Picking out an insurance policy is only half of it when it comes to protecting your family’s financial future. So what’s the other half? Ensuring that you’re getting insurance from an insurance company that has the financial stability and discipline necessary to handle any claims you may have while you are insured.
Understanding Financial Stability
Insurance companies provide much more in benefits than they collect in premiums. For example, if you have a $200,000 worth of coverage on your home insurance policy for insurable incidents affecting your dwelling it is likely you pay a very low premium in relation to the benefit. For the sake of this example, let’s say you pay only $150 a month for the benefit. That means that you will pay very little in premiums over the year in exchange for your benefit. You might even pay only two premiums before you have a claim and even though that amounts to only $300 in premium payments, you will have rights to your full benefit amount if your insurable event qualifies you. And you aren’t the sole policyholder in that lucky spot. Hundreds of thousands of policies are out there worth billions of dollars, and each with the policyholders paying very, very small premiums.
This might make you think about how insurance companies prevent financial ruin while promising all these insurance benefits in exchange for such small premiums. There are three very important ways that insurers continue to be financially stable and pay claims:
- Assessing risk
- Spreading risk
- Building reserves
Assessing risk
In understanding risk, an insurance company must underwrite policies so that they know exactly how much risk the policy will expose them to. This helps them value the policy fairly so that those who demonstrate more risk pay a higher premium and those who represent less risk pay a lower premium. It also helps the insurance company measure about how many of their policies will have a claim. After all, not every policyholder will have a claim on their policy. That means there is a fixed percentage of policies on which the insurance company merely collects premiums. It is these premiums that pay for many of the claims encountered by the small percentage of policyholders with insurable incidents.
Spreading Risk
By spreading out their risks over a large base of paying clients, insurance companies are able to collect enough in premiums to make a profit and amass reserves. After all, the actual percentage of policyholders who must collect money from their insurance policy is comparatively small compared to the ones who pay for it. This theory is known as the Law of Large Numbers and it has been employed by insurers and groups for a long time.
Building reserves
In order to pay the claims that they do receive, insurance companies must set aside funds on a regular basis into what are called reserves. When a claim comes in these reserves can be tapped to fulfill the agreement that each policyholder has with his or her insurance company. The reserves are isolated from all other insurance company expenses and contributions to them are required.
Because insurers have an estimate of the number of claims they will handle over time, thanks to their underwriting efforts and actuarial data, they know what amount to set aside in reserves.
Checking on the Security of Your Insurance Company
In order to discover just how financially solid your insurer is, you should begin by checking their rating on the A.M. Best website. A.M. Best is an insurance rating agency that assesses the financial strength of insurers and assigns them a letter grade that shows just how healthy they are.
The financial strength is based on their ability to pay claims. They compare each insurer with others, examine balance sheets and income statements, studying industry trends and take other qualitative data into consideration before assigning their score.
No matter how economical a quote you might receive from an insurer, it is important that you look into their financial stability before you take out a policy. Paying premiums to an insurance company year after year that won’t be there to fulfill their promise to you is an exercise in futility and one you’d be better off avoiding.
