Nobody likes to be called a dummy by a dummy.

How does insurance work?

I pay something like $5 a month for $350,000 of life insurance, and I recently paid $150 for $1,000,000 of liability coverage for 3 days at a convention. Now, I understand insurance companies try to deny as many claims as possible, and not all claims will be for the full amount, but take for instance the liability insurance. If one person filed a $1,000,000 claim, it would negate the profit of 6,000 other people's insurance purchases. And I am guaranteed to die, maybe tommorow, maybe 40 years from now, but either way $5 a month isn't likely equal $350,000 for them (i'm sure my employer puts a couple bucks in too).  Am I missing something as to how insurance works?  I tried searching on Google but searching anything for insurance brings up tons of spam.
Permalink Phil 
January 23rd, 2006
AFAIK, there are two ways they make money:

1) They take your premiums and invest them.
2) You let your policy lapse and they keep it all.
Permalink bpd 
January 23rd, 2006
It only covers sudden, unexpected death.
Permalink Flasher T 
January 23rd, 2006
Check to see if your life insurance is still valid 40 years from now. Something you're only paying $5 a month for will either stop applying at age 45 or your premiums will go up.

Philo
Permalink Philo 
January 23rd, 2006
Term life insurance is for a fixed term - 10 or 20 years. If you get it when you're 20, sure the rate for the 10 years is low, but when you renew for the next 10 years it'll be much higher, and higher still the 10 years after that. If an insurance company sold you term life insurance when you were 80, it'd be close to the same cost per year than the benefit.

Permanent (presuming you keep paying the premium) life insurance - with a fixed rate forever - is like a savings account of sorts, with a starting small benefit (given that you're unlikely to die), and then a rising benefit the more you pay.

Insurance companies make lots and lots of money, and they are big users of statistics.
Permalink Dennis Forbes 
January 23rd, 2006
You've understood it right there.

The insurance company makes an estimate of how likely some event is to occur and sells insurance at an appropriate price. So, $150 for 3 days for 1million, they assume 1 / 10,000 will claim and the pocket a nice profit. The exact price is going to depend on the companies estimates and they competitor prices.

Finally, the insurance company is collecting from you before they make the payoff. So they have this enormous float. Money collected, some of which will need to be paid off, and they invest that.
Permalink  
January 23rd, 2006
Oh and insurance companies don't make their money by denying benefits, despite the common belief that they do. While they don't allow people to "profit" from an inbalance of information (e.g. you're hiding a big tumor and go sign up for $1,000,000 of coverage), if you have a legitimate claim there'll seldom be a problem claiming.

They work on simple stats. If a 20 year old has an average 1:100,000 probability of dying in a year, then they can make a profit charging 1/80,000 of the benefit per year in premiums, for instance (those numbers completely made up). It all washes out in the end.

(Insurance companies actually seldom take the risk themselves, by the way. The insurance companies that you know are really just marketing vehicles, and their coverage is actually reinsured by one of a few monstrous worldwide reinsurers).
Permalink Dennis Forbes 
January 23rd, 2006
As far as your $5 a month- The policy is probably only good for 10-20 years (and may go up at certain years or not depending on the policy). So if you take your current age and add 20 you are probably looking at ~50-55 years. You get the $5 rate because of your lifestyle (non-smoker, health, etc), if you were a smoker or a skydiver your rate would be higher. They are betting on you living past the term of your insurance (given the percentages most will live past the term and the insurance companies will make money).
Mike
Permalink MikeG 
January 23rd, 2006
I suspected as much, but I didn't take a physical or even answer a questionaire, so I could have a terminal illness they are not aware of, and my odds of dying in a car accident are not THAT long, it just seems risky on their end. But what you all are saying makes sense, I guess they just diversify over a large amount of people and play the odds.
Permalink Phil 
January 23rd, 2006
It's an inverse lottery where you only win if you lose. And like the lottery, the house always wins.
Permalink jz 
January 23rd, 2006
How lotteries work mystifies me too ;)
Permalink Phil 
January 23rd, 2006
"I suspected as much, but I didn't take a physical or even answer a questionaire, so I could have a terminal illness they are not aware of, and my odds of dying in a car accident are not THAT long, it just seems risky on their end."

At $350,000 there are usually some rudimentary checks (was that $350,000 in accident coverage, or general death? Often accidental coverage is a multiples of the "natural" death rate because accidental deaths are actually much rarer). Below $250,000 there are usually no checks, $250,000 - $499,999 are basic checks, and then $500,000 up is the whoel gamut. Generally of course.

However the killer, ha ha ha, of insurance is usually a clause that they don't cover death due or largely caused by pre-existing conditions (they're not trying to scam anyone, but if this were allowed then everyone would wait until their doctor gave them bad news to get insurance. This of course would mean that people getting preventative insurance would face enormous costs because the odds would be off kilter), so if you've had a giant tumor that your doctor knows about and has documented, and you go sign up to some no-check insurance, it would probably deny payout if the tumor then killed you.
Permalink Dennis Forbes 
January 23rd, 2006
It's easier to think of it as a bet (which is how it started). You bet them a small amount each month that you're going to die and if you do then you win.

*They* get to set the odds - and as we all know the bookies win overall. They also have the benefit of a whole profession (Actuaries) built around calculating the odds in their favour.
Permalink a cynic writes... 
January 23rd, 2006
There's also the bit about reinsurers. That $1,000,000 comes from multiple sources should your demise materialize.

The risk is spread out and pooled. They buy and sell the risk behind the scenes so that the percentages work out much better. The profits from investing the pooled monies more than cover the difference in premiums and benefits. Lapses in term insurance are a windfall.

They don't make their money by denying benefits. Make no mistake though, it's a business. If they can find a reason not to pay you won't get anything. Say for instance you've pounded a few brews. Sitting in your living room, the ceiling collapses and you perish. There is a clause in your policy stating that they owe you nothing if you die with alcohol in your system. The fact that the alcohol had nothing to do with your death is beside the point. This is something I know has happened....
Permalink I am Jack's major mundane Monday 
January 23rd, 2006
I should slightly factualize some fictional numbers above.

"If a 20 year old has an average 1:100,000 probability of dying in a year, then they can make a profit charging 1/80,000 of the benefit per year in premiums, for instance (those numbers completely made up)."

In reality it would be 1/80,000 + admin fees. For $350,000 of coverage you're probably paying about the same in admin fees than you are in risk fees.
Permalink Dennis Forbes 
January 23rd, 2006
Hmm, maybe I should have gotten into actuarial science, it sounds very interesting... in a depressing kind of way.
Permalink Phil 
January 23rd, 2006
Oh, and the greatest thing about insurance - At younger ages it's usually only the careful and nerdly that apply: Even if 10 young adults per year extinguish themselves in street races a year in your town of 70,000, they're unlikely to have been the type to sign up for term life insurance, coupled with the fact that insurance doesn't pay if death was in the commission of a crime.
Permalink Dennis Forbes 
January 23rd, 2006
That's way overinsuring a 20 something. Hell, it's way overinsuring most anyone. They won't just let anyone buy that much risk. The higher the benefit, the more chance there is antiselection at play. (People who are most likely to collect the benefit being most likely to purchase it.)

Most people probably only have something like $10k-$20k or if they are a bit better off, management types etc... something like a 1x-2x salary benefit.
Permalink I am Jack's major mundane Monday 
January 23rd, 2006
Phil,
Sounds like you have a 10 year term policy. The insurance company is offering you a low rate because they think you won't die in 10 years. Im guessing you are young and in decent health.

A 30 year term might cost 10 times as much. Whole life 20 times.

It's all a matter of risk the insurance company takes on.
Permalink Yo! 
January 23rd, 2006

This topic was orginally posted to the off-topic forum of the
Joel on Software discussion board.

Other topics: January, 2006 Other topics: January, 2006 Recent topics Recent topics