After 47 years in the insurance industry, I’ve come to believe that most people think that insurance is too boring to learn about and just pay their premiums as they come due. This can be a very costly decision. With health insurance in the political spotlight, I thought it would be helpful to review 14 important points people should know about insurance.
1. Insurance doesn’t take risks; it manages them.
2. Insurance should only be used when the potential loss is larger than the insured parties can afford to lose.
3. Insurance relies on the “law of large numbers,” which states that the larger the number of insured people or organizations (called insureds), the more accurate the number of losses will be. Looking at 100 38-year-olds, you have no idea how many will die in the next year, but looking at 1,000, you can be pretty sure that two will be dead at the end of the year.
4. When insurers don’t have enough insureds to use the law of large numbers, they enter into reinsurance contracts with other insurers to get their numbers up to a predictable amount. Insurance companies are exempted from antitrust laws to allow this, and the federal government has gotten into the reinsurance business with the Affordable Care Act.
5. Insurance companies are regulated by the individual states that approve policies, rates, and the conduct of the agents, agencies and companies. Federal regulation, though growing, is minimal.
6. Insurance companies are generally divided into those that insure things (property and casualty) and those that insure people (life and health).
7. Property casualty agents are usually paid a renewal commission that is a percentage of the premium you pay.
8. Insurance can be divided into social insurance and private insurance. When risks are to the society as a whole, the government provides insurance such as flood insurance, Social Security, Medicare, Medicaid and crop insurance.
9. Social Security is a social insurance plan that pays current benefits out of current premiums. It projects future benefits and uses reserves to accumulate and pay for benefits when current premiums aren’t enough to cover current claims.
10. Private insurance is designed for those who want coverage for risks the government doesn’t cover.
11. Private insurance relies on underwriting to assess the risks they are going to manage and will refuse to cover — or charge more for — those most likely to file a claim.
12. Health insurance companies historically have divided their business into covering individuals or covering groups. The group business provided enough insureds that the law of large numbers allows them to forgo underwriting. The individual market relied on underwriting to exclude sick people from buying coverage and to keep premiums lower by covering only healthy people.
13. With the use of underwriting being banned by the Affordable Care Act, meaning that health insurance companies cannot refuse to cover people with pre-existing conditions, the only justification for separating group and individual markets is to be able to charge higher premiums to the individual market, which now includes sick people.
14. The insurance industry in 2017 had 920 lobbyists and spent over $160 million on lobbyists.
Carl Berdie was vice president of advanced underwriting at a national insurance wholesaler and holds both Chartered Life Underwriter and Fellow Life Office Management Institute degrees.