How does insurance work?

insuranceInsurance. You can’t live with it, and you most definitely can’t live without it. Not if you own a car or a house anyway.

Insurance is there for our peace of mind above and beyond anything else, affording us a level of protection to cover for all eventualities. A largely unseen force of good which serves us well as we go about our everyday lives. There to come to our rescue if fate, law of averages or Mother Nature takes a turn for the worse.

Stopping short of referring to insurance as some form of superheroic entity, it is nevertheless lurking in the background with good intent most of the time, only reminding us of its existence when something bad goes down. Apart from when we have to pay for it monthly or annually that is. But what we really want to determine is just how does insurance actually work?

To the uninitiated, insurance in all of its predominant forms and functions (both domestic and commercial, personal or public) is essentially a financial product offered (and then subsequently sold) to us by dedicated insurance providers.

The premise being that these insurance policies discussed, planned, drawn up and executed by the insurance companies effectively safeguard us all against the clear and present danger/calculated risk of loss, damage and theft of ourselves and our property. Think flooding, burglary, accident, etc… to get a better idea.

While some departments of Insurance PLC require you to take out insurance as a mandatory and law-abiding fact of life (such as motor insurance if you own/drive a vehicle, and buildings insurance as a result of contractual obligations of arranging a mortgage), others are more voluntary, if not strongly urged by the relevant insurance-procuring parties. Such as life, home, health, pet, travel, wedding, holiday and pension insurance. You just know it makes sense.

A Far-Reaching Range of Insurance Policies Provide Peace of Mind to Millions of People

Although nobody wants to think they’re regularly forking out for something they will never actually benefit from, it’s worth bearing in mind how you’d cope if things suddenly went pear shaped in an area of your life with no prior notice. Or if some kind of disaster struck.

We’re not implying Armageddon here, merely something personally damaging to you. At best, inconvenient, at worst, well, fatal.

Things have to be put in place to ensure everybody’s circumstances are advantageous to them. Hence the role of insurance in its plethora of guises. In its most rudimentary form an insurance policy is a contract which you sign up to with an insurance-providing company which protects you against specific risks, under the agreed terms set out in your individual policy.

A virtual fail safe mechanism which means you can go about your business (leisure and pleasure) without needlessly stressing about the ‘what ifs’ in life.

Getting down to the nitty-gritty, and the basic principles of an insurance policy allow you to make a claim with your insurer (who’ll then action a pay-out for the implicated loss covered under the specific policy once all the facts and figures have been referenced), providing of course you keep up with your previously arranged regular payments; known as premiums.

Unfortunately you won’t see your money again if you don’t claim at some point, as that’s not how insurance works. Everyone’s premium money is pooled together, which forms the pay-out pot for individual future claims.

Before you even start researching the insurance providing companies out there who can arrange a policy for you (our tip would be to check out the large selection of online price comparison sites when the time comes), you must first answer some elemental questions. Such as why you need cover? What your cover must include? How much you can afford? The length of time you envisage you’ll require cover for? And whether or not your cover is for solely yourself and/or loved ones to benefit from?

Once you’ve ascertained the insurance bread and butter, then you can look to see which insurance companies cover you for what, when, where, how, which and indeed, why.

Risk Data Measures the Likelihood of Any One of Us Being Susceptible to an Unpredictable Event

Also it’s imperative that you understand and appreciate how insurance premiums are calculated, so it doesn’t come as a surprise later. Knowledge is power as they say.

Pretty much the world over you’ll discover that insurers use what’s referred to as ‘risk data’ to calculate the likelihood of the event you are insuring yourself/your car/your home/your business against from happening. For example, if you choose to live halfway up an active volcano, you’d expect to stump up astronomical home and life insurance premiums on account of the ludicrous and prevalent risk factor involved!

This data is then used to work out the cost of your monthly/annual repayments. The greater the risk, the higher the premium paid, which wouldn’t come as a huge shock to anyone.

Two monumentally important factors taken into consideration by insurers are as follows:

How likely is that person to make a claim? And, is that person deemed a larger or smaller risk than the average policyholder?

To explain better, a young person owning/driving a high powered car would be charged a high motor insurance premium because, statistically, they are many times more likely to be involved in a road accident than a mature, experienced driver in a Nissan Micra – according to a multitude of insurance industry-accepted sources, reports and white papers.

Moving on, and despite policies promoting an array of terms and conditions contrasting those of their nearest rivals, there are three common denominators which remain a constant across the ever-broadening insurance spectrum…

Standard Policy Conditions Remain Core Values of Personal Insurance Policy-Making

Firstly, it’s widely acknowledged that cover refers explicitly to the current market value of the property or item which has been reported as lost, stolen or damaged beyond repair (in essence, it’s replacement value) and not its perceived sentimental value which in most cases can’t realistically have a figure placed on it.

Secondly, there needs to be a measurable volume of comparable risks so that the likelihood of a claim can be spread amongst policy holders. Insurers must be able to calculate the proposed loss in order for a resultant premium to be arrived at commensurate with the implied risk. This is a given. And lastly, losses must not found to be deliberate, otherwise all subsequent claims will be declared null and void.