What is Insurance?
Insurance is a system under which individuals, businesses, and other organizations or
entities (the insured), in exchange for payment of a sum of money (a premium), are
guaranteed compensation for losses resulting from certain perils under specified
conditions.
In general terms, insurance is funded by pooling premiums from insureds for the
purposes of building a fund with sufficient reserves to pay for claims made on policies
issued. Essentially, insurance involves a large number of people paying a small amount of
money to make sure the few who need to make a claim are covered.
Insurance companies should try to make sure that every individual who has insurance
pays a premium that reflects their risk. For example premium collected from home owners
would ordinarily enter a home owners insurance "pool" as would premium collected
from business owners ordinarily enter a business insurance "pool".
This method helps insurance companies price and monitor group risk with a higher level
of accuracy and ensures low risk insureds are not penalised by higher than necessary
premiums to fund losses from higher risk insureds ie, hairdressing salon premiums
increased because of losses from motor vehicle insurance.
However, this is not necessarily always the case as some insurance companies do in fact
pool all premiums together in one central fund to cover various risks.
The advantage of having insurance is that it allows the community to pool risks. This
takes away the need for people to pay the full cost of loss or damage on their own, which
in some cases, could, if it occurred, leave people in great financial difficulty.
What is Risk?
Risk is a word that is used often by insurance companies.
In general terms, risk means the chance of something unpleasant or unwelcome happening
such as something valuable to a person being lost, stolen, damaged or destroyed. It can
also mean the chance of a person being injured.
One of the things insurance companies do is to work out the cost of insurance premiums
by assessing and pricing risk. In other words, putting a financial value on the risk. For
further definition of "risk" and in fact just about any insurance term please
visit our Insurance Dictionary by clicking here.
Assessing and pricing risk involves working out the chance of whatever is insured
becoming accidentally injured, lost, damaged or stolen, and how much it will cost to
repair or replace what is insured.
Working out how much it costs to pay claims and how often people are likely to be
injured or have their property lost or damaged is a very important part of an insurance
company's work. This is called pricing risk. By pricing risk, insurance companies know how
much money they need in the `pool' to pay claims.
The better insurance companies are at pricing risk, the better they know how much money
needs to be in the 'pool' to pay their customers when they make a claim.
What is an Insurance Premium?
An insurance premium is an amount of money a person pays to an insurance company for an
insurance policy. This payment could be regarded as transferring some or all of the risk
(or cost) of loss or damage. For example replacing, repairing or rebuilding a particular
valuable if it is lost stolen, damaged or destroyed.
This is also the same for insurance against accidents at work or on road that may hurt
and injure people.
The cost of an insurance premium needs to take into account the;
- Expected number of claims multiplied by the expected average claim size;
- How do insurance companies calculate the insurance premium they charge?
No one knows for sure if or when what is valuable to someone will be accidentally lost,
stolen, damaged or destroyed or when someone could be injured on the road or at work.
Because of this, insurance is based on what may or may not happen in the future.
Insurance companies spend a lot of time trying to work out the chances of their customers
having to make a claim and the potential cost of that claim.
Generally the higher the risk of loss, theft, damage, destruction or injury, the higher
the insurance premium. Not everyone's risk is equal. So the amount people pay for their
insurance cover or premium, may differ depending on their own circumstances.
Insurance premiums are made up of different parts, including the cost of estimating,
collecting and managing the premiums, the cost of paying the claims, taxes, levies,
duties, reinsurance costs, the profit margin and the cost of the insurance company
administering the insurance cover, and the cost of insuring the particular valuable.
An insurance premium is not like paying for a typical service or product because:
- Insurance companies are selling the customer a promise to cover what is insured by the
insurance policy. For example if the customer's insured property is accidentally lost,
stolen or damaged and the customer makes a claim.
- The cost of paying a claim is not certain at the time the insurance policy (coverage) is
sold.
- Insurance companies do not know what misfortune any of their customers may encounter.
Therefore, insurance companies may not know exactly how often a customer may make a claim.
- Insurance companies usually offer insurance cover for 12 months at a time and insurance
premiums usually need to be paid and renewed every 12 months.
What is a claim?
A claim occurs when something unfortuitous happens to cause loss or damage to insured
property.
Whether or not an insured person and/or entity "the insured" will be entitled
to cover under a policy of insurance will depend on the circumstances giving rise to the
loss and the limits of cover provided by the insurance.
For example, where a small business has its stock and contents insured for fire, and a
fire occurs which causes loss and/or damage to the stock and contents, the insured can
expect to be covered.
This principal is similar in all insurance classes, from small business insurance to
home and motor vehicle insurance. *
Where a claim is accepted the insurer will register a claim and make appropriate
financial reserves in its books of account to cover the claim. It will usually make a
financial reserve for rejected claims in the event their decision is challenged.
Paying a claim is the moment of truth for an insurance company because paying claims is
what insurance companies do.
When an insurance company pays a claim, it is keeping its promise to pay the claims of
those who have policies with the insurance company.
It is in everyone's' best interests if people check what is covered in their insurance
policy when they first buy, or renew their insurance.
The insurance company may send out a loss or claims assessor to look at and check the
claim for the loss or damage.
The Insurance Council of Australia has a General Insurance Code of Practice, which sets
out rules that insurance companies, that are members, must follow. The General Insurance
Code of Practice outlines principles and standards about the insurance claims handling
process.
The Insurance Code of Practice can be found at http://www.ica.com.au/codepractice/.
Insurance Claims are also subject to the Insurance Contracts Act click here for a
copy. **
Note:
The liability of an insurance company is always contingent on the coverage,
conditions, exclusions and limitations of an insurance policy thus, where a breach of the
coverage, conditions, exclusions and limitations occurs it might give cause for the
insurance company to reject the claim.
Not all insurance companies are bound by the Insurance Contracts Act. In some cases
certain types of insurance might not strictly be subject to the Insurance Contracts Act
such as Marine Insurance or insurance issued by foreign insurer, authorised or
unauthorised.
