Suppose you and nine other people buy a boat. You want to protect that boat in the event that it burns, sinks, or suffers some other catastrophe. The boat is valued at, say, $100,000. That means each of you is at risk for $10,000 in case of loss. So, you all decide to pool your resources and tuck away $10,000 each in case of a loss. This is called spreading the risk. And insurance companies refer to the owners of an insurance policy as “the risk.” Don’t be offended; it is purely a subjective reference.
Suppose instead that there are ten boats to insure, each with ten owners, and each boat is worth $100,000. That is a total value for the “risks” of $1,000,000, and the risk is spread among 100 owners. Each owner now still has $10,000 of risk. But now, the collective owners begin to look at the different boats. Some have leaky gas tanks.
Some are not maintained very well, or are docked next to a fueling station, or are left with the keys in the boat and otherwise unlocked. The responsible owners might think that the irresponsible owners should possibly pay more than $10,000 and the more responsible owners should pay less since they are creating less risky conditions. This is now called underwriting; determining the amount of risk and charging accordingly.
The number of risk factors is many, and the underwriters have a big job, but ultimately this is how the premiums are decided.
If for example, the loss rate is one boat in ten for every year, you might be able to break the premium up into $1000 per year on average for each owner (more for each irresponsible owner and conversely, less for more responsible owners.) Age, condition, location, amount of use, and many other factors come into play, but this is how the first underwriters created insurance.
Who Are the Parties to an Insurance Policy?
The insured is considered the first party. The insurance company is considered the second party, and everybody not associated with the first two is considered a third party.
Property coverage protects the property of the first party. It could be a boat, a home, a car, or a business, but it is meant to make whole the owner of the property and the insurance contract.
Liability coverage is meant to protect the owner of the property from third-party lawsuits. If you run over a skier on your boat, he would certainly sue you, and your liability coverage is designed to protect you.
The exact details of how you are covered for property and liability by perils of environment and action are defined by the policy you purchase. And that is where the fine print comes in. It is important to know the facts of the fine print. One more thing; the policy starts at the exact minute and date when a policy is bound.
I have had a walk-in customer who wants to write for a casualty insurance policy immediately. I came to find out later that he had had a traffic accident that morning, did not have current auto insurance. He thought that if he wrote a policy that day, it would retroactively cover his accident. Had we not had an exact date and time of insurance binding, he might have gotten away with it.
They Don’t Insure a Sure Thing
That brings up another subject. Insurance companies will not insure you if you are aware of impending losses. I had a young woman call me to say she wanted that renter’s policy I had quoted for her some time ago—the one she did not buy. The problem is that “the fires were a couple of blocks away” and she wanted to cover herself for that impending loss. Nope. It does not work that way.
Insurance agents are eager to write a policy on just about anyone who appears in the doorway. I recall one small clothing store that wanted coverage. The owners were a bit cagey about information of ownership and property coverage. Too suspicious. They must have procured insurance somewhere, and later I noticed that half of the shopping center had burned down, destroying the business of one of my clients in that same center. Arson was suspected. I decline to write coverage on such cagey situations.
And by the way, don’t think of misrepresenting material facts on an application. If you do, the insurance company has the right to revoke the coverage as if you were never covered. They might happily refund all of the premium you paid and deny the filed insurance claim. Or they might mitigate the payout if the situation warrants it.
Insurance is similar to a loan. Put yourself in the position of a lender. Ask yourself what you would like to know about the person or business to whom you will be lending $1,000,000. Would you like to know how reliable they are? Do they have the ability to pay premiums? Are they representing the risk honestly? What are they hiding that could lead to a claim? Accidents happen. That’s why we have insurance. But Insurance Companies don’t want to insure a loss that is sure to happen.