Insurance Revisited

If you customarily read my blogs, you’ll remember I already wrote about my dad in another posting, but I have to acknowledge once again his positive influence. I began to learn about insurance as a child. Although his formal education was in accounting, during my childhood my father worked as an insurance agent until he arrived in the US as a political exile.

Dad took great pains to explain to me in age appropriate terms what insurance is about and, while at the time I may have dismissed perhaps too much of what he taught me, life brought me around. It’s clear that his efforts were not wasted. The distribution of insurance has been my life’s work and and as far as I’m concerned, it’s been a fair and noble enterprise.

Even during the years I was formally teaching in an academic setting, I worked with insurance. I make this distinction because when today I sit down with prospects and clients to discuss financial matters, no longer in front of the classroom, I still impart knowledge and skills outside the traditional learning environment.

From my father I learned how insurance products provide a valuable service to society, to the government, to business concerns, and to individuals in general. In our conversations I sensed his faith in the product and he passed on to me the same conviction. Not casually am I stating here that everyone is better off with the products insurance companies make available. I speak with first hand experience of families after a loss staying in their home, of widows receiving monthly checks, of education dreams realized despite the untimely death of a bread-winner, and of old age benefits to supplement Social Security payments, relieving the anxiety of smaller income flows after retirement.

Dad wanted me to understand early the ins and outs of insurance so later, as the needs came up, I’d feel comfortable with the products. If everyone learned about insurance while growing up, our society would function better. We wouldn’t have so many misconceptions about the insurance industry and the myriad products we rely on for financial freedom.

I also wrote specifically about insurance a couple years ago but, as at present the Supreme Court hears arguments on the constitutionality of issues brought up in the Patient Protection and Affordable Care Act–PPACA–or Obamacare for some, a revisit of the subject at this time is opportune and warranted. This law carries the imposition on all Americans to purchase health insurance beginning in 2014. The commentary from pundits and the public in general makes it clear that a good number of people ignore why insurance companies exist and how they operate; particularly, people short on financial knowledge think insurance companies are out to get them.

As a licensed agent, I find disparaging comments on insurance published in the media alarming. Many postings ignorantly distort products conceived to provide peace of mind and guarantees of financial security if used properly. Insurance contracts and the benefits they provide reduce, if not outright eliminate, the possibility of losing large sums of money–catastrophic losses even the ultra-rich would be loath to sustain. The potential for losses is referred to as a liability in financial terms.

In exchange for removing the potential for a catastrophic financial loss insurance products allow us to sustain a smaller loss, something everyone with a liability should be willing to trade for. This smaller amount of money that we willingly give up in trade, in insurance terms is called a premium. Allow me to emphasize here that an insurance contract is not meant to eliminate all losses. Actually, the subject of insurance is the reduction of losses we would not be able to afford in exchange for surrendering to the insurance company an amount of money we can better afford, the premium.

It may be redundant–and I apologize–but let me restate this in different terms.  If I have the possibility of losing my property to a fire, that fire would be called a peril in insurance terms. In order to eliminate the risk of losing the full value of my property in a fire, logically, I’d rather lose anything less than the full value, right? Once again, in insurance terms, the anything less I’d lose is called the premium.

To eliminate the possibility of a catastrophic loss if my property caught fire–if the peril struck–I would look to pay a premium to an entity obligated under contract to step in and absorb my potential catastrophe if one occurred. The entity is the insurance company. To negotiate the terms of our agreement, the insurance company figuratively would sit down and draw up a contract. This contract explains the terms of coverage and in insurance terms we call this contract an insurance policy.

In essence, the insurance policy explains the terms under which the insurance company will absorb my risk provided I also assume specific responsibilities. However, primarily the specific terms of coverage inform me what is covered under the policy and what is excluded from coverage; it forbids me from creating a bigger loss if one takes place, indicates what I must do after a loss, and excludes perils brought on by my own actions or omissions, including fraud. The terms of coverage also specifically state that the peril is covered as it applies only to accidents, events that come up suddenly and unexpectedly causing losses; it excludes gradual occurrences–things that happens over time–and inherent vice–things that are going to occur no matter what–as well as maintenance that is neglected, and normal wear and tear, which are also not covered by most insurance contracts.

The company would come up with a specific and carefully worded list. It would be a list showing what I must do to pass the risk onto them. In simple terms, the list stipulates that the company would do x if I do y. The list would show clearly the type of risk the company assumes and also the part of the risk that I still retain. Recall I wrote before that insurance companies don’t assume all the risk of loss connected with a peril. They mostly share the risk with me, the insured.

The first few items on that list would deal with protection measures I must implement to prevent a covered peril from striking my property. The next group of items on the list would name things I am obligated to do to prevent more losses after a peril strikes. The next group of listings would indicate additional or supplemental sums of money the insurance company would pay me if I suffer a loss–such as the financial support to rent another place, how the company will reimburse me for actions taken after a peril strikes to prevent additional damages, how the company would pay for the extra expenses that come up when I am obligated to remain outside my home, and other similar accomodations to make my life easier while my property is out of commission after a covered loss.

Further, the company would stipulate at what level of loss it would step in to pay for the covered loss. During the premium determination process, the company gives me options to determine the level of premium I will pay. Maybe I decide to retain a flat amount of money or perhaps 1% of the loss or 2% of the loss or higher percentages partly because by assuming some portion of the potential and actual losses my premiums comes down. Beyond the reduction in premium, the insurance company wants to ensure that I remain vigilant, preventing losses and reducing further losses when a peril strikes; it’s logical, having skin in the game keeps me honest.

This retention of risk on my part is called a deductible. A deductible is the amount of money an insured person is willing to absorb before the insurance company steps in to pay the rest of the covered losses. Before issuing checks to cover losses, insurance companies subtract the deductible from their final payment. To reiterate, the scope of the coverage would place an exact dollar amount for the premium I must pay–my immediate and certain loss. In exchange for the company’s acceptance of the risk, I accept the deductible amount and how it would be applied.

Remember, the premium’s the amount of money I would immediately have to pay. It’s the money I lose without question. In exchange, I also immediately get the peace of mind that comes with the knowledge that the insurance company assumes the rest of my financial liability if a loss were to occur. From that moment on–the moment of inception of the policy, when the contract becomes valid, the date and time when the coverage begins, when coverage is in force–the insurance company would become liable for any actual losses to my insured property. But remember, the losses I would be relieved from sustaining are losses that have not yet occurred and losses that I must prevent from occurring for the policy to be valid.

The subject of insurance contracts is never a loss that already took place. Insurance coverage is never for a loss that is unquestionably going to occur. Insurance policies cover perils that potentially could occur in the future, but they do not cover losses that will definitely occur or that occurred in the past. There is an important element of potentiality of loss, not certainty of loss, in all insurance contracts–except in life insurance contracts where everyone eventually dies, but contracts of different scopes of coverage mitigate this certainty of loss.

This brings us back to the PPACA. Aside from the issues of constitutionality and personal freedom, the law places certain obligations on a private enterprise that in practice would cause it to fail. If you’ve understood my explanation of insurance thus far, you’ve learned that insurance contracts never cover events that are definitely going to take place or events that took place already. The subject of insurance is clearly only for events that potentially could take place in the future–without certainty.

The obligation placed on an insurance company to provide coverage to applicants with health conditions that already exist is a violation of the insurance principle. Individuals who choose to avoid paying premiums for health insurance are individuals who run a calculated risk–by ignorance or conviction. At some point, they may become uninsurable and no one gets prior warning of this tragic event. Consequently, in our system of laws and in our capitalist society, it’s a risk that no one is forced to bear and frankly, no one should assume with a sober mind.

It’s akin to my owning the same property we were discussing before and resolving to run the risk myself that the property will not burn down only to find out the morning after that a fire struck, engulfed my house, and caused me a serious financial loss. If such an accident occurred, I would not expect my neighbors or the community to pay me for my loss nor would any law obligate an insurance company to pay for this personal miscalculation. The extension of this is to question why anyone would expect reimbursement for illnesses or accidents striking them when they made the conscious decision to assume all onto themselves all future consequences of their conscious decision.

For the insurance company, the assumption of a risk that is certain–as it would be if a new client arrives with pre-existing conditions they will be forced to pay–is a mandate to become insolvent. Insurance companies work on the principle of greater numbers. It means that when a large group of insureds pays premiums and the company absorbs liabilities, the law of greater numbers demonstrates that only a reduced number among those insured will actually sustain losses. The overwhelming majority will pay a premium and not suffer a loss during the time the policy is in force.

The company will collect premiums and after paying the outstanding claims, place the rest of the premiums collected in what is called reserve–pools of money to offset potential claims that may be incurred but not reported during the policy period or that may arise the following year or the year after that from written business. The excess premiums always go to the reserve pool. The reserves help offset the adverse experience–meaning the losses that exceed the actuarial predictions.

Actually, actuaries study risks and the incidence of risk or the proportion of premiums received to claims incurred, anticipating a loss ratio. If more payments are made than premiums are received, the company eventually would file for bankruptcy. Logically, when more money goes out than comes in, the disproportionate unbalance causes any enterprise to fail.

The obligation placed on insurance companies by this PPACA legislation discounts the need to have sufficient money in reserves to pay for claims. Such imposition will cause one of two things to occur. Either the insurance company will surcharge everyone to offset the arrival of sick individuals seeking insurance after they learn of conditions that will cause  them to spend their own money for health care or the insurance companies will be forced to fail for not planning to absorb these contingencies.

In either case, We The People–you and me–pay for everyone else’s irresponsible behavior, be it in higher premiums now or by losing benefits later. It will actually seem better for all to wait until serious conditions plague us before paying any insurance premiums for health care. In the end, this law encourages irresponsibile behavior.

The best solution would be an actuarial study that determines the cost of health care for all individuals in the nation, from cradle to grave. Take this figure and divide it by the number of years everyone expects to live–according to actuarial tables and their subsequent revisions–and have each and everyone pay that fixed amount of money as premium for health care insurance year after year. All insurance companies would charge everyone the exact same premium throughout a lifetime. The choice of insurance companies would then depend on the individual and the companies with the best service would see their reserves swell while those providing the worst service would see their reserves diminish, all according to public perception. The idea that the money flows where the people find better service would prevail.

Everyone would be required to provide proof of insurance at every stage of life–pre-schooling, elementary grades, middle school, high school, college, and career employment. No proof of insurance, no acceptance; something similar to what some nations demand before tourists or new immigrants are allowed in the country. All would be easily monitored.

This would remove the burden of communities paying the debt public hospitals incur when they treat patients without resources and without insurance. A flat, single premium structure for all would figure in all personal budgets, a manageable amount for being constant, resulting in no surprises to anyone. It would make everyone responsible for him/herself. Yet, the conception of a single premium structure would not become a heartless measure; the system could be loaded to account for a percentage of individuals who face financial difficulty for a period of time and for many who will never be able to carry their own weight over mental or other painful, extraordinary conditions.

As in all my postings, I welcome everyone’s contribution. If you agree or not, share your thoughts. Healthy discussion is what our Congressional representatives currently lack. It’s the best way to air differences and formulate a consensus that moves us forward.

About Francisco

Born in Cuba; political exile; American by choice; polyglot; father of four, grandfather of two; occupationally semi-retired; reader; writer; lover of mankind and nature; searcher of truths; hungry for wisdom; open-minded; romantic realist; critical thinker, enemy of despotism, government abuse, and inequality; believer and faithful; social liberal, fiscal conservative; in a quest to unmask the hypocrisy and the corruption enslaving overwhelming numbers of God's creatures around the world.
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