Insurance and the Transfer of Risk

Many people buy insurance to gain security and peace of mind. Comprehensive insurance policies can protect our assets, health, and loved ones' financial well-being. Insurance coverage involves allocating risk between the insurance company and policyholder.

This article explains how the insurance industry handles the transfer of risk. It also briefly discusses how this risk allocation works in several situations. For more insurance information, visit FindLaw's Insurance page.

How Risk Transfer and Allocation Works in Insurance

The transfer of risk is an essential tenant of insurance contracts. When you purchase an insurance product, the insurance company takes on certain obligations under the written contract. The insurance company will agree to indemnify you for a certain amount of loss up to the policy limits.

The insured agrees to pay an insurance premium for the insurer's protection. An insurance policy is a legally binding contract. It 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 willing to take it on. The insurance company agrees to take on the risk for a fee.

For example, if you buy a home, you'll likely also purchase a homeowners insurance policy. With your purchase, you pay the insurance company to take on various risks that come with homeownership. The insurance underwriting process determines whether the insurer will write a policy for the customer and, if so, the premium cost.

Risk Pooling

Risk can be transferred from insured individuals to insurance companies. Insurers can also transfer risk to reinsurers. This is known as "risk pooling." An insurance company collects millions of dollars in premium payments each year. The company spends this income to meet company expenses and pay out insurance claims.

The company calculates premiums using actuarial statistics and other data. Prudent risk management requires insurance companies to ensure that the amount of premiums collected exceeds the amount the company pays out.

Reinsurance Companies

The dollar value of the risk insurance companies typically take exceeds the capital they maintain to pay out for claims. Insurance companies often pass some risk to reinsurance companies to ensure they meet payment obligations for claims.

Reinsurance provides insurance companies with insurance against loss, helping to protect against catastrophic loss. For example, there can be widespread property damage and bodily injury claims when a large-scale natural disaster occurs. Such an event would cause insurers to issue many payments at once. A reinsurer helps an insurance company manage its risks.

Insurance Meets Needs During Life Events

Different types of insurance policies guard against any number of risks. Insurance agents are an excellent resource for exploring insurance policies. They can help you with common types of insurance for you or your small business, including the following:

• Automobile insurance
• Health insurance
• Workers compensation insurance
• Life insurance
• Property insurance
• Business insurance policies

Insurance regulation occurs at the state level, though federal insurance laws and regulatory oversight cover some matters. State law or other contractual obligations can require specific types of insurance coverage. In other cases where you aren't required to have insurance, coverage can minimize policyholders' exposure to risks. Several of the most common types of insurance are briefly discussed below.

Auto Insurance

Risks covered by insurance are highly variable. You may get in a car accident with another motorist. In such a case, you'll want to be able to rely on your insurer. They can make you whole if you sustain property damage or suffer a personal injury in the accident.

Insurance coverage can compensate you if an uninsured motorist causes your damages. If the accident wasn't your fault, your insurer can pursue the at-fault driver's insurance. If the third-party insurer delays paying for repairs or their bills, your insurer will typically cover the costs. Subrogation allows your insurer to recoup its costs, including repairs and healthcare costs.

Homeowners Insurance

Your home may be burglarized or damaged by fire. Knowing that you have protection gives policyholders great peace of mind. After paying your deductible, your insurer will provide coverage up to your policy limits.

Life Insurance

A 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. An estate is all the assets and funds you would bequeath to your heirs. But your family may be unprotected if your estate isn't big enough to pay for all necessary expenses. Expenses can include the following:

• Funeral expenses
• Burial expenses
• Other funds to ensure your family's financial security

A life insurance policy serves as a medium to transfer that risk to an insurance company. By taking your premium payment as a form of consideration, the insurance company must pay your beneficiaries a specified amount upon your death.

Get Legal Help With Insurance Issues

Insurance contracts can be complex. But it's critical to understand the basics of your policy, including coverage, policy limits, and exclusions. If you have legal questions about issues like risk transfer, your insurance coverage, or trouble with an uncooperative insurance company, help is available. Seek legal counsel to protect your interests. Contact an insurance law attorney in your area to learn more.