Glossary: Insurance Terms and Concepts
Insurance, it has been said, is legalized gambling. It is an area of commerce and law that has its own vocabulary, and this section will introduce and explain some of the terms. It will not address business insurance and worker's compensation, which are discussed under other topics.
- There are basically three different kinds of entities that sell insurance to the general public.
- Stock companies are owned by shareholders and run as for-profit businesses.
- Mutual companies are technically owned by their policyholders, although they have a structure of corporate governance similar to a stock company. Mutual companies occasionally pay dividends in years they are profitable.
- Subscription companies are not common in the United States. The most famous of these is Lloyd's of London. They are groups of investors (or names) who agree to insure against a particular risk. Subscription companies have suffered financial disasters in the last few years.
- The contract between a customer and the insurance company (or insurer) is called a policy. There are two basic kinds of policy.
- Indemnity policies pay you if a certain event occurs. Health insurance, life insurance, and fire insurance are all examples of indemnity policies.
- Liability policies pay other people if you become obligated to pay them. Automobile liability, premises liability, your title insurance policy, and even your AAA membership are examples of liability policies.
Note: Some policies are combinations. Homeowner's and renter's policies, for example, typically contain indemnity portions for theft and liability portions if someone hurts himself or herself in your home.
- When you purchase a policy, you pay a premium. An insurance premium is the insurer's best guess of how much it is profitable to charge you for a risk that they will have to pay a claim, or a request for payment. Risks that are certain, like death, have high premiums. Risks that are not likely, like title insurance, have relatively low premiums. (Title insurance premiums are now as low as they might be; title companies typically pay out less than four percent of their premiums on claims).
- The list of risks that an insurer is agreeing to pay you for is called coverage, and you are usually covered only for what is specifically agreed to in the policy. Most policies include exclusions, or risks for which they will not pay. Most homeowner's and renter's policies, for example, exclude damage from floods.
- Most policies have conditions of coverage. Under most policies, for example, you have an obligation to report claims immediately. You also have an obligation to cooperate with the insurer in investigating or defending your claims.
- You may also have to help the insurer assert its subrogation rights. Subrogation means that if an insurer pays you if someone destroys your house, it obtains any legal rights you may have had against the person who did it. That means that it can sue the person who harmed you (in some jurisdictions, in your name), and you are obligated under the policy to help the insurer.
There are many kinds of insurance policies, and your agent can explain them to you. Policies can range from travel insurance or trip cancellation for a single flight to complex instruments designed for estate planning purposes.