Insurance is confusing to lawyers and non-lawyers alike. When you apply for insurance, a homeowner's insurance policy for example, the insurance agent will ask you anywhere from what your roof is made of to whether you have a fire extinguisher to what type of breed your dog Spike is. After compiling that information, he gives you what your insurance will cost and sends you a packet full of numbers, information, and language that appears to come from another planet. It is at this moment that you ask yourself: What exactly is it that I'm buying? Why did he have to ask me all of those questions? What are all of these numbers? Is this policy language in English? It is in this stream of blogs, “Understanding Insurance,” that I will attempt to answer these questions.
Why did he have to ask me all of those questions?
In Part I of “Understanding Insurance” we discussed the general concept of what insurance is, what it protects you from and why it works. In doing so, I used a hypothetical in an imaginary world where everyone pays the same amount in premiums for their insurance. We know, however, that in the real world people do not pay the same amount for the same policy.
Why is this? Well, to answer this question, we must first go back to the original concept of insurance: you pay the insurance a premium and they promise to cover your risk of causing an accident. Second, you must ask yourself: is your risk of causing an accident the same as the guy next door? The answer is an obvious no, and this is why premiums range from person to person. How much your premium costs depends entirely on how “risky” of a person you are, or in other words, how much risk the insurance company is going to have to cover in order to insure you.
One the biggest tasks for an insurance company to run efficiently is to properly evaluate risk, which is why when you apply for insurance you have to answer all of those questions. They want to know if you have a fire extinguisher or if there is a fire station within 5 miles of your house because they want to know how much damage a fire would do to your house before you had the ability to start putting the fire out (some policies give discounts to those that have a fire extinguisher in their house). They ask you what breed your dog Spike is because they want to know if Spike is the type of breed that has a tendency to chase after a jogger's legs like it's a rare piece of tenderloin. They want to know what your roof is made of and how old your house is because they want to know if it will stand tall or crumble at any minute. Once they have evaluated how “risky” of a customer you are, they put a price tag on what it's going to cost them to cover that risk. The more risk you have of causing an accident in their eyes, the more they will charge for taking on your risk.
Insurance companies have also found trends regarding risk in certain demographics or groups of people, and the price of your premium could be influenced by things you have no control over, such as your age or your gender. For example, teenage boys who drive fire engine red convertibles will likely have a higher premium on their automobile insurance than a teenage girl who drives the same car because insurance companies have found a trend that young males are more likely to get into automobile accidents than their female counterparts. A life insurance policy premium for a male is likely to be higher than that of a female of the same age with the same policy because insurance companies have found a trend that females have a longer life expectancy than males.
After answering all the questions, receiving the price of what it will cost, and paying your premium, you receive a packet in the mail full of numbers you don't understand and policy language that might as well be written in Sanskrit. Stay tuned for the translation…