What is insurance? How does it work? Where does the money go?
Most people look at insurance the same way they look at their utility bill or cable bill: just another cost of living. When you think about it, life is a series of chances that you take. You work hard for the things you have: cars, homes, jobs—you name it. These are very serious investments that you make, and all of them have risks associated with them. Risk is nothing more than the chance of a loss occurring. In the case of insurance, you’re covering your chance of financial loss. There are a lot of different risks associated with owning a home. Some are pretty easy to imagine: fire, lightning, hurricane, just to name a few. Beyond the obvious risk of things that can happen to the house, there is the risk of being sued for things that happen around the house—a trip and fall is a good example. All of these events, whether damage to the house or a lawsuit, can bring tremendous financial hardship to you if they happen.
Homeowner’s insurance is designed to be a transfer of the financial risks associated with your home. When you think about it, paying an annual premium to the insurance company, which is there to pay for losses when they occur, is far less expensive than paying for the loss out of your pocket!
So then, how does insurance work? And where does the money go? Both of those questions can be answered at the same time. Insurance companies hire math geniuses who calculate the statistics involved in certain types of claims—they call them actuaries. These people use complicated math problems to determine what the company should charge, based on these statistics they come up with. One important thing to note here is that these rates are based on large numbers of people being insured. The insurance company then sells policies to people like you and me. The money from the premiums paid is pooled together. Expenses for internal salaries—company underwriters, claims people, clerical help, etc.—come out of the pool, and the rest is there to pay for claims when they occur..
Because of the responsibility associated with pooling money, insurance companies are subject to financial regulation by state insurance regulators. They make sure that the companies maintain a minimum amount of money to be able to pay claims when they happen. The amount of money required is based on the amount of insurance each company writes. Having insurance gives confidence and peace of mind because it is there to help pay for possible claims. There is also confidence in knowing that the state government is looking out for your interest in your insurance company.