The general sentiment when it comes to insurance of any kind is, ‘Necessary to have it, even better never to use it.’ It is used primarily as a way to manage risk, and very often seen as a necessity. So how does insurance work for companies and individuals?
According to the Insurance Institute of Michigan, the roots of the industry – basically the concept of ‘sharing risk’ – actually stem from the days when sailing ships lost considerable goods due to bad weather and started dividing their cargo among several boats, thus only losing a small percentage if anything were to happen to one of the ships.
From health, life, and fire to vehicle insurance, one is faced with a multitude of decisions, made even trickier by the number of service providers available for different levels of coverage.
Insurance Industry Explained
Investopedia defines insurance as ‘A contract (policy) in which an individual or entity receives financial protection or reimbursement against losses from an insurance company.’ A major way these companies earn revenue is from the sheer number of non-claiming policy owners who far outweigh the number of claims made.
In a way, insurance is a gamble on both ends of the spectrum: The policy holders gamble that they will need it at some time while the insurance companies calculate that less claims will be made against the revenue earned from the sheer number of holders they contract policies to.
It should, however, be pointed out that insurance companies allot considerable resources to calculating risk and weeding out fraud (actuarial science).
Another way that insurance companies make profits is by investing the collected pool of premiums in the same way that a bank would invest customers’ finances. These companies bank on the premise that not all clients will claim on their premiums at any one time; once again, similar to a bank’s handling of savings accounts.
How premiums are determined
How insurance premiums are calculated are enough to confuse the savviest of us. Those in the industry will know that companies come up with these figures following methods that are used across the industry. Such factors as previous health conditions, whether one is a smoker or not, age as well as occupation all help determine one’s risk level.
The industry specific Insurance Score is a rating used to predict the likelihood that a customer will file an insurance claim – based on an analysis of a consumer’s credit rating – with the method for calculating it varying from insurer to insurer.
It should be noted that an insurance score is not used to ascertain creditworthiness but to calculate risk – according to insurancesscored.com, one’s insurance score represents the likelihood of someone filing an insurance claim during the time that you have coverage with that particular insurer.
Investopedia also states that the Investment Score is predominantly calculated by collating a customer’s outstanding debt, length of credit history, payment history, and amount of revolving credit versus amount of credit in the form of loans, available credit and monthly account balance. This thorough process is adopted by most insurance companies to reduce risk.
With a growing global ageing population, more people living in cities as well as advancements in healthcare, the insurance industry is only set to grow in the next few decades. Both sides of the spectrum will still be participant to ensure risk is minimised and all bases are covered.