Several processes are involved in evaluating risk for insurance. Initial rate-making involves evaluating the severity and frequency of insured perils to determine the expected average payout. Insurance companies collect historical loss data, then compare those losses with premiums collected and expense loads to calculate rates. Similarly, rating a risk involves comparing losses to “loss relativities”. If several characteristics are present, insurers may also conduct multivariate analyses. If the costs of loss are not constant, insurers can also choose to charge a higher rate per $1,000 of coverage.
The basic idea behind insurance is to protect an individual from major losses. The insured party pays the insurer a premium to guarantee coverage against losses specified in the policy. The premium is used to fund the insurance company’s overhead and accounts reserved for the payment of claims. A portion of the premiums is deposited into reserves for the insurer’s future losses, and the insurer’s profit is taken out of the remainder. The insuring party’s profits depend on the amount of premium paid.
In addition to protecting individuals against unexpected losses, insurance helps organizations pool the resources of many people with similar risks to protect those who suffer the most. By purchasing insurance, customers are putting money into a pool that they draw upon in the event of a catastrophe. Insurance can help prevent a financial crisis and reduce mental stress. Insurance is an important tool for anyone seeking financial protection. If you’re in the market for a policy, shop around and compare prices.