How Do Insurance Companies Work?

Insurance companies sell coverage designed to help protect you against loss, theft, or damage to you or your property. The insurance companies make this possible by sharing risk among a large group of people.

Transfer of Risk

Think of insurance as a way for a group of people to pool their money to help each other pay for accidents. The premium you pay to your insurer goes into the pot and, when you or someone else files a claim, that money is used with the rest of the pot to help pay for damages. This lessens the risk of insuring you because the responsibility on helping for repairs falls on everyone with insurance, rather than just the company alone.

How do insurance companies determine premiums?

Insurance premiums are determined before actual costs of damages are known and can vary based on the type of insurance. Because providers don’t know the cost of damages, they’re forced to base premium prices on the severity of each claim in terms of overall cost and how frequent people file claims. Insurers also work to regulate fraud, people filing false claims, in order to keep premiums down.

What happens to my money?

The money you pay into your insurance policy is distributed in three ways.

  1. To help pay others’ expenses – Part of the monthly premium you pay will help pay for repairs incurred by other individuals, or to help pay for your own repairs, if needed.
  2. To cover the expenses of “underwriting” – Underwriting fees are the costs involved in running an insurance business. The money is used to pay for taxes, state fees, and performing background checks on potential customers, as well as other business-related expenses, like employee salaries.
  3. It’s invested — To recoup underwriting losses, insurance companies also use money collected from premiums for investments. Some state regulators use an insurance company’s investment returns to determine if the company is charging a fair price for their premiums. The investments help insurance companies keep your premium low.

How are insurance companies regulated?

Insurance companies are subject to the same government oversight as all businesses and most are overseen by their own state agencies. A chief insurance regulator is appointed to govern insurance companies in each state, which is why insurance policies and procedures can vary.

Insurance companies are regulated for fraud committed by the companies themselves and the individuals who pay premiums. Fraudulent activity can adversely affect the premium rate an insurance company might require by raising it to cover instances of fraud. For example, you’ll often see characters on TV faking neck injuries in a car accident and then reporting it to their auto insurance company. Insurance companies and regulators monitor for situations like this to help keep insurance premiums down.

Looking for a new insurance company?  We’ve reviewed top auto insurance companies to help you compare those in your area. Or, call a licensed agent who can help you find the coverage you need and the customer service that will make you feel comfortable.

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