While it may seem complex, insurance is really quite simple: The
payments (or premiums) of the
many pay for the losses of a few. Your premiums go into a large pool, if you
will, at your insurance company. The claims of the few are paid from that pool.
Because there are more people contributing to the pool than there are making
claims,
there is always enough to pay the claims – even large single claims
like when someone is permanently disabled as a result of a car collision, or
many smaller claims like those resulting from a natural disaster. (The 1998 ice
storm that hit parts of Ontario, Quebec and New Brunswick resulted in an
estimated 700,000 claims for damage total $1.4 billion.) However, large disasters (such as the ice storm) do come close
to emptying the pool.
Insurance for
insurance companies
Even when the pool comes close to emptying, there is another pool
from which insurance companies can draw
to pay claims. Some of your premiums are used by your insurance company to buy
reinsurance – insurance for insurance companies. Sometimes losses are so big –
like those resulting from an earthquake – that there is no way that an
insurance company can cover the costs. Reinsurance is an extra layer of protection
against large losses.
Annual
replenishing
Your insurance is an annual contract, so the pool operates for
only one year at a time. Your premiums and the premiums of others are based on
how much money the insurance companies think they will need to pay the coming
year’s claims. Your premiums do not build up over the years – unlike the
premiums for some types of life insurance.
How premiums are
calculated
Within reasonable limits, some of which are prescribed by law,
your premium is calculated to reflect the probability that you will make a
claim – that is, that you will draw funds from the insurance pool. Those who
are unlikely to draw from the pool pay less than those who are more likely to
draw from it.
Insurers take many factors into consideration to determine the
likelihood that you will make a claim. A common misconception is that a
policyholder who has never made a claim should pay less, little or nothing for
insurance. While it is true that past claims history is important, a more
reliable indicator of how likely a person or business is to make a claim is the
statistical group to which he/she/it belongs.
Your Insurance
Dollar
Here is a breakdown of where your insurance premium dollars go.
For every dollar of premiums gathered from policyholders, 53.1¢ go
back to policyholders in the form of claims, 15.9¢ go back to communities in
the form of various government taxes on insurance, 20.5¢ go to industry
operating and regulatory costs and 10.5¢ go to industry profit.
These percentages are based on a 7-year national average from 2004
to 2010.
Insurance pays
for …
Insurance pays for only those types of losses described in your
contract. It is very important that you read your policy and/or talk to your insurance
representative about what you are covered for and what you’re not. Insurance
will not pay for every problem that you may encounter, nor is it a maintenance
contract. Insurance is generally intended – and priced accordingly – to help
policyholders cope with the financial consequences of unpredictable events that
are "sudden and accidental." If, for example, you live on a
floodplain by a river, flooding of your property in the spring is not sudden or
accidental; it is inevitable and, therefore, un-insurable.
