How Does Insurance Work?
Insurance, at its most basic, is an investment in a future risk that may or may not happen.
When you take out an insurance policy, you are making an agreement with the insurance company that you will pay premiums and in exchange, the insurance company will take care of you in the event of a claim. Policies determine the criteria for what is covered, for how much, and all the details in between.
The policy states the value of the insurance—for instance, you could be covered for up to $10,000 worth of flood damage. But the premium is the cost—for example, each month, you will pay the insurance agency $10 as your end of the flood damage coverage. A premium is calculated based on factors like the specific type of risk and your likelihood to make a claim. Meaning, the premiums for flood insurance would be pretty different for a person that lives at the bottom of a flood plain versus one who lives at the top of a hill.
Monthly premiums are paid by you and all the other insurance clients. Carriers create a large pool of money and when a client files a claim, the money awarded to cover the damages of that claim come from the premium pool.
So why bother to go through insurance instead of a savings account or using your out of pocket money, if your risk factor is low?
The financial difference between having and not having insurance is substantial, even if you have emergency savings. For example, if there is a house fire that burns down a home, without insurance that homeowner would not only be responsible for replacing their stuff and finding a new home entirely out of pocket—they’d still be responsible to pay off the house that burned down.
However, with a homeowners policy, that same homeowner will pay their deductible and that’s it. Everything else is taken care of. Suddenly that low monthly payment and several thousand dollar deductible cost don’t seem like much—not compared to two mortgages and replacing everything you own!
The moral of the story is this: Even if you believe you are low risk for an insurance claim, there’s still a chance you’ll have to pay for reparations that savings would have a hard time covering. Both in the amount of money and time invested towards self-insuring through a savings account, insurance becomes a no-brainer because, among other reasons, you can get the full amount of funds when you need them—instead of saving and hoping you can hold off emergencies until you have enough money to cover it. Insurance companies are able to manage this because they pool premiums from many policyholders together and know that each policyholder will not have the same claim and may not have any claim at all. Policyholders get piece of mind, insurance carriers can spread their risk.
If you have questions about how to make sure you’re covered, contact your CommunityAmerica insurance advisor.