How Insurance Works

If you like to get your information from people who have no particular credentials, today is your day!  With all the talk about insurance lately, I get the feeling that some people – even big shots in Congress – don’t get how insurance works, so I’m going to share what I know.

The first thing to know about insurance is that it has everything to do with risk.  My dad talked sometimes about how people become “insurance poor” by trying to eliminate all possible risks in their lives by getting every kind of insurance possible, and lots of it.  They’re safe, but broke.

Lately, most conversations about insurance have been about health insurance, but the factors at play also apply to homeowners’ insurance and car insurance.  We pay insurance companies money, and in exchange, they make us feel secure.  With car insurance, we don’t pay as much if we have a high deductible, which means we pay for some of the repairs out of our own pockets.  And, if you have accidents, your premiums will go up.

We don’t expect our car insurance to cover new tires, windshield wipers, car washes, or oil changes.  We don’t expect our house insurance to pay for new paint or siding.   And, if we live near a river that floods, they won’t even sell us homeowner’s insurance, because it isn’t worth the risk for them.

Somehow, over the years we’ve evolved into treating our health insurance in a different way.  We think it should be inexpensive and all-encompassing.  When I was a kid, my family expected to pay for physical exams and other office visits.  The insurance was there for the big stuff.

But why does insurance cost so much?  Well, car insurance cost a lot less when our cars were worth $3,000, like our first brand-new Honda Civic back in 1977.  Replacing a $40,000 car costs, well, $40,000, so the car insurance companies have to charge enough to cover your potential loss and make a profit.

Likewise, the cost of health care has gone up so much and so fast that health insurance companies are struggling to keep up.  One example: the health insurance provider for the company I work for paid out more in claims for our company’s employees last year than they took in in premiums.  So, they had to raise our monthly premiums for this year.

Some people have a hard time getting health insurance because they have risky lifestyles or pre-existing conditions.  Insurance companies hire people called actuaries to help them calculate their risk.  If you have had a couple of heart attacks, for example, the actuaries have a chart that shows how likely you are to have another one, and another chart that says how much it would cost them if you did.  If they are likely to pay out more for your care than they bring in from your premiums, you aren’t worth the risk either.

Any insurance regulation that requires people with pre-existing conditions or risky lifestyles to be given insurance at the same rates as everyone else… well, that will cause everybody else’s insurance premiums to go up to cover the higher risks.  It would be like having someone with five DUI’s pay the same for their car insurance as all other drivers, or people living on a frequently flooded river bank paying the same as people who are high and dry.

Of course, people can’t help that they have pre-existing conditions, unlike the drunk driver above who shouldn’t be driving if he or she drinks.  That’s one reason most people think something should be done to help those higher risk people.  Whether the entire system should be changed in order to insure those people is open to debate.  But, I do know that any insurance company that is forced to ignore their actuaries and charge premium rates that cause them to lose money will go into another business.

So, that’s how insurance works, or doesn’t, as the case may be.  It will be interesting to see how it works, or doesn’t, in the years to come, or if it even still exists.


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