Many people buy insurance in order to gain security and peace of mind. Comprehensive insurance policies can protect our assets, our health, and our loved ones. Insurance contracts function by shifting the risks you face every day to your insurance company. Read on to learn more about this transfer of risk.
How the Transfer of Risk Works
The transfer of risk is an essential tenant of insurance contracts. When you purchase an insurance policy, the insurance company will agree to indemnify you for a certain amount of loss in exchange for your payment of a set premium. An insurance policy, which is a legally binding contract, effectively passes the risk from the party who doesn't want to take it on (the insured, or purchaser of the policy), to the party who is willing to take on the risk in exchange for a fee (the insurance company). For example, if you buy a home, you will likely also purchase a homeowners insurance policy. By doing so, you are essentially paying an insurance company to take on the various risks that are associated with owning a home.
Risk can be transferred from insured individuals to insurance companies, and can also be transferred from insurers to reinsurers. This is known as "risk pooling." An insurance company will collect millions of dollars in premium payments each year. The company will spend these premiums meeting company expenses and also paying out claims as necessary. The company uses actuarial statistics and other information to calculate premiums to make sure that the amount of premiums collected exceeds the amount that the company has to pay out.
However, because the dollar value of the risk that insurance companies typically take on exceeds the amount of capital that they maintain for paying out claims, insurance companies often pass on some of their risk to reinsurance companies. Reinsurance basically provides insurance companies with insurance against loss. This comes in handy in the case of catastrophic loss, such as large-scale natural disasters that cause insurers to issue many payments at once.
Insurance and the Risk of Death
Different types of insurance policies guard against any number of risks, including the risk that you may get in a car accident or that your home may be burglarized or damaged by fire. However, perhaps the greatest risk we face every day—and the one we don't always like to think about—is the risk of unexpected death.
Many people choose to purchase life insurance to ensure that their loved ones are cared for in the event of premature or unexpected death. Every person has an estate—which is basically all of the assets and funds that would be bequeathed to your heirs when you die. But, if your estate isn't big enough to pay for all necessary expenses (including your funeral, burial expenses, and other funds to ensure your family's financial security), then your family may be left unprotected. A life insurance policy serves as a medium to transfer that risk to an insurance company. By taking your premium payment, which is a form of consideration, the insurance company becomes obligated to pay your beneficiaries a specified amount upon your death.
Get Legal Help with Insurance Issues
Depending on the nature of the policy, insurance contracts can be complex. If you have legal questions about issues like the transfer of risk, you may want to consider seeking legal counsel. Contact an insurance law attorney in your area to learn more.