available, which ones are suitable for your needs, and offers a basic understanding of how insurance works. We’ll discover more details in this series. Let us know if there are topics you would like covered.