Insurance/Insurance Coverage/Reinsurance Law Insurance, at its most basic level, is a contract binding one party, the insurer, to indemnify a second party, the insured, against a specified loss. In taking out an insurance contract, a person or business is laying off risk that they don't want to assume on their own.
The types of losses for which insurance is sought are as varied as the risks people and businesses want to protect against. They range from potential hurricane damage to possible malpractice lawsuits to the chance that a musical act won't show up for a concert.
If you want to protect yourself against a risk, you can bet that somewhere someone is willing to sell you insurance at some price. Among the more common types of insurance are health, homeowners, business, life, disability, mortgage, auto, professional liability, long-term care, and directors and officers coverage.
Insurance is a heavily regulated field, mostly by state law. The following is a discussion of how insurance works and a description of common types of insurance.
Contract. Under a typical insurance contract, the insured pays an annual premium to the insurance company. The insurer in return assumes the risk insured against and promises to pay benefits on all valid claims filed that year. The insured is also entitled to what is referred to in the insurance industry as a retention. A retention is the part of the premium that the insurer keeps for itself for overhead, services rendered, and profit. The insurer may also keep part of the premium in a reserve account to pay for claims incurred during the year that may not be paid until later.
Self-insurance. Some larger companies choose to self-insure rather than to pay premiums to an insurance company. A self-insured plan is one that pays benefits directly from its own assets.
Companies choose to self-insure where it makes financial sense. The idea behind the insurance business is that you can make a profit if you can collect more in premiums than you pay out in claims. The key, of course, is to get a large enough pool of insureds to spread the risks out and to reduce the chances that any one insured's claims experience will sink you.
Employers with a large pool of employees can play the same game. According to one source, the average self-insured plan paid out in benefits 93 cents of each dollar contributed to the plan, which means 7 cents of every dollar went into the employers' pockets.
Companies that self-insure handle it different ways. Some self-insureds administer claims with their own staff. Other self-insureds find it cheaper to pay insurance companies to administer claims rather than to hire their own employees to do it. Still others self-insure only part of the risk and purchase insurance, for example, to cover catastrophic risks.
Occurrence vs. claims-made. Liability insurance policies are one of two types: occurrence or claims-made. For an occurrence policy, coverage is triggered by the date of the event that gave rise to liability. For a claims-made policy, coverage is triggered by the date that a claim is made against the insured.
Thus, suppose a shopkeeper carried liability insurance to cover injuries sustained by customers who might slip and fall in the store. Suppose that a customer slipped and fell in the store on December 15, 2002. Suppose further that the customer's sore neck didn't start bothering him until a week later and that he notified the shopkeeper on January 5, 2003, that he hurt himself in the store. If the policy is an occurrence policy, coverage is triggered on December 15, 2002. If the policy is a claims-made policy, coverage is triggered when the shopkeeper tells his insurance company that the customer is making a claim against the store for his injuries.
The distinction is important if, for example, the shopkeeper switched insurance carriers at the beginning of the new year. In fact, if the shopkeeper switched from a claims-made to an occurrence policy, he would not be covered at all for the slip and fall in this example because coverage was not triggered under either policy.
Risk pools. States legislatures have created special health insurance risk pools to provide a safety net for the medically uninsurable population. The medically uninsurable are those who have been denied health insurance coverage because of a pre-existing health condition or who cannot afford private coverage.
Illinois provides a risk pool called the Comprehensive Health Insurance Plan (CHIP). Eligible persons are those who have applied and been denied coverage because of a pre-existing condition, those who have a policy similar to CHIP's but their policy costs more, or they have one or more of 31 conditions that are presumed to be automatically rejected by an insurance company. Those eligible for federal help also automatically qualify for Illinois assistance.
All state risk pools lose money and need to be subsidized. While the individuals in risk pools pay somewhat higher premiums, roughly 50 percent of overall operating costs need to be subsidized. In Illinois, where shortfalls exist, CHIP is funded by payments from the general revenue fund.
Premiums in CHIP are 125%-150% of the average rates charged other individuals for similar coverage. In 2000, annual premiums averaged about $3,800. Generally, there are no exclusions. CHIP offers plan alternatives with different deductibles and coverage options. Its board contracts with an insurance company to administer the program.
Risk pools are not created to serve those who cannot afford health insurance. Risk pools are designed to serve people who would not otherwise have the right to purchase health insurance protection. The poor can access coverage through Medicaid or similar state programs.
Reinsurance. Where the coverage risks are too high for insurance companies, they insure their insurance. The practice is called reinsurance, which involves the insurance company paying a premium to the reinsurer for part or all of the liability assumed by the insurance company for policies of insurance that it has issued. The reinsured may be referred to as the Original or Primary Insurer, or Direct Writing Company, or the Ceding Company.