Insurance companies are in the business accepting financial risks that individuals and other organization have but they do not accept all risks!
For and insurance company to accept a risk, there needs to be certain elements evident or else they themselves could avoid, reduce or transfer the risk themselves.
Here are the 6 elements an insurance risk must have for an insurance company to accept it from a potential insured:
- Loss must be due to chance: The risk must be due to chance and outside the insured control. It cannot be intentional (though a suicide is covered by life insurance after the policy is in force for 2+ years.)
- Loss must be definite and measurable: An insurance company must be able to put a dollar amount on the amount of loss.
- Loss must be predictable: Insurance companies are masters of understanding statistics. They must be able to predict how many people or businesses will experience an event during any period of time and they must be able to predict the amount of losses that will occur from those events. Sometimes risks are mostly predictable but have some uncertainty in them.
Take for example car insurance. A car insurance actuary can determine rates for an area based on certain known facts such as an insured’s driving record, type of vehicle and miles they drive a year.
What the insurance company cannot predict is when the next category 5 hurricane will hit a coastal city where they have a lot of policies issued and the event destroys 30% of the cars in that area in a few days.
This event could be financial devastating to the insurance company if they did not exclude hurricanes as an event they did not cover (check your policy.)
The insurance company in this case will transfer that risk away from themselves if they can find a re-insurer to accept that risk for them.
- Risk must not have the potential to be catastrophic to the insurer:
Insurance companies accept risk they understand and can financially handle when claims occur. They will never accept a risk that could wipe them out financially (which is what Decision Tree Financial encourages our clients to consider when they are deciding how to address risk in their lives.)
Example, a life insurance company may not issue a life insurance policy for $100 Billion dollars on a person life Jeff Bezos, the richest person on the planet.
If he is healthy, odds are he will not pass away and they company stands to make a lot of money on a $100 Billion Dollar Premium!
However, if he did die, the loss of $100 Billion dollars could be catastrophic to the survival of the insurance company therefore they would never issue such a policy even if he qualified for it based on their underwriting criteria of income and assets.
- Needs to be a lot of like risks to pool together: Back to the car insurance example above, an insurance company knows what the probability and amount of loss will be for drivers at a certain age, with a certain car, driving a certain number of miles.
There is a very large sample size and they would have a number of insured’s who are pooled in this block of business.
- Loss exposure must be randomly selected: In addition to everything else, the group to be insured must be randomly selected. They must have good risks to go along with risks that may not be as good to reduce potential claims.
Example, if someone bought a life insurance policy at 40 years old when they were healthy but 5 years later have a high probability of passing away due to cancer, the insurance company will need healthy 45 year Old’s to help the company reduce claims on the block of business.
Is there coverage for risks that do not meet these criteria?
The answer is YES but you will not find this coverage through traditional methods. There is coverage available for all types of risks. Entertainers insure their voices and their legs, art collectors insure the collections and businesses insure their unique products.