Insurance Coverage Basic Terms

Insurance Coverage Basic Terms

In order to understand the business of insurance, it is important to master the following basic insurance coverage terms: Indemnity; Limit of Liability; Premium; Deductible; Coinsurance; and Claim.

Indemnity

Indemnity Insurance is defined as insurance that compensates the beneficiaries of the policies for their actual economic losses, up to the limiting amount of the insurance policy. The term indemnity means "to make whole." Insurance policies agree to provide payment of benefits to restore the insured's economic loss. For health insurance, the policy agrees to indemnify the insured for the financial loss caused by accident, illness or disability. If the medical bill for repairing a broken arm is $1,500, to which the health policy agrees to cover the full amount, the insurer will pay $1,500; however, the insurer will not pay $2,000 which would result in a $500 profit. Insurers require proof of loss to avoid overpaying an insured for a loss.

Life insurance is intended to ward off financial hardship that may result due to a person's premature death. An insured's earning potential or dependents' needs is used to determine the amount of money required to pay final bills and keep any dependents financially stable in the event of an untimely death.

Limit of Liability

A limit of liability is the total amount the insurer will pay for an insured risk. This term is more often used in the property and casualty lines, but the concept is transferrable to health insurance as the lifetime maximum benefit. For example, the lifetime maximum benefit on a health insurance policy is $1 million, which means that the insurer will pay a maximum of $1 million for all claims on the insured. Policies may also contain sublimits termed inside limits which restrict the dollar amount of certain coverages within a policy, such as a room and board limit of $200 per day.

Premium

A premium is the amount to be charged for a certain amount of insurance coverage. The policyowner pays premiums to the insurer. The premium amount is established by the insurer and is based on the degree of the risk insured.

Deductible

A deductible is the amount the insured must pay before the insurer will pay for the claim. For example, if an insured has a $500 deductible, but incurs $3,000 worth of loss, the insured will be required to pay $500 out-of-pocket before the insurer will cover the remaining $2,500. Deductibles apply to health insurance and are used to reduce premium costs and prevent abuse of a policy by unnecessary claims. 

Coinsurance

Coinsurance is a cost-sharing mechanism between the insurer and the insured, and applies only to medical insurance. For a certain range of coverage, the insurer agrees to pay a large percentage of the expenses, and the insured is responsible for paying the remainder. Each policy has its unique coinsurance percentage; however, typical coinsurance is 80/20, in which case the insurer is responsible for paying 80% and the insured is responsible for paying 20%.

Claim

An insurance claim is the insured's notification to the insurer that a payment is requested for a covered loss. The term claim applies to all lines of insurance.

Adverse Selection

Adverse Selection is the tendency for poorer than average risks to seek out insurance. Insurers must seek to minimize adverse selection. For example, non-smokers are more likely to live longer than smokers. Therefore, smokers may be more likely to buy insurance, which would create a selection of policyholders that is adverse to insurers due to the higher mortality rate of smokers. If an insurer cannot compensate the poor risks associated with smokers with better than average risks, then its loss experience will increase and its ability to pay claims may be compromised.

Reinsurance

 

All insurable risks must avoid catastrophic losses. However, if an insurer suddenly experiences more losses than normal, the total dollar value of the losses may be detrimental to the insurer's financial stability. One way insurers deal with catastrophic loss is through reinsurance.

Reinsurance is defined as spreading risk from one insurer to one or more other insurers. Reinsurance is a way insurers cooperate to prevent bankruptcy. The insurer that accepts the additional risk is termed the reinsurer. The insurer that gives the risk to the reinsurer is termed the ceding company or primary insurer. When a claim is submitted on a risk that was reinsured, the ceding company pays the portion of the loss equivalent to the risk retained. The ceding company then submits a claim for any portion of the loss that was reinsured to the reinsurer.

One way insurers deal with catastrophic loss is through reinsurance, which is defined as spreading risk from one insurer to one or more other insurers.

Common Types of Insurance

There are many different types of insurance available to prospective insureds. These include life and health insurance, annuities, property and casualty insurance, credit insurance, and variable insurance. 

Life

Life insurance is designed to protect against the risk of premature death. The financial risks associated with premature death include final expenses, burial, funeral, family and dependents' continued income, and business income.

Health

Health insurance is designed to protect against the severity of financial loss due to illness, disease, short or long-term disability, wages lost while ill or disabled, and medical expenses.

Annuities

Annuities protect against the risk of living longer than expected. Annuities provide a guaranteed life income to protect against the risk of depleting retirement funds.

Property

Property insurance protects against the risk of damage and destruction to all types of property.

Casualty

Casualty insurance protects against the risk of legal liability for injury, death, disability, damage and destruction to property.

Credit

Credit insurance protects against the risk that a person in debt, termed debtor, cannot repay the debt to the creditor because of accident, sickness, disability or death. Credit life and credit health insurance cover these risks.

Variable

Variable insurance is comprised of variable life and variable annuities. Variable insurance products invest premium dollars in securities, which carry more risk due to price fluctuations. A requirement of selling variable products is a securities license and a life insurance producer license.