As discussed in earlier posts, insurance is not a gamble taken by a policyholder. Instead, the policyholder buys insurance to protect himself from the risk of a loss, whether it be a medical bill, damage to the policyholder’s property, an untimely death or a liability claim made against the policyholder by a third party. The insurance company sells the policyholder a set of promises to pay covered claims. Those promises are set forth in the insurance policy itself. Once the policy is in place, the insurance company’s obligations to the policyholder and the policyholder’s rights and coverages are set, and cannot be changed until the policy is later renewed or is canceled for some reason.
Before the insurance company ever actually sells and issues the policy to the policyholder, it has gone through a process of determining how it intends to make a profit on the policy. Insurance companies employ actuaries and underwriters who study the company’s risk associated with selling insurance policies. Based on its analysis of its risk, the insurance company either agrees to sell the policy to the policyholder or decides not to do so because it does not believe the risk is a good one. If an insurance company decides to sell a policy, it then decides (with some oversight by the Department of Insurance) how much money it will charge the policyholder in premiums.
When an insurance company decides to write a policy and sets the premium for that policy, the company has decided to take a risk that the losses the insured suffers under the policy will not cost more money than the premiums the policyholder pays.
In effect, the gamble the insurance company takes is taken at the time the policy is underwritten, priced, sold and issued to the policyholder. If you think about it, an insurance company’s business model is based on taking risks. And, judging by their bottom lines, they are very good at it.
Once the insurance company has done this, it must live with the consequences. If it turns out the policyholder’s claims exceed the premium collected by the insurance company, so be it. The insurance company doesn’t have a right to make a profit. Instead, the insurance company in such a situation has lost its gamble. The policyholder is entitled to the coverage he purchased for the price he paid. If the insurance company no longer wants to take the risk of insuring a given policyholder, they can choose to change the bargain with the insured at the end of the policy period for renewal of the policy. They can either refuse to renew or charge a higher premium. Likewise, the policyholder can choose to go elsewhere for insurance.
However, regardless, the insurance company’s obligations and the policyholder’s rights are established up front. As will be discussed in my next post, the insurance company cannot try to lessen the impact of paying claims on its bottom line at the time a claim is made under the policy by attempting to pay less than what is owed on claims. To do so violates the duty of good faith and fair dealing.