Insurance concepts

What is insurance?

Insurance exists to protect your possessions against unforeseen loss or damage. Whether you’re insuring your house, car or CD collection, the basic idea is that you pay an annual premium and your insurance company will pay to replace or repair whatever items are insured if lost or damaged. People band together, through a company or mutual association to pay premiums that create a pool of money out of which insurers can pay for the losses suffered by the people who have contributed premiums to the pool. This protects people from suffering a major loss if their assets are damaged or destroyed.

Utmost Good Faith

The concept of insurance is based on utmost good faith, where the insurer spells out what losses they will cover and what exclusions they won’t cover and the insured party discloses full details about the assets being covered and the risks to these assets. An insurance policy is a legally binding contract that demands complete honesty from both parties.

The insurer is required to observe and honour the contract conditions. If the insurer doesn’t treat you fairly, you can take your case to court or to the insurers disputes resolution provider.

The customer is required to disclose to the insurer all material facts that could affect the risk. For example, a person who travels overseas and leaves their house empty needs to tell their insurer, as an empty house is more risky to insure than an occupied one. Failure to tell your insurance company everything they need to know to assess your risk accurately may jeopardise your insurance cover. If in doubt about what you need to declare, ask your insurance company. A rule of thumb is that you should declare any information that would make the insurer alter the terms and conditions of your contract.

No Better or No Worse

The underlying principle of any insurance contract is to enable you to be in the same position you were in before a loss. This is because if you were in a better position after an insurance claim there would be a financial incentive to make claims.

Insurance Supports The Economy

Without insurance, the economy would almost grind to a halt. Insurance provides a safety net for people to take the risk of investing in assets. Who would sink their life savings into buying a house if there wasn’t cover for fire, flood and earthquake risks that could destroy the property and wipe out the investment? Most people would look to rent and let the landlord take that risk. But why would a landlord purchase property and take the risk? Insurance gives people confidence to invest in assets. This applies not only to houses, but also to vehicles, machinery, factories, office buildings, inventory and all other types of assets used to create wealth in the economy.

Imagine if the people in Christchurch had no earthquake cover, there would be tens of thousands of families who could not afford to repair or replace their homes following the recent earthquakes. Whole communities would be destroyed. Many businesses would also have been destroyed and people left jobless. Insurance sustains communities by rebuilding and repairing the damage from disaster events.

The Cost of Insurance

The cost of insurance (ie. premiums) is determined by the claims experience of the company. This is why young drivers, who have a high claims rate, may pay higher car insurance premiums than drivers over 25 years of age. This is also why female drivers, who are considered a lower risk, may get cheaper car insurance than males.

If claim numbers and the cost of claims increases, then so may insurance premiums.