Some believe that insurance got it’s start in the pubs in England in the 1600’s. Patrons at the bars would wager whether ships headed to the “New World” would return safely. It is from this ganbling in pubs that Lloyd’s of London got started. So, its probably safe to say that insurance is a form of gambling. You are betting your are going to have a loss and the insurance company is betting you are not going to have one. If only it was that simple.
The Amish do not have insurance. They do not believe in it. Instead, they have a community that, should your home be destroyed, shows up and rebuilds your house. No charge! Insurance works pretty much the same way. We all the the cost of damage and loss, but instead of having to show up and help rebuild, the premium dollars we are paying get divided up among those people who suffer the loss. When there are a signicant number of losses, the amount we all pay increases. If there is insurance fraud, it increases everyone’s cost. When uninsured motorist causes damage, it increases what we all pay. (By not being insured, their money isn’t going into the “pot.”)
The cost of insurance ins’t just the total of the losses paid. It includes the cost of attorneys to defend lawsuits. It includes the fuel for the adjuster or appraiser to inspect the damage. It includes the health benefits for the people who process the claims. When these costs rise, the insurance companies include these additional costs in the premiums. They must first receive the approval from the Insurance Department. Insurance companies cannot charge whatever they want to for car and home insurance. Rate changes must be approved by the Insurance Department like the Public Utilites Commission regulates itilities.
The State also gets involved from another point of regulation. They make sure that insurance companies have enough money to pay the losses for all of the insurance policies they have. The State requires that insurance companies pay money into a Guaranty Fund in the event an insuror becomes insolvent and losses still need to be paid and/or premiums need to be refunded. (This is like the FDIC except it hanldes insurance companies insolvencies.) So, a percentage of what you pay to the insurance company gets paid into this fund.
So, it isn’t that simple. Insurance is a very complex process. But, it is essential. The entire financial world would change if insurance did not exist. As the third largest expense in every American household, it is important to understand how it got started, why it exists and how it works.